Sep 19, 2014

Is Every FX Trade a Carry Trade?

In this video blog Udi Sela, Vice President of the Numerix Client Solutions Group and Numerix CMO Jim Jockle sit down to discuss the recent FX news in which renowned currency specialist and Global Head of G10 FX Strategy at Citi, Steven Englander, argued that “every major FX trade in place right now is really a carry trade in one form or another.”

In his analysis of this statement, Udi breaks down the dynamics of a typical carry trade and discusses the dramatic movements in the foreign exchange market, in particular amongst the G3—dollar, euro, and yen. He also provides insights into the economic forces behind the four trade types the market has been buzzing about, and why these trades make sense right now. In addition, Jim and Udi conclude by exploring how the significant unrest in the Middle East has been impacting the current FX market, most specifically in regards to non-deliverable forward (NDF) contracts.

Weigh in and continue the conversation on Twitter @nxanalyticsLinkedIn, or in the comments section.

Video Transcript:

Jim Jockle (Host): Is every FX trade a carry trade? Welcome to Numerix Video Blog I’m your host Jim Jockle. Joining me today is FX specialist Udi Sela. Udi, how are you?

Udi Sela (Guest): Thank you. Very well, yourself?

Jockle: Very good, thank you. We want to sit back, in recent news, on September 6th, currency specialist and Global Head of G10 FX strategy at Citi, Steven Englander, recently argued that “every major FX trade in place right now is really a carry trade, in one form or another. Different only in scope and the risk it entails.”

So, in your experience, well first of all why don’t you give us a little background as it relates to the carry trade and the strategy that investors would utilize that, but then really what does this statement mean exactly, and do you agree with Mr. Englander?    

Sela: Yeah, definitely. So in terms of carry trade basically, the idea is that you purchase a currency which offers a higher yield and you sell the other currency which actually trades at the lower yield. And what Steve Englander is trying to say, and I actually had the pleasure of meeting him, and working with him, is that we have now basically two types of economies in terms of economic cycle.

So we have economies that seemed to be getting out of the woods, with growth, and economies that really are just still fighting the deflation and trying to take extreme measures. So, when I’m mentioning measures and cycles, let’s have a look at the U.S. economy. Where the QA has been on for a while and now just this week again the Federal Reserve Bank has announced that they will reduce further the purchases and continue the tapering, as opposed to for instance to the European Central Bank which really announced a very aggressive plan this July.

And similarly in Japan, we’ve discussed that over previous video blogs. Japan implying again the economics, which basically is also a lot about quantitative easing. And we’ve seen dramatic moves in the foreign exchange market as a result. So when we started discussing Japan – the dollar yen traded at 76 yen to a dollar, and today we’re almost at 110 (Japanese Yen per Dollar). We’re looking at 108.70. Similarly, the euro has weakened against the dollar from levels of 1.4000 (US Dollar to one Euro) a few weeks ago to 1.2850. So, this is basically what Steve Englander is referring to.

Jockle: So specifically, and we’re seeing the fixed income markets, bond markets, react to this change in net policy and European policy, as well as it relates to rates. But more specifically on the FX side, there are four particular trade types that we’re hearing already from traders that are very typical right now. Perhaps you can give us a little bit more insight as to what those trades are looking like.

Sela: Yeah, so if you go back to everything, again we’ve referred to this review by Mr. Englander, and he’s looking at a few markets. So one thing is what he calls the G3, or what the market calls G3, which is typically dollar, euro, and yen (the most heavily traded currencies). And within the G3, he’s looking at weakening of the euro and weakening of the yen, and the strengthening of the dollar. He’s not mentioning it, but if we look at economic cycles, basically the sterling, is now that we have the Scotland referendum behind us, since this morning, the sterling is much more in line with the dollar, as opposed to the euro and the yen, and even if you look at the ten year (government bonds) yield, UK bond yields, so you see that the gilt trades may be ten basis points below the dollar, so 2.60 and 2.50 as opposed to the yen which is the ten year JGB trades at 50-55 basis points, and euro makes an effort so Germany is at like 1.10, France is 1.40.

Okay, so that’s one type of trade. The second one is looking at China. And pretty much is saying the overall Asian market in terms of the FX trading community is positioned short dollar and buying the yuan because again the yuan is perceived to be undervalued. So he’s pretty much in line with this position. And he is also looking at what he calls the relative volatility index. He’s looking at the interest rate differential and dividing it by the implied volatility. And he says when the ratio is above one, it’s a clear trade. So that’s one of the ways he’s looking at it. And if you think about it, it makes a lot of sense. If you have a big interest rate differential basically it means that the market has to move dramatically in order to catch up. So that’s the way it looks. 

Jockle: Another question for you Udi. In terms of unrest in the Middle East, I mean obviously Scotland is now behind us as of today. What is the implications or the impact on the market now with the rise of the ISIS or ISO, depending on the agency you’re talking to?

Sela: So that’s an interesting question. What people who want to trade in the Middle East so and they look at the FX market, look at the Saudi and typically Jordanian dinar. Because these are of course countries that have bordered with Iraq right? And of course because these markets are not very liquid,investors tend to trade forwards. And in many cases, those forwards are actually NDF contracts so, non-deliverable forwards. So, basically it’s just like a cash settled deal deal. And when the market is looking for a big move, or if you like a depreciation of the local currencies. This is what happens when it’s tense in the market. Like during the war in Iraq and so forth. So foreign investors and foreign bankers will buy the dollar against say the Jordanian dinar or Saudi riyal. And you would see the forward points explode and when everything settles down the forward points go back. And often times, the NDF rate can imply in extreme situations, negative yields, for the dollar.

Jockle: So one final question for you. So, clearly there’s a time horizon as it relates to quantitative easing – I’m coming back to our original topic as it relates to carry trades. What is the window here? How long is this going to be the case into the market, and are we talking about six months? Or, are we thinking a little bit more of the longer term?

Sela: Well, clearly there’s a lot of uncertainty, so it’s a bit difficult to predict the timelines. I would say it’s much more than six months because if we think of the different measures that the Fed has taken, since the Lehman crisis actually, we’re looking at a cycle of at least five years. And we want to mention that the U.S. banks have also cleaned their balance sheets, which hasn’t been the case in Europe so far.

And only one of the measures that the ECB has announced was again a loan facility. It was just published today that, I think, that the European banks took something like 86 billion out of 1 trillion. So basically this shows that the banks don’t really have people that want to invest, and to borrow money. And banks don’t want to take money just for the sake of bank government bonds because now the yields are so low, so there’s not much upside. And, if you just place the money at the central bank you can actually get no return. So that’s kind of a deflationary cycle, which basically is indicating in my opinion that there still is a long way to go. So I think we’re looking at, at least a year or two. 

Jockle: Well, Udi if it’s a long way to go, then we’re going to have a lot to talk about in the upcoming months. So, I want to thank you again for joining us for today’s video blog. Please follow us along on twitter @nxanalytics or on our blog on And of course we want to talk about the topics that you want to hear about. So any feedback, please feel free to share with us. And Udi, we’ll see you next time on the blog.

Sela: Thank you very much Jim, for having me.

Jockle: Thank you. 

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