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4
JUN 10

More on the Carry Trade




When we point to the carry trade as a problem we see claims that there is no correlation in this cross rate or that to interest rate spreads.  Remember correlation is not causation – the theory goes that exchange rates should be correlated and respond to trade flows but there is bugger all of either in that regard, trade is swamped by speculation. Guess who likes that outcome.

I repeat the NZ$ is traded daily at 43% of GNP that is madness from the point of view of the trade exposed economy.

Going to the correlation dicussion the spread at any given time has to be marked against the risk perception – in a happy pre-crisis world a few 100 basis points might be sufficient to ignite the carry, in crisis rife world; troubles here and there might require many hundreds of basis points for the same magnitude of carry. 

But differentials in interest rates fundamentally drive the flow of carry always moderated by risk.  A bit like ohms law, voltage is intermediated by resistance to determine current flow.
 


tags: carry trade, exchange rates, interest rate spreads
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