Are Carry Trades Back?

Carry trades continued to track the US stock market tick for tick. Today, impressive rallies were seen in all of the Yen crosses, raising the question of whether carry trading is back. Although it may be tempting to say that it is because we could see a bit more strength in pairs like AUD/JPY, USD/JPY and GBP/JPY, the market environment has changed significantly over the past few weeks. The age of easy money is over with many leveraged buyout deals and plans for stock buybacks cancelled.

These were the primary drivers of equity market strength in the first half of the year and their disappearance will make it much more difficult for the Dow to return to its record highs. If the Dow fails to rally back towards its prior highs, then carry trades will probably not see new multiyear highs either. Furthermore, carry trades thrive in low volatility environments and the recent intraday moves in US stocks is anything but low volatility. With harsh lessons learned over the past few weeks, speculators will be far more cautious about assuming risk in the months to come. Standard and Poor?s warned today that they may cut ratings for more than $900 million Alt-A bonds, which means that now is not the time to become complacent. Although Japanese economic data continues to be weak, it will have a more of a secondary impact on the Yen crosses.