Economists have said that interest rate cuts could further impact the already unwinding carry trade. Investors are reportedly retreating from carry trades in the wake of the worldwide sell-off of stocks.
Interest Rate Cuts May Worsen Carry Trade Unwind
Carry trading occurs when investors borrow at low interest rates and invest in assets with higher returns. Weak US economic data triggered a stock plunge, which may prompt the US Federal Reserve to cut interest rates in an attempt to stem a recession. CNBC quoted a note from TS Lombard analysts, which read:
The natural reaction from the Fed to soft labour market data and fresh recession risks would be to cut rates and to do so relatively rapidly. But this would exacerbate any carry trade unwind. The US economy should trump all else, but it would make sense for central bankers to be cautious.
These economists said that they hope to see a “coordinated message from the Bank of Japan and Fed to soothe market nerves”. They also said that if a carry trade unwind is truly problematic, central banks should implement “quantity measures” that would avoid the sell-off of assets related to yen carry trades.
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HSBC Holdings (HSBC) strategists said that the markets face a “triple whammy” of worries: carry trade unwinding, artificial intelligence (AI) commercialisation and a looming US recession. In a research note, they stated:
We think it’s too early to buy just yet, but fundamentals are still broadly supportive. We think the biggest risk now is a self-feeding sell-off that would eventually prompt a recession, given negative wealth effects and tighter credit conditions.
