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March 10, 2007

The Carry Trade

The carry trade is a strategy that many investment managers have been using for some time, and the amounts of money involved in this trade are astronomical. The Carry Trade is basically this: investors borrow yen in Japan where the interest rate is only .5%, and then convert this yen into US dollars in the Foreign Exchange Market. This change causes a subsiquent decrease in the value of the yen, which is advantageous because when you go to buy back your yen to pay the loan it will cost less to get yen. The US dollars are then used to purchase US securities or bonds (which have a yield near 5%, much great than the .5% and with almost no risk).

After the market drop last week many investors that have been using the carry trade have been unwinding it (selling securities and paying back their loans). The unwinding of the trade has caused the yen to increase in value by almost 4% in the past two weeks, a massive move by currency standards. No one really knows exactly how much money is involved in the carry trade, but some estimate it at around $1 trillion. This could make owning yen a very attractive thing, and it may be a very bad thing for those with assets in US dollars. Similar decreases have been seen in the British Pound Sterling. No one knows how long the process of people unwinding their trade will last, but one thing is for certian, the value of the US dollar is going to face serious devaluation pressure vs. the yen until the majority of the trades are unwound.

Posted by jkill at March 10, 2007 04:45 PM

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