The Favorite Carry-Trade for FX Traders
January 14th, 2009 Posted in In-Depth Analysis
In forex trading, the New Zealand Dollar (NZD) Japanese Yen (JPY) pair is considered an exotic currency pair that is especially popular among carry trade investors. This potentially lucrative form of trading involves selling a currency with a low interest rate and buying a currency with a higher interest rate and earning from the interest rate differentials.
The NZD/JPY pair is traders favorite carry trade, but at times it pays to be cautious despite the good returns available. It considers being a very stable pair, since it’s not volatile at all (Typically less movement than 150 pips daily) and traders are able to open huge, long positions with less risk ratio.
For many years now, carry trades involving selling the Japanese Yen have been very popular due to Japan having a low interest rate. In fact, Japan had 0% interest rates between 2000-2006 to try and help their poorly performing economy; this, of course, was highly attractive for carry traders. Today Japan’s rate is at 0.10%, still very attractive when we look at the interest rates of many other countries; such as the European Central Bank (ECB) and the Federal Reserve in the US.
Currently, the New Zealand interest rate really stands out, it’s the highest among all other countries at 5.0%. As with all FX trading, there is considerable risk in the carry trade. When investors buy New Zealand Dollars and sell Yen they are taking the risk on the currency pair NZD/JPY. Historically, this pair had been on a strong uptrend, that is, until July 2007, so their carry trades would have earned the income from the interest rate differentials, as well as the appreciation of value of New Zealand Dollars against the Yen.
Trading the carry trade using leverage can be highly profitable; but it is very important to fully understand the potential risks and rewards before acting live carry trades. With carry trades, there is always the risk of a major carry unwind. This is where a huge number of carry trades are closed and the money goes back to Japan. Historically, there have been a number of significant carry trade unwinds.
In conclusion, the carry trade is a potentially lucrative way of trading/investing; however, it is not without considerable risks, especially when traded with a large amount of leverage. Although, recently the mounting fears of a global recession paired with the lack of stability in the financial market continue to favor a bearish outlook for the NZD/JPY and may offer many profitable opportunities for forex traders.
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Tags: carry trade, JPY, New Zealand Dollar
