Currency Carry, Momentum, and Global Interest Rate Uncertainty

Returns to currency carry and momentum are compensations for the risk of global interest rate uncertainty (IRU), with risk exposures explaining 92% of their cross-sectional return variations. The unified explanation stems from its impact on financial constraints of FX intermediaries. Higher global IRU tightens constraints and triggers losses from carry trade, it also makes FX intermediary reluctant to accommodate gradual cross-country asset flows, leading to losses of momentum in currency and other asset markets. Using data of bilateral asset flows, I provide evidence supporting the mechanism. The explanatory power is not driven by existing measures of uncertainty or intermediary constraints.