The Hard Working Dollar

Currency Carry Trade 2009: Short The US Dollar

Posted by A.L.K. On August - 18 - 2009

Currency Carry Trade of The Year: Short The US Dollar

Despite the widespread turmoil and confusion in financial markets, shorting the US Dollar prevails as the best currency carry trade for 2009.

Before discussing the various ways to take advantage of this trade, let us first discuss the carry trade definition.

Executing a carry trade is the practice of borrowing in the currency of a first country where interest rates are low and lending the proceeds in the currency of a second country where the interest rates are higher, in hopes of profiting from the difference.

Currency Carry Trade Example
A simple carry trade example is when a person receives a loan from a US based bank for $10,000 in US Dollars at the low loan interest rate of 1% and uses that $10,000 to open a savings account in a country like Australia which has a higher annual percentage rate of 5.5% for savings accounts. The savings account is denominated in Australian Dollars.

This allows the US borrower to earn a carry trade interest rate of 5.5% – 1% = 4.5% on his debt (as opposed to paying 1% if he had not opened the Australian savings account).

The only carry trade risk is caused by the possible decline in the value of the Australian currency when compared to the US Dollar. However, in current market conditions, this risk is mitigated by the US Dollar’s weakness year-to-date.

Top carry trades for 2009

Hungarian Forint
Symbol: USD/HUF
Direction: Short
Carry Interest: 7.7% APR
Year-to-Date Currency Gain: -0.36%

Turkish Lira
Symbol: USD/TRY
Direction: Short
Carry Interest: 7.2 APR
Year-to-Date Currency Gain: 2.72%

South African Rand
Symbol: USD/ZAR
Direction: Short
Carry Interest: 5.2% APR
Year-to-Date Currency Gain: 15.86%

Mexican Peso
Symbol: USD/MXN
Direction: Short
Carry Interest: 3.2% APR
Year-to-Date Currency Gain: 5.94%

Australian Dollar
Symbol: AUD/USD
Direction: Long
Carry Interest: 2.05% APR
Year-to-Date Currency Gain: 19.14%

New Zealand Dollar
Symbol: NZD/USD
Direction: Long
Carry Interest: 1.2% APR
Year-to-Date Currency Gain: 16.70%

Note: Currency Gain does not include carry interest earned. Carry Interest APR and YTD Currency Gain are based on data as of 08/18/09 provided by Oanda.com.

My personal favorite carry trades are the Australian Dollar, the New Zealand Dollar, and the South African Rand trades (in that order). These are my favorites because the underlying fundamentals support this trend’s direction more so than the other carry trades. This support is easily visible in the year-to-date gains in the underlying currency’s value.

The forex carry trade is a pretty passive way to earn a high interest rate in currency markets, especially if you are already a trader. However looking forward, entry into new carry trades at this point in the year and economic cycle should be done cautiously with careful consideration of future changes in economic conditions, interest rates and market sentiment.