Interest rate carry trades favour the high yielding currencies

The Bank of Canada surprised the markets yesterday with another 25 basis point rise in interest rates. Swiftly on the heels of an unexpected 25 basis point rise from the Reserve Bank of Australia earlier in the week. The ECB has all but confirmed they will also be raising rates next week by 25 basis points and are likely to signal that they are not done yet. The Bank of England is no exception to the rate-hiking frenzy. Markets are pricing in a further 1 % rise in rates over the coming months as inflation remains persistently strong. 

The 10-year interest rate chart below shows the major 8 currencies' 10-year bond yields. The NZ, GB AU US, and CA all show rates ranging from 3.4% to 4.6%.  The JPY and the Swiss yields are, on the other hand, struggling to get above 1 %.  Now compare this to the City Traders momentum meter which pitches the top 8 currencies against each other. We see the high-yielding currencies at the top and heading higher and low yielders, The CHF and JPY heading lower.

Trading is all about having an edge and exploiting that edge. A Forex trade is a two-dimensional trade. Traders buy one currency and sell another.   If a trader is following the trend, the edge is to buy the stronger currency and sell the weaker. Here, the technical are aligning with the fundamentals. Buying Yen crosses have the edge. Buying any of the high-yielding currencies against the CHF has the edge.  The carry trade, which is where traders exploit the differentials in interest rates should see this edge continue until the inflation story truly gets under control and central banks consider pausing then subsequently dropping their rates.