Relative Values: The Carry Trade In 2014

By Kathleen Brooks | More Articles by Kathleen Brooks

Since the Fed embarked on its tapering programme in late 2013 the market has started to focus on the potential for a normalisation in monetary policy from the world’s most important central bank. Where the Fed goes others tend to follow and one of the chief themes of this year is trying to determine who will follow the Fed and move away from ultra-lose monetary policy in the coming months.

This has required careful monitoring of global central banks and economic data and in recent weeks there has been some clear divergences in market perceptions about the path of monetary policy going forward. Two camps have started to emerge: the haws and the doves. Of course, this is all relative, the banks included in the hawkish camp are not traditionally hawkish, however they do seem less likely to make policy more accommodative in the coming months.


New Zealand: Rising house prices could force the RBNZ to be the first central bank to hike rates in the G10 space. Last week’s CPI data inched up to 1.6% from 1.4%, which is still low, but moving in the right direction. This could trigger a rate rise as early as March. Next week’s RBNZ meeting will be crucial to determine just how close the Bank is to hiking interest rates.

UK: After the drop in the unemployment rate to 7.1%, the market once again doubts the Bank of England’s forward guidance. If the BOE believes that there are upside risks to its growth forecast and unemployment is falling sharply, why would it hold off from raising rates? The market may continue to price in the potential for earlier than expected rate hikes until next month’s Inflation Report.

Fed: The Fed seems to be sticking to its tapering programme even though December payrolls were dismal.


Japan: The BOJ remains committed to its “QE Eternity” programme, it may have to do more to reach its 2% inflation target this year, especially if the planned rise in the sales tax in April hurts the economic recovery.

Canada: The BOC has taken an uber-dovish stance after some weak economic data of late. The BOC revised down inflation and GDP data for this year. It has also called for a weaker CAD.

ECB: The spike higher in Eonia rates, which could constrict lending to the economy, combined with weak inflation could trigger further policy action from the ECB in the coming months.

RBA: Although the RBA is unlikely to cut rates any time soon after Q4 2013 inflation jumped to its highest level since Q1 2012, the RBA is still trying to talk down the currency. It has called for a rate of 0.8500 in AUDUSD. 

The FX implications:

The list above is in an approximate order, i.e., we see the BOJ as the most dovish central bank in the G10 and the RBNZ looks like the most hawkish. Relative monetary policy is a pillar of the FX market, and we think it could become one of the major themes this year.

The crudest way to look at this is that the hawkish currencies may appreciate, while the dovish ones may struggle. On a broad basis then, we look for a stronger USD this year and a weaker yen. It also may be worth keeping an eye on NZDJPY and GBPCAD.


This has been a popular carry strategy in the past, as you can see in the chart below; it tends to move in line with the NZ- Japan short-term yield spread. From a technical perspective, NZDJPY is consolidating between 85.50 and 87.50. A hawkish RBNZ next week could trigger a break out to the upside in this pair. Key support lies at 85.50 – recent low, and then 85.15- the 50-day sma. On the upside, resistance lies at 87.50 – the high from 15th Jan, above here opens the way to 90.50 – the highest level since 2007.

Figure 1:



This cross has reached its highest level since 2009, and the bias is higher after the break above the 100-month moving average at 1.8047. On the long term charts this cross looks constructive. The CAD looks weak right now, and the path of least resistance for this pair seems to be higher. Due to this, and the contrasting central bank stances, we could see back to the 2009 highs at 1.90 then the high from 30th June 2009 at 1.9300 in the coming months.

Figure 2:


NB: It’s worth noting that there are other factors that move the market and the carry trade is a notoriously risky business, so watch out and be sure to protect yourself if you use this strategy.