Profitable carry trading from a land down under
THE currency market’s attention has been focused on the announcements made by the US Federal Reserve, the Bank of England and the European Central Bank. But at the same time, there are a large number of traders taking advantage of the policies of other central banks, such as the Reserve Bank of Australia (RBA), and their relatively high interest rates.
The RBA announced yesterday that it would be maintaining its current rates. The interest rate has been held at 4.75 per cent since November last year, when the RBA raised rates by 25 points. With the announcement, RBA governor Glenn Stevens said: “The current mildly restrictive stance of monetary policy remained appropriate.”
While this announcement knocked the Australian dollar, it was nevertheless a boost to those taking advantage of carry trades, which involve borrowing in countries with low interest rates and investing in nations with high interest rates.
According to Angus Campbell, head of sales for London Capital Group: “The Australian dollar is a popular currency for carry trades. An investor who buys Australian dollar-dollar, for example, should attract a small interest payment each night as Australian base rates are at 4.75 per cent, whereas the Fed has held their base rate between 0 and 0.25 per cent for a substantial length of time, hence the weakness in the US dollar in the past couple of years.”
With the end of the Fed’s program of quantitative easing in sight, most had expected an increase in US rates, and with it a drop in the gains available to a carry trade. But according to Christopher Beauchamp, research analyst for IG Group: “It looks like traders will be able to continue benefiting from the carry trade for a while longer yet. Previously, markets had begun to expect a small degree of tightening in the US in the third quarter, but last week’s run of bad data (especially the non-farm payrolls) has resulted in a shifting of opinion, with tightening in the fourth quarter now more likely.” Beauchamp added, “if data continues to disappoint then a delay in rate hikes until the first quarter of next year is not completely out of the question.”
NOT SO LOONIE HEDGING
At the same time as benefiting from the relative interest rates of the paired currencies, it is prudent for traders to hedge their positions. Trading Australian dollar-dollar outright means that a trader is constantly exposed to carry trade unwinding.
According to George Tchetvertakov, Head of Research at Alpari UK, hedging a trade on the Aussie dollar with a dollar-Canadian dollar trade is prudent (see graph, above). “Going long Aussie dollar-dollar could be complemented with an additional trade designed to protect the trader in case the dollar receives a strong bid at short notice, for example long dollar-Canadian dollar,” explains Tchetvertakov. “This leg would usually make a loss, but because Aussie dollar-dollar gain outweighs dollar-Canadian dollar loss, the strategy works.”