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Central Bank Rate Cuts Hurting Carry Trades?

Thursday, 12 Jul 2012 | 11:17 AM ET
Shanna Baker | Photographer's Choice | Getty Images

The softening global economy is leading central banks to cut rates, and that could change your carry trade strategy.

Unless you've been spending quality time in Outer Mongolia, you've probably noticed that the global economy is softening.

Olivier Desbarres, director and head of FX strategy at Barclays, says that's creating pressure on central banks around the world to cut interest rates.

In the last few days, both Korea and Brazil have cut rates, and their moves followed action by the European Central Bank, the Bank of England, and China.

All this has the potential to upend a longtime pattern of carry trades, whereby traders could sell a longtime low-yielding currency against one offering higher rates and be fairly confident that they would be able to pocket the difference.

A case in point: Japan'sdecision not to cut interest rates has some traders talking about a shift in which currencies still work for carry trades, with the yen, a longtime funding currency, high on their lists.

Central Banks Are Under Pressure to Ease
Olivier Desbarres, Director & Head of FX Strategy, Barclays says both G10 and EM central banks are under pressure to ease given soft global growth levels. Despite this, he adds that overall volatility levels still remain low.

Not so fast, says Desbarres. Noting that volatility remains relatively low - and in light of the ongoing problems in the euro zone - he notes that there are still profitable short trades on the euro against higher yielding currencies like the Australian and Canadian dollars.

The bottom line: watch that volatility, but don't upend your carry trades just yet.

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