AUDJPY To Increase With Carry Trade

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Includes: CROC, FXA, FXC, FXY, JYN, UDN, USDU, UUP, YCL, YCS
by: D. H. Taylor

Summary

U.S. interest rates will outpace Japan.

Tapering by BoJ will take time.

AU economy to push forward with global expansion.

The carry trade has been mired in a push-and-pull landscape the past few weeks. With interest rates heading higher in the United States, the carry trade should move forward and become a very profitable trade

In the United States the 10-year is yielding 2.575% interest rate. This compares to the 0.010% that the Japanese 10-year is being pinned to by the Bank Of Japan. The Bank has been pressuring the long end to keep interest rates as low as possible for as long as possible. However, the payoff has only been small in comparison to what is really needed to push economic growth forward for Japan.

In the meantime, should you be long USDJPY in the FX market you are long the carry trade. You are borrowing the JPY to buy USD. The differential is paid out to the long, and higher side of the interest trade. In this case, since the USD is higher, you are paid the differential between a bank rate in America versus a bank rate in Japan. By carrying the trade overnight, past the New York fix, you are paid that differential (as opposed to being short the differential paying the other side).

Interest rates are heading higher in the United States. I believe that interest rates are going to head much higher much faster than a lot of other market participants believe.

First, The Federal Reserve is pushing interest rates higher. The yield curve is responding by becoming more normalized with the longer end pushing higher. Wage growth and consumption continue to push the economy forward and jobs are being printed at a healthy rate.

Second, if the Republicans actually get their tax break pushed through, something I am a slight fan of, then the economic activity in the United States will have the opportunity to increase even more. Right now, the tax structure favors American corporations leaving money overseas. Bring those funds into the United States with tax credits and banks will be in a position to lend these funds out and accelerate the economy even more.

Third, the TIC data is showing that foreigners are becoming net sellers of U.S. Treasuries. That data is starting to look highly lopsided. However, the money is staying inside the United States. The rest of the TICS data support a long USD position and long other assets such as the equity markets. But, with net selling taking place in the bond market, there is going to be pressure on price; interest rates are heading higher.

Given these variables, I am very bullish on the American economy and by consequence the carry trade. USDJPY will outperform significantly. It is simple mathematics of being able to borrow money in Japan and deposit those funds into an American bank and earn a differential for nearly zero risk. This will push USDJPY higher.

At the same time, there are other legs to the carry trade, namely AUD, NZD and CAD. All three of these tend to be good terms-sided currencies for the carry. AU and NZ have 10-year yields that are positive over USD. However, AU is sitting just about 25 basis above the U.S. 10-year rate. But, with continued economic development in the United States this will pull these countries forward with their own economy.

Mostly, I see the worst for AU and NZ being behind these economies. This is the very beginning of the growth that will propel their economies forward. This is not linear and it is not straight line. I expect a fair share of ups-and-downs. Mostly, however, I expect the last chart below, AUDJPY, to move higher.

I have been buying on dips via risk/reversals. I am short the puts, long calls, delta of 30/25, respectively. Theta is equal. I am looking over 1% moves on each and then wait for the reload. This trade has worked several times over the past several weeks. I expect continued results.

Disclosure: I am/we are long AUDJPY.

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.

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