The carry trade loses its lustre

The fundamentals that supported South Africa’s benign status as a carry trade destination have weakened.

- Andrew Duvenage

Given the low-interest-rate environment in South Africa, are there benefits to utilizing a carry trade strategy? Although such a strategy is less applicable than in the past, it continues to exist and cannot be discounted. Essentially, a carry trade is a trading strategy whereby an investor borrows money at a low-interest rate to buy an investment that provides a higher rate of return, in order to generate a larger risk-adjusted profit. It is typically based on borrowing in a low-interest rate currency and converting and investing the borrowed amount into another currency.

The reason that carry trades occur is due to the fact that over time global capital flows seek out higher interest rates, providing support in the form of foreign capital flows into markets with systemically higher interest rates.

Carry trades were a popular trading strategy after the global financial crisis of 2008 and 2009 as capital from the developed world desperately sought out higher yields.

In theory, currencies are supposed to weaken at the rate of the inflation differential between them – the theory of purchasing power parity. Interest rates include the inflation rate within them, which usually more than compensates for the inflation differential, making the carry trade worth doing.