HIBOR Plunge Gives Wings to Carry Trades, Sustainability in Question

Tuesday, 07/03/2023 | 11:39 GMT by Arnab Shome
  • The latest Hibor plunge has opened many doors for carry trades.
  • Drew Niv: "a great trading opportunity, but these windows open for a short period."
FX Trading

Carry trading has been a popular strategy in the world of forex trading for traders looking to generate income through interest rate differentials. Although many long-term opportunities for such trades are available, the recent plunge in HIBOR rates has put this strategy back in popularity.

The latest Hibor and Libor rates gap is not the only carry trade opportunity. The continued low interest of the Japanese yen at sub-zero makes it the most attractive option for carry traders.

However, the strategy is not immune to risks. As the global economy remains uncertain and market conditions remain volatile, many brokers are investigating whether carry trading can be a source of stability and a way to mitigate losses during recessions.

"In the short term, [Hibor plunge] is a great trading opportunity. Historically, these windows open for a short period. As the HKD peg always held, so arbitrage traders generally win here and bring rates to alignment pretty fast. However, with geo-political tensions if they boil over in Taiwan then all bets are off," Drew Niv, the CEO of TraderTools, told Finance Magnates.

Versatile Trading Tool

Carry trading is a forex trading strategy that involves borrowing money at a low-interest-rate currency and investing it at a high-interest-rate currency. The goal is to earn the difference in interest rates, referred to as the 'carry', as income. This strategy is applicable in both rising and falling markets, making it a versatile trading tool.

Carry trading can assist brokers during recessions. Risk-averse investments are in high demand during recessions as traders seek ways to protect their capital. This strategy can provide a solution for brokers because the interest rate differential income can offset any losses from price movements in the forex market.

Furthermore, carry trading can be used to generate consistent returns in a low-yield environment, providing brokers with a source of stability.

Drew Niv, CEO of TraderTools

However, traders need to be opportunistic to execute the carry trade strategy. The recent drop of Hibor, one-month interbank funding costs for the Hong Kong dollar, from a peak of 5.08 percent in early December have opened up opportunities for carry trades. The plunge has created the widest spread between Hibor and Libor since 2007.

"Carry trade has two elements to profit: from the rate differential and/or the movement in favor of the higher-yielding currency in the pair. Some traders pick the highest yield and go with it. Some also play the movement, which, in past few months, have been the gap in yield between EUR/JPY and AUD/JPY. These currencies moved up even against the USD and so more so against the yen," Niv added.

Yen yield gap

A survey conducted by Moomoo Financial Singapore revealed that 66 percent of Singapore investors want to trade more for potentially better gains and returns, while 81 percent intend to allocate more funds to their trading accounts. This rise in the retail traders' sentiment and the open opportunities will grow interest in the carry trade strategy.

Jürgen Molnar, the Chief Capital Markets Strategist at RoboMarkets
Jürgen Molnar, the Chief Capital Markets Strategist at RoboMarkets

Carry trades are appealing to risk-averse investors during recessions and periods of low volatility because they provide the potential for consistent returns while limiting exposure to market volatility. During recessions, investors seek low-risk investments in order to protect their capital. Carry trades can provide a solution because the interest rate differential income can offset any losses from price movements in the Forex market. Furthermore, carry trading can generate consistent returns in a low-yielding environment, providing stability for risk-averse investors.

"Carry trades are in principle 'normal' currency trades, and for brokers, the motivation for the trade is indistinguishable," said Jürgen Molnar, the Chief Capital Markets Strategist at RoboMarkets, to Finance Magnates. He added that "Professional brokers manage their treasury risks in a professional way, and as such, carry trades do not require special measures. All professional brokers are interested in and are welcoming trading volumes regardless of motivation or trade ideas. After all, this is their core business."

Dangers of Short-Term Volatility

While carry trading has several advantages, it is not without risks. Currency devaluation is the most significant risk, as a drop in the value of the currency borrowed can result in substantial losses. Furthermore, changes in central bank policies and abrupt shifts in the global economy can rapidly impact interest rates, making carry trading a risky strategy.

"As the carry trade earns money overnight, exposures are long-term in nature. Risks and additional opportunities lie in the movement of FX rates," said Molnar. "However, short-term volatility can be dangerous if margin limits are breached. The leverage should be chosen to be safe in terms of the observed short-term volatility. The safety margin in setting leverage is determined by the risk appetite and/or the loss-bearing capacity of the investor."

