Is it time to get back into the carry trade?

The differential in US 10-Year yields and Japanese 10-Year yields is widening. The yield in the U.S has been moving higher whereas the yield in Japan has been stuck in a narrow band and moving slightly lower.

Currently, yields on the 10-year for United States and Japan are 2.493% and 0.093% respectively. The trend in The yield of the United States has been upward.


You can borrow in Japan at near zero rates for 10 years, then depositing those funds into any bank in the United States for a quick carry-over. Just sitting there doing nothing you can earn a quick nice profit.

The gateway for this selling JPY and buying USD – Long USDJPY in the inter-bank. But, there is one key ingredient to all of this: steady interest rates with an increasing differential. When stocks sell off the carry trade gets rocked a bit and unwinds.

This trade was a massive trade from about 2002 – 2007 when it all unwound in a crash because of the turbulence of the financial crisis. Now and quietly, the beginnings of this trade have been starting to move again. The trade has been inconsistent of late. But, there appears to be a normalization of FX prices.

Every evening, at the New York fix, FX brokerages “clear out” all positions that are carried overnight. Interest is adjusted at that time. If you are long the currency with the higher interest rate, you are paid that interest. If you are short the interest rate, you pay that interest rate; in that regards, FX is a zero sum game. Your broker will kindly take a cut in the middle, of course. That is when you earn your money, The interest payment, at the fix.

My expectation is that the carry trade will become bigger and bigger once the rest of the world starts to move interest rates higher, such as Great Britain, Europe, Australia and New Zealand. The later two are some of the bigger players in the carry trade; AU and NZ tend to have some of the highest interest rates in the world.

For now, until the rest of the world gets moving, I am front-running this idea with smaller trades. I have been selling USDJPY puts, naked, with strike prices 10 days out, roughly with a 30 delta. Worst case scenario, should your option go in the money you will need to wait out a period until we get another move higher in the equity markets.

What is most intersting about this trade is that it has a feedback loop. As more money flows into this trade that money that gets parked into the terms country (In USDJPY, USD is the terms, JPY is the base), that money will be put to “work”. Banks will loan it out. This encourages more economic activity. That will push the hand of the terms central bank, pushing up rates, drawing in more money chasing the etter interst rates; the cycle perpetuates itself.

The timeline for this trade is actually right now. I see interest rates pushing towards 3.00% in the United States by year’s end. All the while, Japanese interest rates are expected to remain the same. Simultaneously, interest rates in the other major economies, Great Britain, Europe, Australia and New Zealand, should start the long process of normalizing.

Be certain to keep an eye out for volatility. This trade works only if there is consistency in the interest rate differential. Should there be any sharp moves in equity markets, and coincidental moves in interest rates, the trade unwinds. The subsequent FX moves can get sharp. Your exposure then, is the currency movement.  But, given the current economic landscape, I see the risk skewed more towards success.

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