Did Someone Say "Carry Trade"?
By Ed Ponsi, President, FXEducator.com
Greetings from New York! After another great trip to the U.K., it's good to be home in the U.S.
I received quite a few comments about last week's chart showing a massive double-bottom formation on the Australian Dollar/U.S. Dollar pair (AUD/USD). As it turns out, this formation is popping up in a number of pairs involving the Aussie and also the New Zealand Dollar (NZD). For instance, here is the same bullish pattern on the NZD/USD currency pair (see figure 1).
Figure 1: NZD/USD attempts to break out from a double-bottom formation. Source: Trade Station
Compare this chart to AUD/USD, and you'll see that the New Zealand Dollar is lagging behind its Aussie neighbor, falling short of the breakout point near .6000. Why is the "Kiwi" (so-called because of the picture of a kiwi bird on the New Zealand Dollar coin) having such a tough time in comparison to the AUD? Traders believe that New Zealand's central bank, the Reserve Bank of New Zealand, isn't finished cutting rates, and expect to see a 2.5% rate after the RBNZ's next meeting on April 30th. RBNZ Governor Alan Bollard recently said that the central bank is "projecting interest rates to remain at relatively low levels for an extended period," which also helps explain weakness in the Kiwi.
We haven't discussed carry trades in quite a while, but this strategy may be coming back into vogue. Many assume that carry trades must include a short position in the Japanese Yen, but this is not the case; any currency that possesses low interest rates becomes a viable shorting candidate for this trading strategy. Current interest rates reveal a number of excellent potential candidates among the majors:
Japanese Yen 0.10%; U.S. Dollar, Swiss Franc 0.25%; Canadian Dollar and Great Britain Pound 0.5%
And which of the major currencies have the highest rates, making them appropriate for the long side of the trade? Australian Dollar and New Zealand Dollar, both currently at 3%, are the highest yielding of the majors, but as we will see, there are other currencies that currently feature higher yields.
Regarding AUD/USD and NZD/USD, suffice it to say that U.S. rates have remained below Australian and New Zealand's rates for the past decade, and there is no scenario in which I can envision the U.S. Fed Funds rate exceeding the benchmark rates of those two countries. What about AUD/JPY and NZD/JPY? Those currency pairs are looking pretty bullish, sporting – you guessed it – double-bottom formations. Here is a look at AUD/JPY (see figure 2).
Figure 2: AUD/JPY breaks out of a bullish double-bottom formation. Source: Trade Station
A quick look at the daily chart of NZD/JPY reveals a very similar situation, as the pair also has broken out of a double-bottom formation. This trade also produces positive carry, as New Zealand's benchmark interest rate is higher than Japan's (see figure 3).
Figure 3: NZD/JPY daily chart reveals another successful double-bottom breakout. Source: Trade Station
One last piece of evidence that the carry trade has returned; an equally weighted basket of currencies consisting of Turkish Lira, Brazilian Real, Hungarian Forint, Indonesian Rupiah, South African Rand and Australian and New Zealand dollars – purchased with Japanese Yen, U.S. Dollars and Euros - earned an annualized 196% from March 2 to April 10. In other words, those taking the trade were long high-yielders such as the Brazilian Real and the South African Rand, and at the same time, they were short low-yielders like the Japanese Yen and U.S. Dollar, with the added diversification of using baskets instead of individual currencies. That same trade produced a 41% annualized loss from September, when Lehman collapsed, through February. Benchmark rates in those seven "long" economies range from a low of 3% in New Zealand and Australia to Brazil's astronomical 11.25%. Here is a three-year chart of these two baskets – it appears that a bottom may be forming (see figure 4).
Figure 4: A basket chart of high-yield vs. low yield currencies shows a bounce. Source: Bloomberg.com
Paradise? Not Really…
Fiji's central bank recently slashed the country's currency value to boost exports and tourism. The Reserve Bank of Fiji appointed Sada Reddy as the bank's new governor, one day after the former central bank governor was removed. Reddy immediately announced that the Fiji dollar was to be devalued by 20%, a decision that will probably send inflation soaring.
Fiji's international credit rating was downgraded last month from stable to negative, but the currency devaluation might drive tourists to the island paradise – assuming that their finances haven't been damaged by the current worldwide economic downturn. Thanks to the devaluation, the cost of a vacation to Fiji effectively drops by 20%. However, Fiji is currently run by a military regime, which is heavily censoring news and threatening to jail and deport journalists who report on political events there. Maybe it isn't such a great place to visit after all.
Comment of the Week
Q) I just read your email and I came across your article regarding the protests and the G20 summit. Well I though it was great; I am not sure whether you or a ghost writer wrote it, but it made sense to me. I think the problem with any country that has experienced wealth for too long takes what the previous generation did for granted. I am South African and it never ceases to amaze me how socialistic Britain has become, the Polish could teach them a thing or two about communism.
Ed Ponsi) Thank you for your email. No ghost writer here, just me. It seems that people everywhere forget the lessons of history, and those who forget history are doomed to repeat it. Poland has recent memories of Communist oppression, so they don't need to be reminded of the evils of that failed ideology. Meanwhile, in the U.S. and other fortunate countries, we seem to be wandering down the path of Communism, perhaps because we have no experiences that compare to those of Poland or other afflicted countries. There is an easy way and a hard way to learn anything, and I'm still hoping we in the U.S. can learn the easy way – through the experiences of others – as opposed to the hard way, where we repeat those experiences out of ignorance or foolishness.
