Tuesday, April 15, 2014

Is the Yen Carry Trade about to be dismantled? | The study of economics is not a science

Please note that as this coming Friday (Good Friday, 18th April) is a holiday for all important Forex markets, there will be no OmiCronFX commentary on that day.

The “Carry trade” is the name given to the practice of attempting to borrow money in low cost environments and invest it, or loan it out, in high return situations. Depending on the combination of funding currency and carry instrument chosen, the level of risk is either increased or limited. As is normal, the higher the risk assumed the greater the return the investor would expect to attain.

The operation of the carry trade can have an effect on currency exchange rates. It tends to drive up the value of currencies in those regions where high interest rates exist, and drive down rates where interest is low.

Above is a schematic of the makeup of the carry trade. It is not cast in stone, and indeed it changes from time to time. Right now, for example, there is a suspicion that the carry trade in Yen crosses is in the course of being dismantled. This should have the effect of strengthening the Yen. The reason for this is that some investors believe that the ultra-low interest rate environment in Japan might be in danger of coming to an end.

If this is true, the depreciation of the Yen, which has been in train since late 2012, might be about to come to an end. In that case the USDJPY chart could be about to undergo a reversal from a dominant rising trend to one that is in decline.

The study of economics is not a science

The study of economics is not a science. Note that I did not write “exact science”. It is not a science at all. It is a set of beliefs that are held by individual practitioners and invoked under any and all conditions. Economists are Keynesians, Monetarists or follow the Austrian School in the same way as the devout adhere unquestionably to Mohammed or Christ or L. Ron Hubbard. Economists cannot agree among themselves on the right course of action under any given set of circumstances and they most certainly cannot predict what will happen in the future.  

This should be of concern to those who subscribe to fundamental analysis of stocks, bonds and other investments, including Forex. Those who rely on technical analysis are likely to be somewhat more focused, but the state-of-the-art here is also one of flux. Up front and centre at present is the place that computers have to play in developments. Automation is now a requirement for price action research, for learning, for trade entry and management, and for testing assumptions and determining the optimum values for the parameters to be used in algorithmic routines.

That is what we do at OmiCronFX.

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