There are also risks from macroeconomic and geopolitical events that can distort the expected long-term rate of development in the medium term. These risks can be mitigated by a judgment call to select countries with a 'more stable' environment for the currency pairs.

As for executing carry trade with HKD pairs, Hong Kong central already intervened to prevent the plunge of the currency. If the currency of the autonomous jurisdictions jumps significantly, it can make massive dents in short sellers' bets.

"We are of the view that FX intervention has yet to fully run its course, as US-HK rate spreads remain very wide," Cindy Keung, an economist at OCBC Wing Hang Bank in Hong Kong, told Bloomberg.

However, forced interventions have adverse effects on the economy. If the Hong Kong Monetary Authority (HKMA) continues its intervention in the FX market, the city's struggling economy may face headwinds.

"Higher rates will be marginally negative for property and stock markets, as well as hurting loan demand," Stephen Chiu, the Chief Asia FX & Rates Strategist at Bloomberg Intelligence in Hong Kong, explained.

Brokers must carefully evaluate their risk tolerance and the potential impact of economic and market conditions on their trading strategy when considering carry trading as a way to mitigate losses during recessions.

It is also critical to consider how interest rate changes and currency depreciation affect the overall return on investment.

Hedging techniques, such as stop-loss orders, can help reduce the risks associated with carry trading. Brokers should consider the impact of transaction costs on their returns, as these costs can quickly eat into any carry trade income.

"The Yen Has No Competitor"

Though Hibor plunge made HKD short a lucrative option, the long-standing carry trading opportunity lies elsewhere. The continued low interest of the Japanese yen, at sub-zero, makes it the most attractive option for carry traders.

Fat FX spreads over yen

"The real opportunity is in yen crosses and that isn't going away anytime soon and getting better by the day as yen rates stay put while everyone else rises," TraderTools' Niv added. "The more professional clients are also playing EM currencies against the yen but very few retail brokers offer those. There are double-digit yields there without leverage."

Another advantage of the Japanese yen is that the currency has maintained a stable yield for years, whereas the yield of other currencies has changed within a significant range.

Several other currencies have also maintained low interest for years, but the lack of liquidity of those currencies makes them obsolete options for executing the carry trade strategy. The Japanese yen and Swiss franc are two of the most popular currencies for carry trade strategy.

Yen's Unchanged yield

Challenges to Brokers

To facilitate carry trade, brokers need to offer proper rollover rates on overnight positions. However, in today's markets, rolls are not competitive with most brokers and many do not even offer charging rolls. These trading conditions worked with aligned rates but do not fit when there is a yield gap in the market.

Moreover, brokers need to realign risk management by actually hedging trades. The usual risk management practice with bucket game strategy does not apply to carry traders.

Further, for the HKD carrying trading opportunities, the peg of the currency is another risk to the brokers.

Adam Blemings, Head of Trading at IG
Adam Blemings, Head of Trading at IG

"HKD is a pegged currency but there has been talk of the peg being at risk. Clearly, the last de-peg was the Swiss Franc, which didn’t go well for most FX brokers, at least for those who did not hedge," said Adam Blemings, the Head of Trading at IG. "However, the peg debate has been going on for a while now and HK/China have the resources to defend it if they choose to."

"Most brokers margin HKD fairly aggressively, which limits the carry trade opportunity and protects brokers from some of the risks of a de-peg event."

And indeed, brokers are already taking this approach. From 9 March, Forex.com Japan will increase the margin rate for five HKD currency pairs: the current margin is set at 15 percent, whereas the new requirements will increase that to 20 percent. Further, if the trade size exceeds $10 million, the margin requirement would be 30 percent, and for over $20 million it will be 40 percent.

"De-peg introduces potential from bad debt/credit issues. Therefore the margin rates and account limits need to be set appropriately," Blemings added.

The (Recent) Future of Carry Trades

The Hibor plunge has indeed opened a massive opportunity for carry trades. However, traders should be cautioned as the HKMA is intervening in the market, and any slight policy change might majorly impact open positions.

For carry traders, the stable sub-zero interest rate of the yen seems the most resilient option. Even with the Hibor-Libor yield gap opportunity, carry traders should consider their trading options with stable low-yield currencies, JPY ad CHF.

Solomon Oladipupo and Jeff Patterson contributed to this article.

