What Are Funding & Carry Currencies?

Carry trading can be a good addition to any portfolio and is a great way of taking advantage of big interest rate differentials.
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Funding And Carry Currencies

We have a quick question here from Stuart, asking us to do a quick review of funding and carry currencies.

So, just to quickly recap what Stuart is referring to is when investors try to take advantage of a positive interest rate carry, by using a cheap currency, or a low interest rate currency, to buy a more expensive currency, or high interest rate currency.

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Now, the profit comes in the form of the rollover. So every night, if you keep a position open overnight, you’ll basically get charged interest on the currency that you sold, and you collect interest on the currency that you bought.

So what investors would take advantage of is, basically, trying to pay a very low interest rate currency, selling that against a very high interest rate currency. So if we look at the the current interest rates right now, we might take something like the euro, which is sitting at a zero, and we could look to pay that against something like the Mexican peso, which is sitting at 6.5%. So what we would do to take advantage of the carry potential on that, is we would take something like a sell trade on the euro/Mexican peso.

Another example would be the Japanese yen, which is sitting at -0.1, and we can pay that against something like the Turkish lira, or maybe the South African rand, or maybe even the Russian ruble. And if we do that, that’ll mean that we will take, if we take the yen and the ZAR for example, that’ll essentially be a by-trade on the ZAR-yen, or the lira-yen, or the ruble-yen.

Now when we have a very strong risk, apetite for risk amongst investors. They obviously look for yield and they look for carry, which is why we often see upside for your higher yielding currencies, or higher interest rate currencies. And downside for your lower interest rate currencies, that is used as your funding currencies for that type of carry trades.

Now, when we have a string risk of Centamin, of course, we often see carry trades being unwound, which mean that selling the high yielding currencies, and basically buying back the funding currencies. And that is often why we see inflows into something like the Japanese yen and the Swiss franc, and not only because we’re seeing inflows from a safe haven perspective, but also seeing inflows from repatriation, from the unwinding of carry trades.

Also quickly taking a look at something like the euro. Due to it’s low interest rate, the euro was also used as a funding currency, especially against currencies like the Mexican peso, Russian ruble, South African ZAR. And with the onset of the COVID-19 pandemic, we saw a massive unwind of those carry-type positions and that is one of the big reasons why we saw that huge jump.

Short-term jump to the upside in the euro, wasn’t necessarily due to new buyers coming into the market for the euro, But that was due to a big unwinding of those major carry positions that was used by the euro, or by investors for the euro, using it as a funding currency.

So that is just a very quick rundown of exactly what that is, and what type of currencies investors normally look to pair against for taking advantage of carry trades.

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