Is the Great “Carry Trade” Unwind Coming?

Many of you that listen to my daily broadcast know I love to trade the EUR/AUD currency pair. And if you read my blog back in May of this year, we ended up playing a much longer term squeeze in this pair from below 1.3000. Over the summer the EUR/AUD completed and inverted H&S pattern (as seen below) and has spent the majority of the summer bouncing back and fourth from the 1.4000-1.5000 range.

9-24-13EURAUD

I suspect in the coming week(s), the pair is due for one of the largest “unwinding” of the mother of all carry trades.

One of my big clues to trading this currency is following the correlation of the EUR/AUD and the US Equity markets. As you can see below, longer term, the EUR/AUD and equities are almost a “mirror’ image. There are a few uncorrelated times, but over the last few years it was mostly “Euro crisis” centric when the correlations broke. For the most part, the correlation is well behaved.

9-24-13EURAUDES

 

The natural trade since the financial crisis was simple. Just think, a year or two ago, Europe and the Eurozone that we know it was “supposed” to come apart at the seems. Also, China was on track for global domination. Fast forward to “today” and we are far from that. With Angela Merkel at the helm of Germany for the next few years, she alone maybe the glue that keeps the EZ together. For the next 12 months, we could quite possibly see China GDP sub 7% growth. Short Europe (EUR) and long China (AUD as proxy) was the place to be! Plus, the nice carry trade combined with such a great fundamental story? Hell, what could go wrong? Nothing did, and this was the beauty of the fall of the EUR/AUD. However, I would say the layup trade of the last 5 years looks nothing like it had a year or two ago.

The Fed induced rally was meant to re-inflate the global economy and assets. Obviously, over the last 5 years the nice folks at the FOMC sure delivered on the rise of the equity markets. However, in recent months (and as early as last week) you can see how the market is becoming less enchanted of unlimited QE and also understand the current monetary policy era may be coming to an end and indeed may not be “unlimited.”

Considering that the equity markets are near the upper end of the up sloping channel developed since the start of QE, to me, there looks like there could be some near term downside as the market prepares for a shift in monetary policy. If this is the case, I can also build the case for a stronger EUR/AUD. Can’t you? Being short the EUR and long the AUD was the FX trade of the decade (in my view) and one that if unraveled, may not be a pretty site for shorts.

Blake Morrow

Wizetrade.com

Disclaimer: I have been long the EUR/AUD since last Thursday and do plan on adding to my core long position soon. 72 hours? Maybe less, maybe more…have not decided.

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