Bernanke Cements the ‘Carry Trade’

When the dust settles from the recent market volatility, the long-lasting effect of the US Federal Reserve’s decision to commit to zero-rates until mid-2013 will be the dominance of carry. One of the risks of the ‘carry trade’ is when the short leg borrowing cost suddenly jumps. The Fed’s commitment to hold cash rates at zero for two years takes this risk out of the equation…

Carry is popular with hedge funds, bond investors and retail investors seeking income. Even equity investors with high dividend tilts are arguably chasing carry. The popular trades are Junk Bonds, Emerging Market Debt, yield curve flatteners and high-yielding currency trades. Expect these markets to outperform over the next two years as the weight of money piles in.

Is this what the Fed wants from a policy standpoint? I doubt it. The objective of the policy is to encourage US-based job creating investment. Most carry opportunities now reside outside the US – for example EMD, European Government Bonds and the high yielding currency group. Sending money offshore runs counter to Bernanke’s wishes.