With the new QE3 announcement, and the Fed stating it will not raise interest rates before 2015, it's likely that the US Dollar will be the new carry trade. The idea is to borrow cheaply in US Dollars and invest anywhere outside of the USD. This will be most felt in emerging markets, which rallied after the Fed announcement.
When you borrow in one currency and invest in another you are exposed to Forex risk. When you complete the investment cycle if the borrowing currency increases it will create a loss. But what happens in the carry trade such as what happened with the Japanese Yen, a several year steady decline in the Yen means that aside from short term fluctuations, overall the Yen is going down, adding to the value of the carry trade. Some traders simply used large leverage to go long USD/JPY (NYSEARCA:FXY). This worked during periods where the USD/JPY was in an uptrend.
Two distinct periods here, from the summer of 1995 to the summer of 1998, the trend was up. The financial crisis of 1998 caused a retracement of many trends (collapse was not USD/JPY issue there was global financial meltdown). So it resumed in late 1999 again, taking a break in 2002 to resume again in 2004.
What made this possible was a near zero interest rate of the Yen, which is now the case with the US Dollar (NYSEARCA:UUP). Not only are rates not likely to increase, with QE3 the Fed will be creating more money which will need to go somewhere. But where?
Stocks rallied on the news, and will continue to boost stocks and emerging markets, says Mark Mobius. If this is going to persist until 2015 and is not a knee jerk reaction to news, could we be at the beginning of a US Dollar Carry trade, as the new borrowing currency?
US Dollar Carry Trade
There are several ways to trade the US Dollar carry trade:
1. Short US Dollars - Also you could go long (NYSEARCA:UDN)
3. If you have the ability, actually borrowing US Dollars from US banks and investing in emerging market bonds and equities
Other commodities that may be affected include those such as natural gas (NYSEARCA:GAZ), corn (NYSEARCA:CORN), and coffee (NYSEARCA:JO). Basically, any physical asset such as commodities should see a rally from a US Dollar carry trade, especially since the US Dollar is the world reserve currency and oil is priced mostly in US Dollars.
This trade is on a doctrinary level. Based on this doctrinary approach, traders should develop a specific trading plan on a strategic and tactical level.
(Forex Risk Disclosure - Click here to read)
The risk of loss in trading foreign exchange markets (FOREX), also known as cash foreign currencies, or the FOREX markets, can be substantial.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.