The Rise of Carry Trades, a Return to the Future in the Forex Market

Customers' behavior is set to change dramatically in the FX trading industry, necessitating several modifications on the part of brokers.

Interest rate differentials between USD and JPY were 6%+ for individuals too young to have been in the FX sector before the 2008 Financial Crisis, while differentials between GBP, AUD, and NZD were even larger. There were several clients who just traded to earn the daily rolls. These clients usually utilized 5 to 10X leverage and maintained positions for weeks rather than hours.

Because they had lower leverage, they could hold their positions through most minor movements and were only stopped during significant swings. Interest rate differentials in many pairings meant that there were constantly one-way open positions and a lot more herd-like behavior.

Customers clearly compared brokers based on overnight rollover payments as well as spreads. Carry trading clients often had bigger balances, were older, and were more lucrative than day traders who used more leverage.

Following the financial crisis Except for emerging market currencies, most carry trading vanished when interest rate differentials vanished, although those volumes were a minuscule fraction of what carry trades meant when G7 currencies were engaged.

With individual trader engagement significantly larger in 2022 than in 2007, and interest rates on the rise, carry trades are projected to become the norm in the retail forex market, as they now are among buy-side macro funds. Traditional B-book trading will not work to monetize this flow, thus brokers will need to adapt. It would be crazy not to hedge an investment that would pay out daily interest for weeks or months.

To remain competitive, brokers must provide more equitable rolls to consumers, which involves obtaining more competitive rolls from PBs and PoPs. There will be less two-way flow and many more open jobs.

One advantage for FX brokers will be a rise in the attractiveness of FX as an asset class among more mainstream investors, and FX trading will be a lot simpler to sell when it looks more like a fixed-income investment with greater success rates than day trading. Another significant advantage will be that revenues from nighttime rolls will be much larger as a proportion of total sales than they are now, increasing overall profitability.

The following issues will arise:

• Customers' profits from carrying traders, one-way positions, and interest payments will make the B Book obsolete for numerous pairings. This is particularly true in areas where leverage is restricted.

• A book flow will be a lucrative but inefficient per transaction. When the herd in bulk is driven out of positions, LPs will enjoy it, but they will choke on big position margin calls, resulting in numerous arguments.

• As the FX market will be held prisoner to the vagaries of central bank policy, every econ data item will influence the market, making news trading a big return.

• Overall volatility will rise, putting most brokers' too-generous leverage extension policies to the test, as will the possibility of negative balance rises for heavily leveraged traders.

• Competitive rolls must be market standard in any FX product, including retail and wholesale.

• To grab this business, brokers will need to acquire substantial NOP (net open position) limitations.

• As consumers grow more interested in carrying trading methods, emerging market currencies with double-digit rates will become more appealing.

Those that adapt to the new world of trading and do not stick to what worked in the previous 10 years will be the winners in this new era of FX trading. The new PriceOn market-making tool from TTs is ideal for the return to real market-making that this new age will bring in for FX.

Retail FX Brokers may maximize their market making revenue significantly more effectively than A book/B book. Without assuming the risk of a B Book, five to ten times the P/L of an A book may be acquired. Holding inventory risk for minutes rather than hours or days reduces P/L variability dramatically.

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