Federal Reserve chair Janet Yellen faces a tough introductory period.

The US Federal Reserve, under chair Janet Yellen, will continue reducing its economic stimulus program in 2013, with profound effect on investment markets. Photo: JOSHUA ROBERTS

After five years of plain sailing it’s been a strategy that has made plenty of people very rich, but it’s all coming to an end. And the prospect of it unravelling is making the textbook-hugging macro-economics mob very nervous.

The mother of all carry trades is about to be unwound and, according to strategists at Bank of America Merrill Lynch, it’s the major reason why investors should be questioning any investments and themes that have worked well for them over the past five years.

The broker also says it’s why emerging markets still pose a major risk to investors.

The almost-ubiquitous term “carry trade” pertains to a strategy where financial players and investors, such as hedge funds and banks, borrow cheaply in a low-yielding currency such as the US dollar and then buy a range of high yielding assets around the world.

It’s been a winner since 2008 but now, says Ajay Singh Kapur, BoAML’s Hong Kong based strategist, about $US2 trillion in those cheap loans has to be repaid as the Fed tapers it’s ultra loose monetary policy.

“These policies made plutonomists (rich folks) richer and exacerbated income and wealth inequality” says Kapur.

But he adds, “If QE is coming to an end, ideas that worked since end-2008 should be questioned.”

Confusion repeated

It’s not the first time this sort of growth has happened in emerging markets on the back of the carry trade.

The broker says it’s the third time in the past 20 years and each time, for some reason, investors often confuse waves of capital that find their way into emerging markets with economic growth.

The two are very different.

And just like every other investment theme that has hit the headlines over the past quarter of a century, they all hit a fork in the road when global monetary conditions being to tighten, the broker says.

“There are many ebullient investment ideas we have heard over the past 25 years: the massive infrastructure theme, the growing middle class, the nutrition/water idea, the urbanisation meme, the emergence of this sub-region or the other. We remain skeptical and cynical.

“Eventually, these glossy investment views have run into tighter global monetary conditions, the inevitable crises, large capital losses and vows of “never again”. Until, of course, the next global monetary easing, when all is forgiven, and a fresh wave of investors wades in again.” Kapur told clients in a note.

Prior to the global financial crisis when world markets fell, they rarely did so in sync with one another.

Some would wobble, some would plunge - and sometimes a few of them would even go up.

The behaviour of individual markets was perhaps not always what investors would have expected.

Over the past five years, however, they have all moved together, like they’re in a pack.

That’s because the US Federal Reserve has been the key driver of stocks, bonds and currency movements with its policy of cheap money.

Read more from Philip Baker at The Australian Financial Review