Currency traders watch monitors near a screen, back, showing the Korea Composite Stock Price Index , top left, and the foreign exchange rate between U.S. dollar and South Korean won, top center, at the foreign exchange dealing room of the KEB Hana Bank headquarters in Seoul, South Korea, Tuesday, Aug. 6, 2024. BANGKOK — The mayhem that swept across world markets this week was partly caused by a market strategy known as the “carry trade.
They were jolted by a combination of factors, including dread of a possible recession in the United States, the world’s largest economy, and worries that technology shares have shot way too high this year. But the scale of the declines was exaggerated by the rush to sell U.S. dollars due to carry trade deals that had helped drive markets to record levels.Carry trades involve borrowing at low cost in one currency to achieve higher returns from investments in another currency. One of the most recent examples has been to borrow Japanese yen, expecting the currency to remain cheap against the U.S. dollar and for Japanese interest rates to remain low. The borrowed funds would then be invested in U.S.
Carry trades tend to make the most sense when foreign exchange rates are relatively stable and investors can tap into higher yielding market opportunities, like the recent runups of stock prices in places like the United States. The recent market upheavals obliged traders to cover their debts by buying yen and other carry trade currencies and selling relatively more of the higher risk assets they bought under more favorable conditions.
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