What forex carry trade will be the next to unwind?
Discover the dynamics of carry trades and why the Japanese yen carry trade unwound. Learn which currencies are at risk, with a focus on the Mexican peso potentially being the next to unwind due to rate changes.
Key points
- Carry trades involve investing in high-yielding currencies while financing with low-yielding ones to profit from interest rate differentials
- Japanese yen carry trades unwound due to rising Japanese interest rates, reducing profitability and triggering liquidation
- Forex pairs with the largest overnight funding rate incentives are most at risk during a carry trade unwind
- The Mexican peso, with current rates at 11%, could be next to unwind if Mexican interest rates fall sharply
- During the yen unwind, USD/MXN hit 20.000, indicating potential for similar volatility if Mexican rates decline
WHAT IS A CARRY TRADE?
A carry trade is a trading strategy that seeks to generate daily returns by exploiting interest rate differences between two currencies. Traders invest in a higher-yielding currency, such as the US dollar, and finance this position with a lower-yielding currency like the Japanese yen. The profit arises from the daily interest rate differential between the two currencies. This strategy is popular in the forex market due to its high leverage, allowing traders to control large positions with minimal capital. Carry trades are most effective in stable markets with low volatility, providing consistent, albeit small, daily gains over time.
HOW DOES A CARRY TRADE WORK?
A carry trade works by taking advantage of interest rate differentials between two currencies. Traders borrow a currency with a low-interest rate, like the Japanese yen, and use it to buy a currency with a higher interest rate, such as the US dollar. The goal is to profit from the interest rate difference. Each night, traders earn interest on the high-yielding currency while paying interest on the borrowed currency, netting a daily profit. Since this interest is calculated based on the notional value of the trade, high leveraged traders are able to earn much higher return on their initially invested capital. It is important to note that leveraged trades carry significant risks and losses can exceed deposits. Profits from daily carry can be erased quickly if the price moves against the position.
Learn more about carry trading
WHY DID THE JAPANESE YEN CARRY TRADE UNWIND?
The Japanese yen carry trade unwound because Japanese interest rates are rising while most other central banks are cutting their rates. This shift disrupts the interest rate differential that makes carry trades profitable. As Japanese rates increase, borrowing costs rise, reducing profitability and strengthening the yen—prompting traders to close their positions, which leads to an unwinding effect.
WHICH CURRENCES ARE AT RISK?
Forex pairs with the largest overnight funding rate incentives are also at the greatest risk during a carry trade unwind. These pairs are attractive for carry trades due to their significant interest rate differentials. When interest rates of either currency in the pair change drastically, carry trades can become unprofitable, leading to rapid unwinding and increased market volatility. When trading products with leverage, such as forex, this unwinding can be expedited by margin calls and auto-liquidation.
Check out live swap rates to see which pairs have a positive carry
WILL MEXICAN PESO BE THE NEXT CURRENCY TO UNWIND?
The Mexican peso could be the next currency to unwind as Mexican interest rates, currently at 11%, might fall due to a slowing economy. If Mexican rates drop faster than US rates, the attractiveness of holding MXN long positions will diminish, possibly leading to a sell-off. Traders should closely monitor Mexico’s economic indicators and rate policies.
DOLLAR-PESO HIT 20.000 DURING THE YEN UNWIND
The peso is a currency to watch if carry trade unwinds continue to affect markets. During the yen unwind, USD/MXN hit a 22-month high at 20.000, reflecting significant market movement due to changing interest rate dynamics. If Mexican rates start to decline, the peso may experience similar volatility, impacting its role in carry trades and influencing broader market trends.
How to trade USD/MXN
- Open an account to get started, or practice on a demo account
- Choose your forex trading platform
- Open, monitor, and close positions on USD/MXN
Trading forex requires an account with a forex provider like tastyfx. Many traders also watch major forex pairs like EUR/USD and USD/JPY for potential opportunities based on economic events such as inflation releases or interest rate decisions. Economic events can produce more volatility for forex pairs, which can mean greater potential profits and losses as risks can increase at these times.
You can help develop your forex trading strategies using resources like tastyfx’s YouTube channel. Our curated playlists can help you stay up to date on current markets and understanding key terms. Once your strategy is developed, you can follow the above steps to opening an account and getting started trading forex.
Your profit or loss is calculated according to your full position size. Leverage will magnify both your profits and losses. It’s important to manage your risks carefully as losses can exceed your deposit. Ensure you understand the risks and benefits associated with trading leveraged products before you start trading with them. Trade using money you’re comfortable losing.