The currency carry trade is a strategy where the investor sells the currency with relatively low interest rate and buys a different currency yielding higher interest rates. Investors can also use the funds to buy other asset classes in different countries which would give superior returns.
The U.S. Government and the Federal Reserve has kept the interest rates at a record low level so that the U.S. economy recovers. According to the policy, keeping interest rates artifically low would ensure that small business, consumers and even large corporates would get easy funds and that would help in spurring up the economy.
What the Federal Reserve has control over is to keep rates artifically low and throw enough money in the financial system. However, what the Federal Reserve has no control over is where this money goes (in terms of country or asset class).
Real Federal Fund Rates
With negative real federal fund rates who would have the incentive to keep deposits in the U.S. Also, with easy money available, the big players have the incentive to borrow huge sums of money and invest in assets giving much higher returns outside the U.S.
Dollar Carry Trade and Asset Bubbles
The global equity markets have been racing away since their March 2009 lows and one of the primary reasons for this upside is the easy money avaliable to speculate in different asset classes. There is no doubt that the global economy has shown signs of recovery (backed by Government stimulus). However, things are still not that rosy that markets trade at such high valuations. A large part of this upside in markets have been easy money driven.
This can lead to formation of several asset bubbles in different countries and different asset classes in the long run.
