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Reverse Carry Trade, Part I

Image result for Vincent Cignarella

I'm not sure I understand this, or agree with Bloomberg's analysis, but I'll put it in here anyway.

An Aug. 15th Bloomberg story, by Vincent Cignarella (portrayed above), starts with this: The central banks of Australia and New Zealand each recently lowered their benchmark interest rate. According to conventional wisdom, this should have weakened their respective currencies, giving their business a stimulative shot in the arm when functioning as exporters.

But that didn't happen. Rather, the lowered interest rates resulted in ... stronger currencies. What's going on?

If you don't understand why that result is counter-intuitive, you might want to take a step back, Consider a common FX trader's trick known as the "carry trade." The idea is: borrow money in the currency of a country where interest rates are low, then trade it for the currency of another country where interest rates are high, and lend the money out there. You're buying credit low and selling it high. Good on you -- free risk-free money!

Well, it isn't exactly risk free.Nothing is. Central bankers  have a way of changing their minds, and traders attempting the carry trade can end up getting locked into a situation of borrowing high and lending low. Oops.

Anyhoo ... when the central bankers of Australia lowered their interest rates they "should" have made the exchange of their currency, for another more high-interest currency, part of the playbook of carry trade strategists. This should in turn have played a role in the process of weakening the currency, for supply and demand reasons.

But instead what happened, Bloomberg tells us, was the development of a "reverse carry trade," where traders wanted in on the aussie after the interest rates were lowered, strengthening the currency.

I'll stop here and finish up tomorrow.


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