You’re learning about currencies….you’re seeing the impact in markets – you’re having some fun. Who knows? Perhaps a few of you are even getting in there and placing a trade or two – good for you.
An important distinction to make when trading currencies, is to understand what “role” they play in the global economy “aside” from their normal function as a “token of value” in the given country of origin.
We all use money – yes…..but big banks use money in entirely different ways. Ways that can affect global markets regardless of “who” or “where”. I’ve mentioned the Carry Trade many, many times and encouraged you to read up – as it is the most basic and simple example of how banks use “your savings” behind the computers and digital printouts – in order to generate massive profits. You don’t honestly think the money is just sitting there in a vault do you?
Banks ( as well Kong) utilize cash on hand to fund ventures via many foreign exchange strategies in order to turn profit. You are happy to see the printout on your stub when you check the balance – while your actual money is likely being put to work….far, far away in some foreign land.
Simply put – If I can walk in a bank in Japan and borrow money at next to “zero” % interest – then take that money and invest it in Australia where even the base savings account rate is 2.75% – boom – Carry Trade on.
So….the Aussie. The Australian economy has flourished over past years and in turn has been able to offer a considerably higher rate of return on savings than many other countries. So in times of “risk on” money flows to the Aussie like the Ganges River! As big banks ( and Kong) borrow low yielding currencies ( JPY and USD ) and purchase those that offer better returns. Simple as that.
Unfortunately we’ve got a problem here though. Australia is currently in its own “easing period” and has plans to further lower its interest rates ( as Japan as well the U.S has ) in order to keep the economy moving. This puts pressure on Carry traders with the knowledge that the Aussie will continue to “cramp this trade” as it continues to lower its rates….closing the gab between 0% and 2.75% ( not long ago it was 4.50%!) smaller and smaller as the Carry Trade starts to lose its appeal (viability).
This is of incredible significance on a global scale ( and another contributing factor in my longer term view ) as to provide further pressure on an already fragile global banking system. When big banks (and Kong) have one of their largest revenue streams / cash cows producing smaller and smaller returns, in a global environment that is clearly slowing – all the money printing in the world can’t make that one go away.
The Australian Dollar has taken a huge hit already, and as much as I had originally been looking for a solid bounce before getting short ( which I am still going to do ) I am confident that what this really suggests is that the big money has already been backing out in preparation for much further losses to follow. Nothing short term will change my mind about this…as I do look for higher levels in AUD – to sell, sell , sell , sell , sell.
Hi Kong and fellow subscribers,
Thanks for that ez-to-understand explanation Kong. It helped me make sense of the ubiquitous and oft mentioned carry trade.
Perhaps a way to mitigate the currency & interest rate risks of the carry trade is to purchase high grade, short term, fixed income securities. One (and Kong) may lock in a reasonable rate of return by giving up the possibility for greater returns should short term rates increase. We all agree that is very unlikely these days.
My theory is that:
1. the yen will remain cheap or get cheaper,
2. the fixed incomes will return principle and the promised interest if held to their short term maturity,
3. if rates fall, the fixed incomes will rise in price (the yield will diminish) which allows one to close out sooner and still enjoy the expected or a greater return.
I’m certain I am overlooking some important aspects because I’m new at this. There is no free lunch.
Please elaborate on the pros & cons if you think it will be helpful.
My goal is to see “(and Kong AND DEV)” sometime soon. You help us a lot because your comments and analyses are dynamite! Bye for now.
Well said Kong, great analysis. For those of us here in Oz its starting to get a little uncomfortable and as I’ve mentioned before we have a great ability to take a glass half empty approach, even with 3% growth, 5.5% unemployment, sunshine, beaches, low population and so on. We’ve had 21 straight years of growth which may come to an end. So what, its just a economic cycle, right?
So what? Well, the politco isn’t about to let us go into recession without our own version of QE to shore up its reelection prospects. The cash rate could fall another 75 bps (my view) over the next year and the Govt will debt fund an infrastructure program to create jobs inspite of a growing debt/gdp ratio. The lower rate will probably restrict the carry trade as even though the yield differential will stay high by global standards, the perceived AUD risk will be too high for many traders.
Ergo, down goes the AUD. There’s likely to remain central bank and sovereign fund interest even at those lower rates, but a lot less than the volumes that kept the AUD above parity for such a long time and helped kill off the country’s manufacturing base.
How far could it fall? Better judges than me (almost everybody!) thinks below 0.90 cents, but I think lower than that. The big manufacturers don’t make any money at 0.90 (govt subsidies have kept them here) nor small miners, so 0.80 could be a nice resting place to help re-balance the economy.
In other words, an epic short trade, combined with a reducing holding cost – NICE! I’m already short from 0.9950 and intend to scale in as the next leg lower commences after the overdue retracement.
Fantasic insight Deano seriously……this is golden.
I’m eyeing AUD as one of the larger trade ideas developing here in coming days/weeks -“still” looking for just a little better entry short – at higher levels.
I too see 80.00 as a reasonable “end to the slide” and “you da man” being as well positioned as you already are.
All the best there in Oz!
Read up people! – Read this twice!
Thanks Kong. One other thought. The AUDNZD has been falling sharply over the past few weeks, partly due to the interest rate reduction in Oz versus a stable NZD, but also because while Australia exports dirt (iron ore), minerals, wine and some food, the Kiwi’s export mainly food, LOTS of it. So as China cools a little and they buy less dirt and minerals, the Kiwi’s are relatively unaffected – they simply can’t ship enough food offshore.
Also, the NZ housing market especially in Auckland is on fire and the bubble is growing, so the next interest rate move is likely to be HIGHER, which will turbocharge the NZD.
Ergo, a strong prospect of the AUDNZD falling further, my view at least to 1.15 and perhaps 1.10 – another epic short trade and this one with bugger all swap cost! I’m already short from 1.2105.
thank you … great site for learning becoming trader. I learn from you that we must never ever loose the BIG PICTURE a.k.a global intermarket money flow and most importantly not allow ANY opinion entering our analysis. Thanks again for my accoustic guitar … MUCH
Thank you for the additional comments and input about the situation and prospects for AUD and NZD. It is very helpful to have analysis from a “local” person that really understands.
Regards to all.
Totally Deano – There is nothing like having a man on the ground!
I think a bottom has formed & started long position yesterday & continued today….. watching closely to see of this is just a bounce or a final bottom….. The monthly squeeze fire has pulled up from a neg fire for now – but a break is still in the cards – watching this as well…. for now am long AUD/USD
Im nibbling long AuD as well NZD as well here Schmed – and I’m calling it a bounce.
Could be a wopper of a bounce too, as dip buyers in equities and risk in general get caught thinking it’s “still goin higher forever”.
My tech went short risk days ago – and I won’t be switching teams in general – but the great part about some of the short term trading is that you can be on both sides!
I went short JPY against a pile of stuff this morning..and caught the turn literally on a 5 min chart.
I have stops set @ .9514…..
Taking profits in eurusd kong buying usdjpy see how it goes for comming time
Nice – I like where you’re at – be nimble though.
Stay fast like a cat!
Adding to longs – off bounce of support…. let’s see where this takes use into a fun Friday!