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A couple months ago, in a widely read FT op-ed, Nouriel Roubini warned that the “mother of all carry trades,” one funded in U.S. dollar denominated debt, could pump up asset bubbles around the world. This Monday RGE released two new reports, both available exclusively to clients, forecasting where and how this trend might unfold. Our macro analysis, “Carry Trade Hotspots: A Currency-by-Currency Forecast for 2010,” estimates the interest rate paths and currency trends for several potential carry trade funding and recipient currencies. RGE’s strategy team then looks at implications of these potential rate moves for investors in a parallel analysis, “Come to Mother: An RGE Strategy for the 2010 Carry Trade.”
When uncovered interest rate parities break, investors can borrow money in a low interest rate currency (like the U.S. dollar), then loan it out again in a currency with higher interest rates. The “carry,” or the return from this investment, equals the difference in yield between the funding currency instrument and the destination currency instrument. "Positive carry" occurs when the interest rate received surpasses the interest rate paid to fund the investment. "Negative carry" is the opposite. Because the carry from a single trade is often small, carry trades are usually conducted in large volumes through leverage or are held for relatively long periods of time (months or years) so that the small amount of rollover interest collected on a daily basis can add up to a worthwhile amount of passive income.
As both new RGE reports highlight, we expect the carry trade to heat up as 2010 progresses, as policymakers hold rates at zero or low levels in many advanced economies, while inflation leads to further rate hikes in emerging market and commodity-driven economies. We encourage clients to examine these papers for more details on hot carry trade destinations for 2010
(c) RGE Monitor
www.roubini.com
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