Carry trading has been a popular strategy in the world of forex trading for traders looking to generate income through interest rate differentials. Although many long-term opportunities for such trades are available, the recent plunge in HIBOR rates has put this strategy back in popularity.

The latest Hibor and Libor rates gap is not the only carry trade opportunity. The continued low interest of the Japanese yen at sub-zero makes it the most attractive option for carry traders.

However, the strategy is not immune to risks. As the global economy remains uncertain and market conditions remain volatile, many brokers are investigating whether carry trading can be a source of stability and a way to mitigate losses during recessions.

"In the short term, [Hibor plunge] is a great trading opportunity. Historically, these windows open for a short period. As the HKD peg always held, so arbitrage traders generally win here and bring rates to alignment pretty fast. However, with geo-political tensions if they boil over in Taiwan then all bets are off," Drew Niv, the CEO of TraderTools, told Finance Magnates.

Versatile Trading Tool

Carry trading is a forex trading strategy that involves borrowing money at a low-interest-rate currency and investing it at a high-interest-rate currency. The goal is to earn the difference in interest rates, referred to as the 'carry', as income. This strategy is applicable in both rising and falling markets, making it a versatile trading tool.

Carry trading can assist brokers during recessions. Risk-averse investments are in high demand during recessions as traders seek ways to protect their capital. This strategy can provide a solution for brokers because the interest rate differential income can offset any losses from price movements in the forex market.

Furthermore, carry trading can be used to generate consistent returns in a low-yield environment, providing brokers with a source of stability.

Drew Niv, CEO of TraderTools

However, traders need to be opportunistic to execute the carry trade strategy. The recent drop of Hibor, one-month interbank funding costs for the Hong Kong dollar, from a peak of 5.08 percent in early December have opened up opportunities for carry trades. The plunge has created the widest spread between Hibor and Libor since 2007.

"Carry trade has two elements to profit: from the rate differential and/or the movement in favor of the higher-yielding currency in the pair. Some traders pick the highest yield and go with it. Some also play the movement, which, in past few months, have been the gap in yield between EUR/JPY and AUD/JPY. These currencies moved up even against the USD and so more so against the yen," Niv added.

Yen yield gap

A survey conducted by Moomoo Financial Singapore revealed that 66 percent of Singapore investors want to trade more for potentially better gains and returns, while 81 percent intend to allocate more funds to their trading accounts. This rise in the retail traders' sentiment and the open opportunities will grow interest in the carry trade strategy.

Jürgen Molnar, the Chief Capital Markets Strategist at RoboMarkets
Jürgen Molnar, the Chief Capital Markets Strategist at RoboMarkets

Carry trades are appealing to risk-averse investors during recessions and periods of low volatility because they provide the potential for consistent returns while limiting exposure to market volatility. During recessions, investors seek low-risk investments in order to protect their capital. Carry trades can provide a solution because the interest rate differential income can offset any losses from price movements in the Forex market. Furthermore, carry trading can generate consistent returns in a low-yielding environment, providing stability for risk-averse investors.

"Carry trades are in principle 'normal' currency trades, and for brokers, the motivation for the trade is indistinguishable," said Jürgen Molnar, the Chief Capital Markets Strategist at RoboMarkets, to Finance Magnates. He added that "Professional brokers manage their treasury risks in a professional way, and as such, carry trades do not require special measures. All professional brokers are interested in and are welcoming trading volumes regardless of motivation or trade ideas. After all, this is their core business."

Dangers of Short-Term Volatility

While carry trading has several advantages, it is not without risks. Currency devaluation is the most significant risk, as a drop in the value of the currency borrowed can result in substantial losses. Furthermore, changes in central bank policies and abrupt shifts in the global economy can rapidly impact interest rates, making carry trading a risky strategy.

"As the carry trade earns money overnight, exposures are long-term in nature. Risks and additional opportunities lie in the movement of FX rates," said Molnar. "However, short-term volatility can be dangerous if margin limits are breached. The leverage should be chosen to be safe in terms of the observed short-term volatility. The safety margin in setting leverage is determined by the risk appetite and/or the loss-bearing capacity of the investor."

There are also risks from macroeconomic and geopolitical events that can distort the expected long-term rate of development in the medium term. These risks can be mitigated by a judgment call to select countries with a 'more stable' environment for the currency pairs.

As for executing carry trade with HKD pairs, Hong Kong central already intervened to prevent the plunge of the currency. If the currency of the autonomous jurisdictions jumps significantly, it can make massive dents in short sellers' bets.

