I was looking through interest rate expectations for the coming year over various economies and it seems like there is a notable shift in the forecast for yield differentials.

Here is how they stack (expected basis points of tightening or easing over the next 12 months):

Fed: 80bp (Current lvl: 200)
ECB: -4.6bp (425)
BoE: -33.3bp (500)
BoJ: 16bp (50)
SNB: 25bp (275)
BoC: 7bp (300)
RBA: -52bp (725)
RNBZ: -149bp (800)

This could be a big driver for general market direction over the coming months, especially since it overlaps ongoing credit market concerns and a general slowdown in global growth.

It's pretty clear that markets expect rate cuts from current high-yielders and mild prospects of rate hikes from low-yielders. This could be bad for the carry trade generally.

USDJPY looks like its on the brink of a breakout, which could really upset the carry trade balance.

But, other yen crosses have pulled back. It will be interesting to see what happens to USDJPY if the yen crosses continue to push lower.

Wow, the Aussie, a previous pillar of Carry Trade strength, has clearly taken a nosedive. A look at commodity markets and the Aussie yield curve can explain quite a bit of this, as the Aussie interest rate term structure shows clear expectations of Reserve Bank of Australia rate cuts through the medium term. Compounding Aussie woes, the benchmark CRB commodities index keeps taking a dive and shows little sign of recovery. More on the latter theme in a recent DailyFX report: Why is the Australian Dollar Falling Sharply?

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Looks like we got a sharp reversal from most of the yen crosses. Wasn't really data driven, but not surprising given the reversal in equities during the US session and the very weak GDP numbers from Japan.

The DailyFX Carry Trade Index is still deep under water, but this does look like it will give the sell off a break. It will be interesting to see whether it will last or if this is a break before the sustained decline.

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John Kicklighter is the author of Dynamic Carry Trade Basket, Watch What The Fed Watches, and Forex Trading Weekly Forecast on DailyFX.com

I was taking a look at our carry trade numbers today as a number of the yen and swiss crosses were pulling lower. Lo and behold, what do I see? Our Index has pushed to new 6-month lows and a significant trend is now being tested.

Should this rising trend give, I would expect to see carry liquidation pick up until we hit the next major swing low; and depending on where support levels are across the market for these aforementioned currencies, it could simply accelerate into its losses instead of holding at support.

I'm thinking about whether I should apply this carry basket drop as a leading indicator for a USDJPY bearish break. Anyone agree or disagree?

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John Kicklighter is the author of Dynamic Carry Trade Basket, Watch What The Fed Watches, and Forex Trading Weekly Forecast on DailyFX.com

A follow up to that pressure from last week - massive breakout.

This wasn't really founded on any specific event risk or new story, so it will be interesting to see what happens if the freddie/fannie report from the WSJ (suggesting the government will announce something this weekend) pan out....

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John Kicklighter is the author of Dynamic Carry Trade Basket, Watch What The Fed Watches, and Forex Trading Weekly Forecast on DailyFX.com

I was taking a look at the carry trade index and noticed that it was taking on an interesting correlation to the dollar (the blue line is the carry trade and the orange is the dollar index).

Up until July, the correlation was strongly positive, then when risk started to rise, it reversed and went sharply negative. This is likely a reflection of the dollar's advance despite rising financial problems; but will the negative relationship hold? Probably not. the US is the epicenter for the current troubles; so we will need to see if the world's largest economy is suffering alone or things are truly worsening everywhere.

Regardless, the carry trade is being hammered; so its best to stay away from the high yielders for now. A retracement is a dangerous possibility, but trying to call a reversal is like trying to catch a falling knife.

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John Kicklighter is the author of Dynamic Carry Trade Basket, Watch What The Fed Watches, and Forex Trading Weekly Forecast on DailyFX.com

John:

Here:

Lehman Fails And AIG Is On The Verge - What Is The Currency Impact?

you state under "alternatives"

"a long carry currencies (Japanese yen and Swiss franc) and short dollars against comparatively strong currencies will find at least short-term interest."

END OF Quote

John, To further explain the above, could you give example/s of what you
mean in the above quoted statement?

Thank you for your commentary.

Hello winterwhite,

The alternatives in this sort of market environment come in two brands: a cautious approach or an aggressive one.

In being cautious you would want to avoid the US dollar and long major carry trade pairs (GBJPY, AUDJPY, NZDJPY, etc) until the financial crisis is worked through. Otherwise, you are inviting incredible volatility into your trades where technicals and fundamentals mean very little and can be broken with little effort. This means trading pairs like EURCHF, CHFJPY, AUDNZD, EURGBP, etc.

The more aggressive trade would be to short those risky things that you don't want to be long in. So, if you see strong technicals and long-term fundamental reasons for it, you can look for good short dollar and carry trade positions.

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John Kicklighter is the author of Dynamic Carry Trade Basket, Watch What The Fed Watches, and Forex Trading Weekly Forecast on DailyFX.com

Please gentilmens can you tell me something? I watched the pair AUD/CHF and I saw that in 10 years this pare is trading in a range of cca 3000 pips. If you go long you have daily swap of around 35$ if you play 1 lot on standard account. If you calculate, in a year you could cover have more than 1200 pips only with swap. Am I wrong? Sorry I am a begginer.

Thank you very much.

John:

Thank you for the clarification as well as your many
commentaries.

Hello sgoran,

First of all, the rolls on every currency pair will change over time. As central banks change their respective country's benchmark rates and foreign demand for a currency fluctuates, the relative rate its assets yield will change.

However, theoretically, if the daily rollover stays at $35, a long position would make $12,460 in a year ($35*365 days in a year). As a standard pip cost for the pair now is $9.01, that translates into 1,383 pips over the period.

This is a considerable carry; but it is important to remember that the rollover changes with time and you are still exposed to considerable capital losses. It would only take a four pip move against your long position to completely wipe out your carry for a day. This is the burden of leverage and the reason for making carry trade baskets for diversification.

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John Kicklighter is the author of Dynamic Carry Trade Basket, Watch What The Fed Watches, and Forex Trading Weekly Forecast on DailyFX.com

Thank you very much for your help John!

I have an another qustion?

Have you ever looked at the pair EUR/DKK? It's tradeing in a range less then 1000 pips in ten years, but this pair have very sharp springs and upthrust (the biggest was in 2006 making about 4500 pips probably in a moment!). If you go short 1 lot on standard account you get 21$ swap every day. Standard pip cost about cca 2$! So, for example if you have a 20000$ standard account and you want to trade 1 lot without stops(I know is risky, but?) you could survive an upthrust of near 10000 pips! In a year you would get 7665$ only of swap that is 38% profit, without doing nothing and if you calculate every day you will be safe for 10 pips more!

Am I wrong or what?

Thank you!

I haven't even taken a look at the charts recently (I know that this pair moves 500 points with considerable ease), but even by your description of the pair I wouldn't think that it was a safe bet.

You say a $20,000 risk is worth making $7665. That means you would have to be profitable 2.6 times for every time you are wrong just to break even. That is a bad winning percentage over time. What's more, to make the $7665, you would have to hold this dangerous trade for an entire year. While you are holding the trade to collect interest, you could see a margin call within 10 days of normal trading ranges.

And, with that all in mind, you further have to consider the central banks will change with time. So, if the Danish or US central banks change rates, you positive rate position could easily become a negative one.

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John Kicklighter is the author of Dynamic Carry Trade Basket, Watch What The Fed Watches, and Forex Trading Weekly Forecast on DailyFX.com