The Japanese yen and Swiss franc continue to lead the way as the preferred choice of funding currency when employing a carry trade strategy, but an increasing number of investors are now shorting the US dollar to finance the acquisition of higher-yielding currencies. With little prospect of the Federal Reserve boosting interest rates in the short-term, and with a daily stream of bad news hitting the airwaves including yesterdayÃ¢â‚¬â„¢s acknowledgment of a 27 percent drop in existing home sales, followed by todayÃ¢â‚¬â„¢s 12 percent drop in new home sales, the greenback is struggling to find the bottom. Holders of US-denominated securities are surely concerned, but forex traders Ã¢â‚¬â€œ especially those looking to establish large-sized carry trades Ã¢â‚¬â€œ are thinking opportunity.
As a carry trade funding currency, the US dollar is currently checking all the boxes on the carry trade wish list:
1. Low interest rates? Check.
The dollar is at an all-time low with respect to yields and this makes USD one of the least expensive currencies to short as the interest owed on open short positions is lower than most other currencies.
2. High liquidity? Check.
The dollar remains the most widely traded of all currencies. Indeed the EUR/USD pairing alone continues to dominate all other currency pairs with roughly seventy percent of all forex trades based on the EUR/USD.
3. Low Volatility? Check.
ItÃ¢â‚¬â„¢s all well and good to identify a currency with low interest rates with which to buy other currencies, but if exchange rate volatility is so pronounced that at any time it threatens to put your overall position under water, your carry trade could quickly become a liability. Front and center in the FedÃ¢â‚¬â„¢s mind right now, is high unemployment and a slowing economy; thus, it remains unlikely that the central bank will take any action that could cause the dollar to appreciate.
When the Federal Reserve adopted its record low interest rate policy to combat the recession, Bernanke said the rate would remain in place for as long as necessary. Now, a full year and a half later, Bernanke remains committed to this policy with a timeline extending until at least the end of the year. The Chairman has gone on record saying he does not expect an improvement in the employment outlook prior to then.
As recently as three weeks ago, when addressing the annual meeting of Southern lawmakers in Charleston, S.C., Bernanke stated that even though the worst of the past recession is over, Americans still Ã¢â‚¬Å“have a considerable way to go to achieve a full recovery in our economy, and many Americans are still grappling with unemployment, foreclosure and lost savingsÃ¢â‚¬Â.
On August 19th, Bernanke went so far as to suggest that the Fed could find it necessary to return to a more active role to support the economy in the form of further quantitative easing to ensure money continues to flow through the financial system.
Ã¢â‚¬Å“We have to be careful about tightening too quickly,Ã¢â‚¬Â warned Bernanke. Ã¢â‚¬Å“We can maintain some continued support for the economy in the very near term.Ã¢â‚¬Â
The position of the Federal Reserve could not be clearer. For the foreseeable future, there are no plans to raise interest rates, and with yields at an all-time low, there is little chance of significant dollar appreciation. Investors will continue to chase higher returns in other currencies, and the sell-off of US dollars to fund these purchases, should continue well into the second half of the year.
This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.