The Dow plummeted 238 points today, triggering a major turn in carry trades.
For carry trades to thrive, central banks need to be raising interest rates, volatility needs to be low, traders need to be optimistic and risk appetite needs to be strong. Unfortunately, this does not describe today’s market environment. Over the past few months, many of the major central banks have lowered interest rates for the first time in years. The world is embarking on a major easing cycle which will contrast sharply with the global tightening cycle that lasted from 2004 to 2006. Volatility has also rebounded from its record lows while risk appetite has plunged. Part of the reason why carry trades continued to weaken is because traders expect global growth to slow even further. As the US flirts with recessionary conditions, the chance that the Federal Reserve will ease interest rates by 100bp is continuing to rise. At best for carry bulls, the Fed will ease by 50bp this year. At worst, they will ease by 125bp. Either way more easing is a necessity and this dynamic will make it difficult for carry trades to rally. The Dow broke a significant support level when it closed near its intraday low. It is realistic to expect at least another 100 point in losses which would take the index to its August lows. If the Dow to continues to sell-off, we will see further weakness in carry trades. Find out whether our DailyFX readers think that the Carry trade is a Buy or Sell and vote for yourself.