Carry-trade making a comeback

Bloomberg has a nice article on the return of the carry-trade:

The carry trade is making a comeback after its longest losing streak in three decades.

Stimulus plans and near-zero interest rates in developed economies are boosting investor confidence in emerging markets and commodity-rich nations with interest rates as much as 12.9 percentage points higher. Using dollars, euros and yen to buy the currencies of Brazil, Hungary, Indonesia, South Africa, New Zealand and Australia earned 8 percent from March 20 to April 10, that trade’s biggest three-week gain since at least 1999, data compiled by Bloomberg show.

It's still too early but I would be really careful with countries undergoing capital inflows due to currency carry-trades. The problem isn't that they are bad per se; rather it is the fact that carry-trades can unwind rapidly and crush non-speculators.

Carry trades were profitable for most of the past three decades. They produced average annual returns of 21 percent in the 1980s with no down years, the best of four commonly used currency strategies, according to ABN Amro Holding NV indexes.

I remember having an argument on a message board with someone about the point above. He/she argued that carry trades were profitable for long periods of time. He/she was investing in some ETF or maybe it was a CEF (don't remember) that took advantage of the carry-trade. I was arguing that the carry-trade makes no sense from an economic point of view. It's unstable and there is no free lunch in economics.

Needless to say, anyone playing the carry trade probably suffered massive losses in the last year. Many may have lost a decade worth of returns on a supposedly "somewhat safe" strategy. Unless you are pretty good with currencies, I would be really careful with the carry-trade strategy. The carpet can get pulled out from underneath really quickly.


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