Time to Bail on the Carry Trade

• Tweet
• Pin It

Well, it was a good run while it lasted.

The positive news on the EUR debt a few weeks ago indicated a strengthening EUR and a weakening USD, which we used to our advantage with an AUD/USD carry trade. We have been focusing on this trade for a few weeks now. After the initial breakout, we watched the markets move sideways on mixed news. As I've said, major red flags were news of the European debt becoming a problem again, any other news that would strongly weaken the EUR, or any news that would strongly strengthen the USD. If you have been watching the news the past week then you know Europe is at it again.

The situation in Greece was the first sign that things were not as settled as traders had hoped.

The refusal by the general population and a large segment of government to accept necessary cut backs almost derailed the deal and still might. In fact, Greece has already moved with the resignation of one prime minister in an attempt to form a new coalition government. Also, Italy is now drowning in debt and really is too big to bailout. Add in the recent rumors of Germany and France discussing breaking up the current Euro-Zone, and Europe might be in the biggest mess we have seen to date.

These problems are huge; and even dwarf the debt issues of Ireland and Portugal that both countries face.

Stock market reaction to this news has all been negative; a strong sense of pessimism and fear has set in. Italy is one of the largest economies in Europe and their struggles are a double edged sword. A bailout may well collapse the European economy; the belief among many economists is that Germany and France do not have the ability to bail out Italy. Prime Minister Silvio Berlusconi's resignation has led to celebration on the street of Rome, but there are still fears of long term political instability. This is the last thing the markets in Europe need right now.

While European Commission President Jose Manuel Barroso released a stern warning on how dangerous it would be to split the Euro-Zone, Germany and France, the two largest economies in Europe, are discussing just that. While no one wants to the Euro-Zone as a sinking ship, it is safe to say that Europe is in for some rough seas ahead.

Greece struggling to accept the debt deal is hard enough, but to have Italy facing the point of no return couldn't hit at a worse time. There is little question that the EUR is going to continue to drop until these problems are resolved; if they even can be resolved. This is the pessimistic outlook that will continue to drive markets down. Earlier, we thought the debt issues were under control with Greece, but clearly that is not the case. That experience is only going to make it harder to convince traders that any future deals are going to bring about the stability promised.

What does all of this news mean?

It means if you have not already closed out our carry trade, now is definitely the time. There is no sign of a quick solution to Europe’s debt crisis. If anything, the news indicates that worse is yet to come. This means that the EUR as a currency is going to fall across the board and possibly fall steeply.  Any more negative news will speed up that descent. Based on recent weeks and the back and forth of news reporting, it is hard to know if any good news would even have a positive effect.

The weakening EUR means a much stronger USD.

This is not what we want for the AUD/USD trade. The strength gained by the USD working against us will be far stronger than the interest rate differential. We do not want a strong USD for this trade, but there is no sign of the markets reversing direction now. This means we are not watching for any news fishing for stronger EUR or weaker USD news. At this point, we are out of the trade and looking for new opportunities.  Stay tuned because some fantastic profit opportunities are likely to emerge from this volatile situation.

Good investing,

Jason Fielder

facebook   twitter   linkedin   reddit   email