Carry Trades at boiling point

Carry trades have continued to soar higher over the past week. There may still be room for the upside, but the overall dangers are now running at extreme levels.

The overall liquidity conditions are tightening. As central banks raise interest rates, it will gradually slow global liquidity growth. Global lending standards being gradually tightened will cause an important impact on currency market.

There are now very clear warning signs that carry trades are being caught up in the craze for wider asset-price inflation. It shows a sign that markets are ignoring the fundamentals and gaining ground simply because they have been rising.

As credit conditions tighten, there will be an outflow of longer-term capital which will leave asset prices increasingly dependent on more unstable flows to maintain current levels. High-yield currencies and carry trades will also be even more reliant on unstable flows to make further progress.

Given these conditions, there is now an increasing threat that only a small shock will trigger a huge adjustment in global markets and a rapid reversal in carry trades. One possible trigger reminds the collapse of a prominent hedge fund.

So use your margin accordingly when you long a hedge position. EUR/CHF is on a possible reversal righ now and GBP/JPY is at its extreme.