The last post suggested weakness in the US dollar was forthcoming. Factors noted were:
· Excessive borrowing by the US government.
· The risk of losing Federal Reserve Independence.
· A forced restructuring of US bonds held by foreigners, also known as the possible Mara Lago Accord.
· Rumors of a tax on foreigners buying bonds.
· A loss of “Good Faith” from countries that hold US debt.
These are all valid reasons for confidence in the US dollar to decline, for its value to go down.
More than a few people cited disagreements with this view, citing the US dollar’s position as the global reserve currency as the thing that will allow it to keep its value. They thought the idea was crazy.
Regarding US dollar reserve status, there is no disagreement here. Also, the prediction was never for the US Dollar to melt down. Perhaps they took it wrong. The US dollar is not heading for a currency crisis, a violent move downwards.
But few can claim the US dollar is going up in value.
A US dollar that is unlikely to go up creates a trading strategy that can be very attractive called the “Carry Trade”. A carry trade is based on interest rate differences between bonds or currencies, where the interest difference produces a regular stream of income.
When an investor engages in a carry trade, the interest difference between borrowing and investing determines the return. If nothing happens, nothing changes, it is a steady return. This is why the Carry Trade is called the “Trade of nothing happening”.
It is like being a student and getting a student loan that carries a low interest rate. Instead of paying for college, you might invest it in a higher yielding asset or an asset that generates a good return like stocks, or crypto, or high yielding bonds. The difference between what you pay for the student loan (low interest rate) and what you get on the investment (higher interest rate) is the carry.
Once again, if nothing happens, that is, the exchange rate does not change a lot (US dollar up in value) or changes by less than the interest rate difference, the trade is profitable. Even better, if an investor borrows in US dollars and invests in a higher yielding vehicle, and the US dollar goes down in value the investment return is increased when that borrowing is paid off.
Right now, US interest rates versus many emerging market interest rates are low, and the dollar does not seem to be showing possible strength. For investors with a certain risk tolerance, it may make sense to borrow money in something like the US dollar or another low-interest rate vehicle and invest that borrowed money at a higher rate.
Such trades are normally used by wealthy or institutional investors. Crypto is transforming this by offering vehicles to create carry trades for small amounts of capital. Thanks to crypto and blockchain the carry trade is no longer only for the wealthy or big institutions.
In the end, the ideal trade is when the currency an investor borrows in stays stable or goes down. If it goes down, the amount of money from the interest bearing side that has to be paid back is less and the investment return is enhanced.
Now back to the dollar. Whatever you say about the US dollar, it doesn’t seem probable it is increasing in value. Unchanged to down is a better bet. If this is the case, perhaps the US dollar, be it crypto of fiat, is the right currency to fund a carry trade.
This blog is for educational and informational purposes only, covering general market trends, industry developments, and asset features. Nothing herein is investment advice, a solicitation, or a recommendation to buy or sell any assets. Etherfuse and its guests may hold stakes in some or all of the assets discussed.
