Here’s how you can profit from interest rate movements with carry trades and currency ETFs

  • Turmoil in the rates market offers opportunities in currency trading
  • The USD long trade has been the theme this year, but can it continue?
  • Stockhead reaches out to Betashares Chief Economist David Bassanese on how investors can gain currency exposure via ETFs

The ASX 200 is down 5% this year, but here’s a trade that would have done you very well over the past 12 months.

If you had bought USD (and sold AUD) a year ago and converted back to AUD today, your return would be around 10%.

It would have reached 20% a few weeks ago had it not been for the sharp drop in the USD following the US inflation report.

Source: Market Observatory

Over the past 12 months, the almighty USD has appreciated against all major currencies, including the AUD.

This decision showed us that the value of a currency is closely linked to interest rate differentials between countries.

Venture capital is always looking for higher yielding assets and that’s exactly what happened with the USD this year.

Since March, the US Fed has raised its key rate by 3.75% – from 0.25% to 4% – to stifle runaway inflation at home.

And it’s doing it at a pace and size not seen since the 1980s, much faster than its peers.

Here’s a quick comparison of what the major central banks did in 2022.

The US Fed effectively widened the spread between its own rates and those of other countries, attracting capital inflows and “one-way bets” on the US dollar.

“I think the Fed is going to continue raising rates relatively aggressively compared to other countries,” said Betashares chief economist, David Bassanese, Told Stockhead.

“I think the market’s next target would be the slowdown in growth caused by rising interest rates.

“What you might well see in this environment is that the US dollar will remain quite strong, which will not favor the Australian dollar,” Bassanese added.

‘Carrytrade’

Here is another forex trade you could do to extract value from credit spreads.

This is called the “carry trade”.

The idea here is to sell a currency where the rates are lower, against the purchase of a currency where the rates are higher.

As a simple example, if you go long in the USD/AUD forex through a broker (buy USD and sell AUD), you will earn daily interest on your USD balance and pay daily interest on your short balance in AUD.

Since US rates are higher than Australian rates, you will earn what is called “positive carry”.

This daily interest will be earned in your brokerage account until you close your position.

Basically, daily rates (or your net carry) are calculated this way:

Daily Interest = (Long Currency Rate – Short Currency Rate) / 365 x Notional Value of your position

It’s no surprise that the Japanese yen has been the poster child of carry trading for at least the past decade.

With its perpetually ultra-low interest rates of just 0.1%, the Yen is the ideal currency to execute the funding leg (short currency) of this trade.

For example, if you place a long AUD/short JPY forex position, you will accrue daily positive net interest on your position simply because Australian interest rates are higher.

“And if you went long the US dollar funded by the short yen this year, you would have gotten a nice recovery in interest rates, as well as profits from USDJPY currency movements,” Bassanese explained.

“So there’s an example where the carry trade has done very well this year.”

Depending on your position size, this daily carry may be low, but what happens when leverage is used? (Not that we recommend leveraged trading.)

A carry trade is not just about earning interest though. It is also important to note that ultimately you would always experience daily profits or losses on your forex position as the market moves.

More recently, the AUD has increasingly been used as a funding (short) position in emerging market FX trades.

As the RBA moves towards a less aggressive rate hike, Australian dollar-funded emerging market carry trades have increased.

Trades such as HUF/AUD (long Hungarian forint vs. short AUD), PLN/AUD, ARS/AUD give traders huge net positive carry due to rate differentials.

A cheaper alternative via currency ETFs

Betashares offers exchange-traded funds (or ETFs) for ASX investors interested in gaining exposure to the performance of a particular foreign currency against the Australian dollar.

Bassanese explains that these funds offer a cheaper alternative for investors who want to get into the forex markets.

“With these ETFs, you can buy and sell currencies as easily as a stock market.

“It’s just an easy and inexpensive way to gain currency exposure compared to setting up a new foreign currency bank account, for example.

“And on top of that, you can easily get the leveraged exposure that we offer,” he said.

Betashares currently offers five currency funds:

Non-leveraged currency ETFs

BetaShares US Dollar ETF (ASX: USD)

This fund offers an inexpensive way to access the performance of the US dollar against the Australian dollar.

In other words, the fund will be long USD and short AUD, with no leverage.

It’s just a fund. For example, if the US dollar rises 10% against the Australian dollar, the USD return is also designed to rise 10%, before fees and expenses.

Management fees are 0.45% pa

Over the past 12 months, the fund has returned 12.64%.

ETF Betashares British Pound (ASX:POU)

This fund offers an inexpensive way to access the performance of the British pound against the Australian dollar.

In other words, the fund will be long GBP and short AUD, with no leverage.

If the British pound increases by 10% against the Australian dollar, the return of the pound sterling should also increase by 10%, before fees and expenses.

Management fees are 0.45% pa

Over the past 12 months, the fund has returned -6.81%.

Betashares Euro ETF (ASX:EEU)

Again, this fund offers an inexpensive way to access the performance of the Euro against the Australian Dollar.

In other words, the fund will be long EUR and short AUD, with no leverage.

If the Euro increases by 10% against the Australian dollar, the return of the British pound should also increase by 10%, before fees and expenses.

Management fees are 0.45% pa

Over the past 12 months, the fund has returned -6.06%.

Leveraged Currency ETFs

Betashares also offers two riskier leveraged currency funds.

Betashares Strong Australian Dollar Fund (Hedge Fund) (ASX:AUDS)

The AUDS fund aims to provide tailored (or leveraged) exposure to changes in the value of the Australian dollar against the US dollar.

The fund is long AUD and short USD with a leverage of 2x to 2.75x.

AUDS invests in cash and cash equivalents and buys exchange-traded AUD/USD futures to get its matched exposure.

Management fees are 1.19% per annum.

Due to the nature of leverage, this is a risky fund and over the past 12 months the fund has returned -31%.

BetaShares Strong US Dollar Fund (Hedge Fund) (ASX:YANK)

The YANK fund is the opposite of the AUDS fund.

The YANK fund aims to provide tailored (or leveraged) exposure to changes in the value of the US dollar against the Australian dollar.

The fund is long AUD and short USD with a leverage of 2x to 2.75x.

YANK invests in cash and cash equivalents and sells AUD/USD exchange-traded futures contracts to gain its leveraged exposure.

Management fees are 1.19% per annum.

Due to the nature of leverage, this is a risky fund and over the past 12 months the fund has returned +28.82%.

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Any views, information or opinions expressed in the interview for this article are solely those of the interviewee and do not represent the views of Stockhead.

Stockhead has not provided, endorsed, or otherwise taken responsibility for the financial product advice contained in this article.

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