EM FX Carry Trade Update November 18, 2019 EM FX Carry Trade Update November 18, 2019 EM FX Carry Trade Update November 18, 2019

EM FX Carry Trade Update November 18, 2019

Forex 5 minutes to read
John Hardy

Head of FX Strategy

Summary:  Select South American EM currencies have suffered an ugly downdraft led by the Chilean peso recently on sudden social unrest while conditions elsewhere are rather less volatile. EM currencies are supported by still strong risk conditions, but central banks across EM are taking advantage of the conditions to chop policy rates, eroding the ability for investors to extract carry.


Despite what on the surface would appear to be a very supportive backdrop for emerging market currencies, EM currency performance has either been relatively indifferent or in the worst cases, absolutely terrible over the last three weeks. Some of the recent support for EM conditions and the more liquid EMs globally has come from very strong risk appetite as the market holds high hopes for the US-China trade negotiations and as the US Federal Reserve’s recent policy easing and resumption have been very welcomed, especially as a few of the more recent US data points have led to a narrative that the US may skirt recession or is stabilizing now from all of the stimulus.

The US Fed’s efforts do improve USD liquidity in general, all other things being equal. At the margin, another factor has likely been China allowing the USDCNY rate to cross back below 7.00 as China applies whatever goodwill pressure it can to get the US to drop tariffs in the ongoing trade negotiations.

Just before posting this, however, we are reminded of how fragile the trade deal narrative remains as a negative story breaking on a possible misunderstanding between the two sides has the USD moving higher and risk appetite suddenly swooning. One thing for sure, the general uncertainty has muted volatility as we await the outcome, though we are already likely priced for more than any trade deal can actually deliver. Likewise, the market is of course very poorly positioned for a fresh breakdown in talks akin to  what unfolded earlier this year, when Trump jacked tariffs sharply higher.

Chart: Saxo Bank Global Risk Indicator
Before easing back lower a bit over the last couple of weeks, our global risk indicator recently saw some of the most positive readings in its history (remember, the readings for the indicator are never absolute, but rather merely based on standard deviations relative to a moving average, all with a 150 day look-back period.) