Risky Carry Trade Playing in FX
There's a craze today among money traders in the world in playing carry trade. Carry trade playing is when there's betting on weaker currencies and playing that against other currencies.
Timed perfectly, carry trading proves to be very rewarding - if one knows its ins and outs. A word of caution though - it can be very risky and could result to a sudden death in one's money trading career.
Here why...
The rewards in this trade are very tempting, indeed, so that recently money traders sold lots of yen in favor of the euro and other strong currencies. Why the frenzy? The Japanese economy and trade growth plummeted recently triggering deflation and an abnormal economy. The German economy, meanwhile, has been performing well and remains the number one exporter worldwide. So investors started taking the chance, and the trading imbalance went.
The situation is getting out of hand that IMF head Rodrigo Rato cautioned that the Japanese yen will soon recover dramatically and carry trade players might be in for a sudden surprise. Japanese economy has the ability to recover quickly.
The actual carry trade scenario is that massive borrowing in the yen, in which rates are low, are being done for reinvesting in currencies with higher rates.
But Rato warned that "Market participants should be aware that there are downside risks in betting too strongly on the value of currencies and playing that against other currencies." In other words, it is too risky to play with the yen as this can rebound quickly without warning.
The Japanese government is rehabilitating the economy to stimulate more growth, but carry trade playing gets in the way. That's how strong carry trade playing is - no wonder many fall madly for it. It can upset whole economies if unchecked.
IMF is supportive of the monetary reform policy of Japan and do not see any major intervention needed. But because of this, investors took the IMF stance as a "green light" to keep borrowing yen to boost purchases of higher-yielding currencies. When unequivocal talks are given out by major institutions, carry traders take chances.
Rato pointed out that the yen is a free floating currency. The Bank of Japan has a no-hands policy to it. Thus, market players are free to take risks, particularly carry trading risks. Some European exporters are beginning to think that floating the yen is intentional to strengthen Japanese exports.
"Those who are playing carry trades should keep in mind that currency changes can happen very quickly," IMF Chief Economist Simon Johnson said.
Carry trading pays off for money investors for a time while the timing is perfect. But trading moods change minutely and the promise of quick riches can turn suddenly into a curse. Watch what capability the currency one plays carry trading with before a plunge for the play is made.