A term many individual investors have not heard until this week and now cannot get out of their head is “carry trade”. This refers to a strategy that currency traders have been implementing for several years with the Japanese Yen. The goal is to borrow money at a low interest rate, convert the money into a different currency, and invest the borrowed money into a higher yielding bond.
For years, the interest rate in Japan was 0% and offered traders the ability to borrow in Yen and convert the money to US Dollars. An example would be a trader borrowing Yen at 0.25% (the current interest rate set by the Bank of Japan) and reinvesting that money into a 10-year treasury US bond at 4.52%. The numbers speak for themselves and it is not difficult to figure out why this has been such a popular strategy with currency traders.
Over the past there have been a number of reports suggesting traders will be looking to unwind the Yen carry trades. As the Yen rallies and the US Dollar falls, the traders implementing the Yen carry trade could run into trouble and even lose money. The unwinding would result in buying back of the Yen and selling of the other currencies. There are concerns this action could result in a liquidity crunch worldwide.
The US Dollar, which has been in a downtrend since peaking in 2002, will likely continue its slide lower. At the same time, the Japanese Yen had one of its best weeks in a long time, rallying 3.7%. From a technical viewpoint, the Yen broke above an important resistance level that spurred on more buying to end the week. So if the unwinding of the Yen carry trades continues, how can the individual investor hedge their portfolio or better yet, profit from it?
Rydex Investments offers the CurrencyShares exchange-traded funds for investors who do not have access to a currency trading account. If you believe - like I do - that the Yen has more room to move on the upside, the CurrencyShares Japanese Yen Trust (FXY) is your ticket. Over the last week FXY has gained 3.7% as the S&P 500 fell over 4%. Of the other currencies that Rydex offers ETFS, the Swiss Franc is currently yielding the second lowest interest rate. This led to a 1.2% gain in the CurrencyShares Swiss Franc Trust (FXF) during the last week.
The debate between further unwinding of the Yen carry trade will go on for weeks if not longer. If you would like to participate in the unwinding the two best ETF options are FXY and FXF. Even if the large unwinding does not take place, both ETFs should be able to perform well with the US Dollar in a continued downtrend. Carry trade or not, these two ETFs are the best options for investors looking for a way into foreign currencies.
Disclosure: Author has no position in funds mentioned
This article was written by