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Macro outlook: Trump 2.0: Can the US have its cake and eat it, too?
John J. Hardy
Chief Macro Strategist
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EM FX Carry Trade Update October 11, 2019
John J. Hardy
Chief Macro Strategist
Summary: Several EM currencies are staging a very significant rally to close the week on the support from key geopolitical developments: first, a very likely last-ditch Brexit deal in the works after a breakthrough in negotiations, and hopes for at least trade war détente from US and China, though we still await the official word from both sides on the shape of any deal. And broadly speaking, the EM space is a patchwork affair recently, performance-wise.
Many of the major emerging market currencies (RUB, MXN, ZAR, KRW) are surging on the hopes that the US and China are headed toward some sort of a trade deal, even if it is fairly narrow in scope – particularly pivotal for many currencies in the EM space will be the degree and nature of any agreement on the CNY exchange rate as a part of the deal.
But there is certainly a variety of EM currency performance over the last week, with the Turkish lira badly stumbling because it is struggling with geopolitical concerns as the EU may move to sanction the country for its military operations in Syria and even Russian president Putin was out expressing concerns. Given the market conditions, a significant further rise in risk sentiment will likely see a number of EM central banks continuing to feel comfortable in easing rates and the Russian Central Bank chief Nabiullina was out saying as much recently as the inflation outlook there remains benign, keeping real interest rates in Russia highly positive.
Chart: Saxo Bank Global Risk Indicator
The massive resurgence in risk appetite has not entirely been absorbed in our global risk indicator – perhaps as our corporate risk indicators haven’t had time to react today (no data for today as these are based on the US closing prices) relative to the massive resurgence in quick-reaction instruments like major equity futures and currencies. As well, because this has been a sudden comeback, volatility indicators in FX have not improved like those for equities. In short – we’ll need to see conditions continuing to improve in coming days to get traction for carry trades. We also have the economic cycle to contend with, as we suspect the US is headed toward a recession – so wondering how long the after-effects of a narrow US-China trade deal and Brexit can support global risk sentiment and carry trade interest. Some risk in coming weeks that a focus on weak earnings reports offers a more challenging headwind for carry trades.
Carry Trade Short Term Performance
The shorter-term performance of EM currencies shows the variety of performance levels, with TRY badly lagging on geopolitical concerns, the Brazilian real perhaps on concerns that China will promise significant US agricultural purchases and as coffee and sugar prices are weak. On the plus side are many of the bigger EM currencies rising on the general comeback in risk sentiment.
Carry trade performance*
Among the funding currencies, short SEK has been a winner, but JPY and CHF have put in a very weak performance late this week and could be set for a further drop if the US-China trade deal continues to drive a recovery in risk sentiment and higher bond yields.
Note that while many EM currencies have staged a comeback in recent sessions, very few have managed to recover beyond their best levels over the 1-month time frame.
Current carry available*
The chart below simply shows the forward carry for owning the USD versus (mostly negative yielding) funding currencies and the returns on higher yielding EM currencies versus the US dollar.
The chart below simply shows the forward carry for owning the USD versus (mostly negative yielding) funding currencies and the returns on higher yielding EM currencies versus the US dollar.
* Note that all performance calculations attempt to accurately reflect trade spread costs and market conditions but actual results will inevitably vary depending on the timing of rolling forward positions and other factors.
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