This might be a dumb question, but are there any currencies with a positive carry?
- Thread starter Little Whale
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There's really no such thing as a "carry trade", there is just a bet that a high interest currency will go up more due to exogenous factors more than it will naturally decay due to the interest rate differential. And people fool themselves into calling it a "carry trade" because that sounds so much smarter and less like a random prop bet.
There are certainly a few unique situations like the Yen carry trade a decade ago where there might have been some out of market forces that were propping up the currency. But I think you'll be the first to agree that it's unlikely TRY will on average increase or remain static versus a basket of lower interest rate currencies over time and generally the interest rate differential expresses itself as an equal devaluation of the currency.
No doubt, I think professional forex investing is interesting because there are so many non-discretionary players in the space who are forced to make non-market moves. If you master that there's alpha to be had. BOJ was a prime example being backed into a corner with their currency 10 years ago. Now as you said most of the world is backed into that same corner and the one's who aren't like Thailand have either already been burned so badly trying to play the currency propping game that its unlikely they'll try again or don't have the resources to prop up anything.
Obviously that's not the level of thought going into the previous posts though.
I'm beginning to get where you're coming from, Sig, but I need to strongly disagree with your observation that the exchange rate moves according to the IR differential. Your posts make it sound as if a +x% carry would result in a -x% CCY move, although I'm not 100% sure that's really what you're trying to say.
It wouldn't be true. The relationship above would describe the uncovered interest parity theory (UIP), and UIP has been shown to be violated both in academic research and in real-money investing. On average, positive carry has outweighed CCY depreciation, i.e. forward prices do not predict future spot prices. On top of that, if you look at the data since the financial crisis, forwards have been priced as spot price + IR diff + cross-currency basis. Before the crisis, the basis was very close to zero. Today, it's fluctuating wildly for many currencies. So I'd argue that even covered interest parity (CIP) doesn't hold anymore in today's world of "return-free risk". Forget what the textbooks say.
Finally, whether buying a higher-interest CCY should be called a "carry trade" is a semantic argument and beside the point in the context of this thread. My answer to the OP's question remains: Yes, there are currencies that offer positive carry, and yes, you can earn that carry. Just don't be fooled into thinking that a buy-and-hold approach to the carry trade will always turn out positive for you no matter the time frame. Intermittent drawdowns are brutal and can wipe out several years of profit. Like they say, "Picking up pennies in front of a steamroller." I guess we do agree on that.
It wouldn't be true. The relationship above would describe the uncovered interest parity theory (UIP), and UIP has been shown to be violated both in academic research and in real-money investing. On average, positive carry has outweighed CCY depreciation, i.e. forward prices do not predict future spot prices. On top of that, if you look at the data since the financial crisis, forwards have been priced as spot price + IR diff + cross-currency basis. Before the crisis, the basis was very close to zero. Today, it's fluctuating wildly for many currencies. So I'd argue that even covered interest parity (CIP) doesn't hold anymore in today's world of "return-free risk". Forget what the textbooks say.
Finally, whether buying a higher-interest CCY should be called a "carry trade" is a semantic argument and beside the point in the context of this thread. My answer to the OP's question remains: Yes, there are currencies that offer positive carry, and yes, you can earn that carry. Just don't be fooled into thinking that a buy-and-hold approach to the carry trade will always turn out positive for you no matter the time frame. Intermittent drawdowns are brutal and can wipe out several years of profit. Like they say, "Picking up pennies in front of a steamroller." I guess we do agree on that.
For sure +x% carry doesn't certainly result in a -x% CCY move in a single instance. However it would if you took out all other exogenous factors impacting the currency fluctuation. Those exogenous factors, absent some persistent market distorting factors like a country propping up its currency, generally have a mean close to 0 over the long term. Therefore, over the long term and a large number of currencies, you would expect +x% carry to result in a -x% CCY move.
Also important to note the UIP violations are measured in fractions of a percent, which again while certainly relevant wasn't what most of the folks in this thread were thinking about when they thought about carry. In fact the fluctuations in CIP don't even necessarily all sit on the same side of the equation so they could just as often cut into the "carry" profit as add to it. If you really wanted a guaranteed profit you'd do the whole buy at spot and invest in an interest bearing note and sell the futures, or vice versa, to take advantage of that. However at the variations I've seen it's difficult to impossible to make any meaningful profit from that.
So yeah, you get it but I think it's important to clarify for those who are a little newer to this so they don't go down the golden road of thinking "a 7% carry=7% profit" road, which I think has been accomplished.