Is the carry trade dead?

Although carry trades are no longer a one-way bet, they are still one of the most popular trading strategies in the currency market — even if it means traders are just trying to figure out the best time to get in again.

The carry trade will revive when the stock market finally bottoms and begins to turn higher. That, of course, will depend on the end of housing-related losses and the return of the financial market’s risk appetite. Unfortunately, after the big losses traders and investors suffered this summer, the glory days of the bull market are probably over. Those with any remaining money to invest have learned their lessons the hard way and will be far more selective and use less leverage in the months to come.

It will take time for the housing market to pull itself out of its current slump, since lenders have toughened their terms of credit by raising minimum credit scores and requiring full documentation of an applicant’s income and assets.

The carry-trade outlook hinges upon the Dow outlook because of their strong positive correlation over the past 20 years. It shows the movement of the Dow and a dynamic carry-trade basket (black line) that contains the five highest- and lowest-yielding currencies at a given time. In some cases, the Dow leads carry trades, while in others the carry trade leads; overall, though, they follow the same path. If you are still trading carry, keep an eye on the Dow.