A Currency Trading Lesson I Learned

It’s very tempting to trade currencies.

It seems easy to predict which currency might fall, and which might rise. And it’s even easier to see which government’s bonds yield the most.

Perhaps most sinister is the fact that because “currency” seems like a safe asset class, investors then assume that currency trading must be safe as well.

It’s fun to look around the globe for high-yielding government bonds.

About five years ago, I was looking into buying Icelandic bonds – which at the time were yielding over 9% annually.

Even back then, when Treasury bonds yielded over 5%, a 9% yield was huge…

And I almost bought some.

I called one of my cousins, a banker at a brick and mortar bank outside of Philadelphia.

I asked him, “Should I buy this Icelandic bond? It has a huge yield.”

He responded, “It has a junk-bond yield. That means it’s a junk bond. Don’t buy junk bonds unless you’re willing to accept junk-bond risk.”

The lesson here is that currency, as an asset class, is still subject to the same rules and trends of any other asset class. Just because it’s “currency” doesn’t make it any safer than stocks or commodities or anything else.

Today, we’re seeing lots of interest in junk bonds out of necessity. Besides some high-yielding dividend stocks, junk bonds are the only place to find yields above 6%.

The problem is that junk bonds are just as risky as they’ve always been.

I’d argue that in this low-interest rate environment, junk bonds have even more risk than they do normally. That’s because if/when interest rates rise in the coming months or years, the junk bonds you buy today will lose a good chunk of their value.

We’ll see future bond offerings rise in yield, and these older junk-bond offerings will get crushed.

We’re at or near a serious long-term low in interest rates. Eventually (sooner rather than later) this interest-rate scenario will reverse, and we’ll see a serious long-term high in interest rates sometime in the next decade.

Buying long-term bonds today means making a bet that rates will stay low or go lower – and whether the bond you buy is a Treasury bond, a corporate junk bond or some other government bond, you will lose money when rates go higher.

Invest carefully.