New Zealand has raised its base interest rate to 3% from 2.75% overnight – now pushing the Kiwi “higher” than it’s neighbor AUD ( The Australian Dollar ) as far as yield is concerned.
Now……in a typical / healthy / strong / global growth / “risk on” environment – this kind of news would have sent the Kiwi “shooting for the moon” as Carry traders planet wide would most certainly look to take advantage of the % spread. Selling JPY and USD ( at near 0% ) and in turn buying NZD at 3%.
So why on Earth is NZD “lower on the rate hike”? How is this possible? Why would this be?
It’s because Carry traders are currently “unwinding risk” in preparation for what’s ahead. These types of moves take weeks if not months to play out, so once the ball has started rolling there is no way, NO WAY major players / Central Banks / institutions are going to “shift their plans” and “change direction” just because a single country has made a small interest rate hike! Not a chance!
If you ask me – the muted reaction to the New Zealand rate hike is literally a “smoking gun”.
Big boys are turning the boat, and nothing….NOTHING is gonna stop it.
AUD dropping lower ,, currently at 9260 and a good support at 9250 hoping it doesn’t hold ,, and as for the carry trade . no rate hike is expected from BOJ and FED any time soon , then why would the central banks big institutions be unwinding the carry trade as there is still profit for them in carry trade ,, or is it that both NZD and AUD (commodity related currencies) are destined to go down in medium term ,, ? that’s why they are unwinding it , ?
farhan – Hopefully I can explain it below – Fellow Kongites (chimps?) please do correct me if I a wrong.
A low yielding currency such as YEN would be borrowed and then sold in the FX market to buy ie. US$ (remember most FX trade are still executed through the US$ as that’s where the liquidity is). These US$ are then used to purchase high yielding assets, whether they be other currencies (usually bonds of a country), stocks, or any other assets.
Now there is an assumption that the FX rate between the sold and bought currency (ie US$/yen) will remain within a certain range. If Yen starts to strengthen, any gain made through the yield, will be loss on the FX conversion.
Hence when you get a flight to safety and Yen starts to strengthen, investors need to start covering the sold yen so they sell the high yielding asset, convert it back to US$ and then cover the US$/YEN.
This is basically the carry trade in it’s simplest format.
Also remember the JPY and US$ (the bonds of these countries) are generally considered safe havens so when things do seem precarious, you get a flight to safety hence these currencies start to strengthen and hence an unwinding on the carry trade to cover.
Hopefully I haven’t made any glaring errors.
Nice outline.
I’ve explained this here many times before, but its the kind of thing that people really need to hear, then think about, then hear again , and thin about etc….
It takes a bit of time to “get it straight”.
Your outline will help many readers. Thank u.
I suppose a really simple relevant example would be if you brought AUD/JPY through your broker, if you held that position overnight, you’d make perhaps 2-4 pips in swap points. However if AUD/JPY then weakened, what you would have made in swap would be offset by the movement on the AUD/JPY fx rate.
So although the swap rate is positive for holding long Aud/Jpy, you’d only make money if Aud/Jpy strengthened or at least dint’f fall by more than the daily swap points. If it started to weaken for whatever reason, what you gain on the yield, you loose far more on the fx movement.
No problem Kong, just glad to be able to contribute something 🙂
The JPY pairs don’t seem to be turning yet… even though Abe hinted that there may not be any more QE…nikkei and usdjpy drop during the asian sessions but always stick saved during the US session by the FED…This ping pong never seems to end…
Not responding?
Look again Robert….lots of movement in JPY pairs.
Howdy Kong,
Hope you’re well mate. Equities seem well bid. Is this a classic ‘equities is the last to know’? The dollar looks to have carved out a bottom for now and typical risk off currencies are not agreeing with the rally. At times we’ve had the USD going up with equities, maybe a repeat?
Could do – but in this case I don’t think so.
Perhaps not “on a dime” but I’m still of the mindset Equities are gonna roll over here, and USD takes the “repatriation trade” moving higher.
Yeah agreed – I think that will come to fruition sooner rather than later. I’m half expecting a massive spike through 1900 to suck people in long then a sharp reversal. Let’s wait and see though.