Carry Trade — Why Did It Work and Why It Won't Anymore
Carry trade is a kind of Forex trading where
These rate differences would not be so attractive if it was not for the high leverage that allows opening huge positions to earn from those rates. With 1:100 leverage, you could get 450%/year holding a long GBP/JPY position in 2000's. With a higher leverage and a higher rate difference the results are even more impressive. South African rand has 12.0% interest rate associated with it. Buying ZAR/JPY with 1:400 leverage could yield 4600% a year (if you could sustain the potential depreciation of the rand against the yen, of course).
There is no surprise that from 2001 to mid-2007, Forex carry trades were extremely popular. Such currency pairs as GBP/JPY, EUR/JPY, AUD/JPY, and NZD/JPY brought thousands percent of profit through the interest rate difference only; considering that those pairs also rose tremendously during that period, such positions have made some people very rich.
So, what happened in 2007 and why carry trade positions are not very popular nowadays? The global economic crisis spurred by mortgage lending crisis in the USA triggered the growth of global volatility. Central banks had to cut the interest rates and started to focus on stimulus, while
Carry trades did not vanish from the Forex market completely — they just became much less popular and no longer last for years. Now, carry traders prefer to buy at the local bottoms and hold the pair for weeks or even days to gain their interest rate difference. Such situation will probably prevail while the global economic growth remains in danger of another recession.