Tags: El-Erian | risk | carry | trades

El-Erian: Beware the Risk of Carry Trades

By    |   Thursday, 10 Apr 2014 11:23 AM

The enthusiasm for Greece's first long-term bond issue in four years illustrates the strong popularity of carry trades now, says Mohamed El-Erian, former CEO of Pimco.

But these trades could end in heartache, he writes in a guest commentary for CNBC.

A carry trade involves borrowing at low interest rates to invest at higher interest rates. Often the borrowing takes place in one currency, and then investing in another currency.

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Investors can easily "overdo the love affair with carry trades, not just by pushing bond prices too high (and therefore credit spreads too low), but also by failing to differentiate sufficiently between low- and high-risk holdings," explains El-Erian, chief economic advisor to Allianz.

"History reminds us that, when taken to extremes, carry trades can end up delivering quite unpleasant surprises to investors, especially unsuspecting ones."

When things go bad with carry trades, it usually happens in a hurry, as investors rush to exit their position, he notes.

"Investors' natural inclination at that stage is to try to quickly get 'back on side.' This can easily generalize market disruptions, thus impacting quite a large universe of holdings — particularly investment grade, high yield and emerging markets," El-Erian adds.

"The gathering clouds over the increasingly crowded carry trade may well have a silver lining, albeit down the road. The eventual unwinding would tend to create very attractive entry points for those both able and willing to act counter-cyclically. If only it were easier to get the timing right."

Not everyone is excited by Greece's new debt deal. Jon Jonsson, senior portfolio manager at Neuberger Berman, tells The Wall Street Journal that other bonds offer better value.

"I don't think I am being adequately compensated for the risk of buying Greek bonds," he says. "The deal is obviously good for the eurozone periphery, but we are unlikely to take part."

Greece's new five-year bonds have a coupon of 4.75 percent.

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The enthusiasm for Greece's first long-term bond issue in four years illustrates the strong popularity of carry trades now, says Mohamed El-Erian, former CEO of Pimco.
El-Erian, risk, carry, trades
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2014-23-10
Thursday, 10 Apr 2014 11:23 AM
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