Dollar Carry Trade – A Bubble Ready to Burst

Many people are surprised at the pace of the rise in equity as well as commodity markets because economy of the countries like US, Euro zone is still not showing any signs of recovery. Well the answer to the questions about this stupendous rise across the world equity market lies in the currency or dollar carry trade.

Currency carry trade can be defined as a strategy in which an investor sells a certain currency with a relatively low interest rate and uses the funds to purchase a different currency yielding a higher interest rate. A trader using this strategy attempts to capture the difference between the rates, which can often be substantial, depending on the amount of leverage used.

With interest rates in US being 0 % various traders as well as hedge funds are borrowing from the US banks and converting those dollars into other currencies and investing in bonds and stock markets in countries like Asia, Latin America because there interest rates are higher than US and hence trying to benefit from this disparity in interest rates across the globe. Dollar carry trade is one of the main reasons behind this smart recovery in most of the equity markets across the globe. Spurt in prices of all the commodities like gold, silver, crude can also be attributed to dollar carry trade.

Now the question arises when this all will end, well this is difficult to answer because for it to happen either interest rates in US have to go up or some factor like geopolitical conditions lead to appreciation in US dollar, which forces traders and hedgers to reverse their leverage positions or close it . Hence one thing is for sure whenever this dollar carry trade unwinding takes place it will lead to biggest asset bust ever taking down all the risky assets like emerging equity markets, commodities with it.

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