"We are of the view that FX intervention has yet to fully run its course, as US-HK rate spreads remain very wide," Cindy Keung, an economist at OCBC Wing Hang Bank in Hong Kong, told Bloomberg.

However, forced interventions have adverse effects on the economy. If the Hong Kong Monetary Authority (HKMA) continues its intervention in the FX market, the city's struggling economy may face headwinds.

"Higher rates will be marginally negative for property and stock markets, as well as hurting loan demand," Stephen Chiu, the Chief Asia FX & Rates Strategist at Bloomberg Intelligence in Hong Kong, explained.

Brokers must carefully evaluate their risk tolerance and the potential impact of economic and market conditions on their trading strategy when considering carry trading as a way to mitigate losses during recessions.

It is also critical to consider how interest rate changes and currency depreciation affect the overall return on investment.

Hedging techniques, such as stop-loss orders, can help reduce the risks associated with carry trading. Brokers should consider the impact of transaction costs on their returns, as these costs can quickly eat into any carry trade income.

"The Yen Has No Competitor"

Though Hibor plunge made HKD short a lucrative option, the long-standing carry trading opportunity lies elsewhere. The continued low interest of the Japanese yen, at sub-zero, makes it the most attractive option for carry traders.

Fat FX spreads over yen

"The real opportunity is in yen crosses and that isn't going away anytime soon and getting better by the day as yen rates stay put while everyone else rises," TraderTools' Niv added. "The more professional clients are also playing EM currencies against the yen but very few retail brokers offer those. There are double-digit yields there without leverage."

Another advantage of the Japanese yen is that the currency has maintained a stable yield for years, whereas the yield of other currencies has changed within a significant range.

Several other currencies have also maintained low interest for years, but the lack of liquidity of those currencies makes them obsolete options for executing the carry trade strategy. The Japanese yen and Swiss franc are two of the most popular currencies for carry trade strategy.

Yen's Unchanged yield

Challenges to Brokers

To facilitate carry trade, brokers need to offer proper rollover rates on overnight positions. However, in today's markets, rolls are not competitive with most brokers and many do not even offer charging rolls. These trading conditions worked with aligned rates but do not fit when there is a yield gap in the market.

Moreover, brokers need to realign risk management by actually hedging trades. The usual risk management practice with bucket game strategy does not apply to carry traders.

Further, for the HKD carrying trading opportunities, the peg of the currency is another risk to the brokers.

Adam Blemings, Head of Trading at IG
Adam Blemings, Head of Trading at IG

"HKD is a pegged currency but there has been talk of the peg being at risk. Clearly, the last de-peg was the Swiss Franc, which didn’t go well for most FX brokers, at least for those who did not hedge," said Adam Blemings, the Head of Trading at IG. "However, the peg debate has been going on for a while now and HK/China have the resources to defend it if they choose to."

"Most brokers margin HKD fairly aggressively, which limits the carry trade opportunity and protects brokers from some of the risks of a de-peg event."

And indeed, brokers are already taking this approach. From 9 March, Forex.com Japan will increase the margin rate for five HKD currency pairs: the current margin is set at 15 percent, whereas the new requirements will increase that to 20 percent. Further, if the trade size exceeds $10 million, the margin requirement would be 30 percent, and for over $20 million it will be 40 percent.

"De-peg introduces potential from bad debt/credit issues. Therefore the margin rates and account limits need to be set appropriately," Blemings added.

The (Recent) Future of Carry Trades

The Hibor plunge has indeed opened a massive opportunity for carry trades. However, traders should be cautioned as the HKMA is intervening in the market, and any slight policy change might majorly impact open positions.

For carry traders, the stable sub-zero interest rate of the yen seems the most resilient option. Even with the Hibor-Libor yield gap opportunity, carry traders should consider their trading options with stable low-yield currencies, JPY ad CHF.

Solomon Oladipupo and Jeff Patterson contributed to this article.

About the Author: Arnab Shome
Arnab Shome
  • 6425 Articles
  • 85 Followers
About the Author: Arnab Shome
Arnab is an electronics engineer-turned-financial editor. He entered the industry covering the cryptocurrency market for Finance Magnates and later expanded his reach to forex as well. He is passionate about the changing regulatory landscape on financial markets and keenly follows the disruptions in the industry with new-age technologies.
  • 6425 Articles
  • 85 Followers

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