Dollar Carry Trade

One reason for the continued strength in our stock markets is the enormous FII Inflow over the past several months. While part of these investments may be long term in nature, a large part is the ‘Dollar Carry Trade’. This particular phenomenon and its implications should be well understood by investors as the underlying risks in the markets are increasing.

Dollar Carry trade is the process of borrowing in dollars where the interest rates are low and investing in emerging markets like India where the returns are high.  In the past decade, the Japanese yen and the Swiss franc were favorites for the carry trade because of their low yields.  But now, the U.S. dollar presents the same opportunity due to the likelihood that rates will stay low for a long time to come. The money coming in is basically taking advantage of low interest rates in the US combined with a weak dollar and high growth rates in emerging economies. Smart money is making handsome returns taking advantage of both the currency as well as the equity markets. Moment any of the above conditions reverse, i.e. either the interest rates move up in the US or the dollar starts strengthening we are likely to see a reversal of this ‘Hot Money’. This is one big risk with our markets going ahead.

FIIs have invested over 74,000 crores this year. Though things are still looking positive, investors need to keep in mind that at some point a large part of this inflow will reverse. That has the potential of making the markets drop in a panic. So continue riding your profits but keep an eye on the dollar strength and interest rate scenario in the US.