FT Alphaville " RoRo and the carry trade's fight back There have been rumours of the so-called carry trade's demise knocking about for a little while now, but HSBC think it is staging a quiet comeback and taking a chunk out of RoRo's (Risk on/Risk off) importance in the FX markets. This is a chart from HSBC which tracks the importance of interest rate differentials in the FX market over the past few years (click to enlarge): As HSBC note, the data is consistent with the view that interest rate differentials became less important for the FX market as the US subprime crisis evolved, and in the immediate aftermath of the Lehman bankruptcy. However, what surprised them was that that even during the trauma of the Irish, Portuguese and Greek bailouts, the correlations started to rise again and they are now back to the levels observed ahead of the global financial crisis when "carry" was the one and only game in town: The rising influence of interest rate differentials came earlier than we expected, and at a time when the influence of "risk-on/risk-off" is still the dominant feature of the market. They also noted that for most currencies beta has picked up noticeably, even allowing for the movements in correlations. That is, the sensitivity of the currency to an associated rate change has become more pronounced. This, say HSBC, should be a positive for carry trades. From HSBC again (with our emphasis): One explanation for this heightened potency could be the low level of interest rates in general. It is logical to see a 10bp move when rate differentials are small as potentially more significant than a 10bp move when differentials are large. An alternative explanation for this apparent increase in potency is that central banks are becoming more active again, or at least the debate within central banks about appropriate policy settings is no longer a simple chase to zero interest rates. Then there is the RoRo factor which HSBC argue has been waning. While it's still the dominant game in town, it now appears to have some real competition: The FX market may not have migrated back to data-dependent central bank watchers, but an exclusive fascination with risk considerations is equally misplaced. The best trades are when the two line up and you get the double whammy... Related links: Grexit and the euro: an exercise in guesswork - FT Alphaville This correlated world - FT Alphaville This entry was posted by David Keohane on Thursday, May 17th, 2012 at 11:05 and is filed under Capital markets. Tagged with currencies, euro, fx, risk on risk off.