Weakening dollar, strengthening forint: a return to carry trade?
macroeconomic analyst and bond portfolio manager
Carry trade, one of the popular investment strategies of the past decade, suddenly lost its significance in the financial crisis that began to unfold in mid-2007. The weakening of the dollar seen over the past month and the simultaneous strengthening of the emerging markets raises the question: could carry trade be on its way back?
Carry trade is nothing other than a short position in the financing currency (dollar, yen, or Swiss franc, though more recently the Czech koruna has also been classified as such), and a long position in a high-interest-rate emerging market currency such as the forint. Three factors must be in place for this to work: 1) a low-yield envi-ronment on the developed markets which encourages investors to take risks in regions outside the developed markets, while providing a cheap source of funds for investment; 2) a positive interest margin, which makes it worth buying and holding the emerging market currency even if it is not appreciating against the financing cur-rency such as the dollar (this is what the term “carry” refers to); and 3) the volatility of the carry currency needs to be low, so that the exchange rate risk will be offset by the interest differential. As the trend of a weakening dollar clearly increases the attraction of a carry position, we can also assume there is a partial causal relationship between the two phenomena.
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Monthly analysis - May
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