The interest rate game
A third strategy, known as "carry" involves betting on the difference in interest rates between two currencies. Investors purchase the currency with the highest interest rate using a loan taken out in the currency with the lower rate. Profits come from the difference between these two rates. Rendered virtually obsolete by a long period of interest rates close to zero, the carry strategy has regained popularity thanks to higher interest rates from several central banks.
In the current climate, the USD/JPY pair is particularly well-suited to this strategy. "Using a 10 year bond yield as an example, there’s a differential of approximately 3.5% between the interest rates of these two currencies," says Levich. "That results in a sizeable profit."
The carry strategy is reserved for experienced investors, as it can lead to many regular small gains, but it comes at a higher risk. "You’re betting on the fact that the currency with the higher rate will continue to increase and the currency with the lower rate will fall, but if the opposite happens, your gains will quickly disappear," says the finance professor. It also requires patience, as changes in interest rates happen over months rather than over several days or hours.
To implement such a strategy, investors need to closely monitor the differences in interest rates between currencies. The CME FedWatch tool, which makes predictions on future announcements from the US federal bank, can be useful in this approach.