SENIOR DEALER, GFT
PRIOR to 2007 it seemed that every time you turned on a financial news channel someone would mention the “carry trade,” which involved buying and holding currencies with the highest interest rates against currencies with the lowest. Many gambled that the difference in relative yields would more than compensate the holder for the risk of adverse movements in exchange rates.
Then came the credit crunch and many of these carry trades were blown out of the water. Traders found out that the high yields on offer in Iceland did not compensate them for the collapse of the krona.
In the wake of the credit crunch, investors have sought safe havens for their cash and bought US dollars, despite the low yield. And as stock markets fell and economic activity slumped, Americans reduced their investments abroad and repatriated their money. The resulting dollar rally was in stark contrast to the performance of the stock market.
This reverse correlation between the dollar and the stock market has continued in recent months although the world has become a less scary place to invest. The financial system is now unlikely to implode and equity markets have rallied, implying stabilisation.
During this period the dollar has weakened, perhaps because the policies to stimulate the US economy have caused traders to fret about pent-up inflation or America’s ability to repay its debt. But, equally, it is likely that investors are confident enough to look at countries best placed to profit from any recovery.
The true risks of holding foreign currencies are still fresh in investors’ minds and the interest rates of many of the world’s largest economies are similarly low and would not sufficiently reward the carry trade. However it does appear that the market is now willing to look outside the US for higher returns.