Lesson 4: Safe Havens

Okay sometimes, very rarely the Carry Trade doesn't work. Why? Because of “global fear” (recession). In times of global fear, investors objectives change from one purely of capital growth (greed) to that of capital preservation (fear). So instead of buying risky currencies offering high returns, they buy safe havens with no regard to whether they offer any return or not. Its important not to confuse “global fear” with just fear. This is because in all potential carry trades the country with the lower IR will most likely be suffering/recovering from a recession, so feeling some fear. While the country with the higher IR will naturally be experiencing growth, so some positive emotion. IMO The best way to identify “global fear” is to divide the world into 3 mega economies of. 1. US Economy, 2. EU Economy (when added up has a GDP roughly the size of the US) 3. Asian Economy (China+Australia+Japan again equal a GDP roughly that of the US). If any one of these 3 mega economies (US, EU, Asia) falls into recession you want to start trading the safe havens until it has returned to growth(a recession is defined as 2 consecutive negative quarters of growth/GDP), because it affects the entire world as they rely on each other for imports and exports. On a global level this means slower growth everywhere... In the currency market our safe havens are the US Dollar, as it’s the biggest single economy, the reserve currency of the world and is how we price oil. The Swiss Franc, a relic of the cold war when the Swiss Franc offered some safety because of it’s neutrality. And the Japanese Yen, being based in the East it’s economy is thought to be  far enough removed for it not to be too heavily affected by economic problems in the West. Although one can poke some holes in the theory behind the safe havens they work because of 2 reason 1. traders and investors have little other option and 2. The Crowd effect, the desire to follow that which others are doing.