Carry Trade Implosion

We live in interesting times. The Wuhan coronavirus has unleashed an unexpected downturns in industrial production, which in turn has pricked multiple asset bubbles. Clever schemes designed to make money from predictable moves are imploding everywhere.

This is particularly evident in the so called carry trade, where speculators borrow low interest currencies to finance asset purchases denominated in high interest currencies. People have borrowed Yen and Euro to buy the US stock market and speculative assets such as Bitcoin.

While this may seem like a great idea, it is inherently unstable and risky. It only works as long as the risky assets appreciate in value. When the bubbles created by carry trade eventually pop, there's tremendous pressure to unwind positions. Risk assets must be sold, and borrowed currencies must be bought. As a consequence, low interest currencies such as the Yen and the Euro explode higher while risk assets implode. When the dust finally settles, low interest currencies end up higher than where they started, and risk assets end up lower, the exact opposite of what the central planners had in mind when they implemented their low interest policies.

By European Central Bank - www.ecb.int, Public Domain, Link