FOREX TRADERS

[twk000jester]

Unwinding of the Carry Trade Has Finally Hit Currencies
by: Jeffrey Frankel October 29, 2008

Why has the yen strengthened so much this week, even though the Japanese stock market has plummeted?

The financial media have largely got this one right: the answer is the unwinding of the carry trade, and the associated flight to quality, which means a flight to yen and dollar (cash and treasury bills).

This was to be expected. It is an unseemly tooting of ones’ own horn, but earlier this year I wrote in an article in the Milken Institute Review (vol. 10, no. 1, pages 38-45):

The traditional pattern is most clear with the carry from the yen to the euro: it has been predictably profitable for the last five years, and this will predictably end soon, as the yen reverses its depreciation against the euro.

(Getting Carried Away: How the Carry Trade and Its Potential Unwinding Can Explain Movements in International Financial Markets.)

Although the phrase “carry trade” became widely popular in the context of currency speculation, where scholars know it as the “forward discount bias,” its etymological root is in commodity speculation.

The same phenomenon is observable in housing, equities, commercial bonds, and emerging markets: when money is easy and nobody is worried about risk (2002-2005), the search for yield sends the excess liquidity surging out of the low-interest currencies, and into all other assets.

When the process reverses, investors pull out of the risky assets and retreat back to the safe haven of the low-interest-rate currencies. Over the last six months, the reversal of this broadly-defined carry trade hit equities and bonds first, and then commodities (having hit housing earlier, of course).

This month it is finally hitting the high-interest-rate currencies.

Link - http://seekingalpha.com/article/102777-unwinding-of-the-carry-trade-has-finally-hit-currencies?source=article_lb_themes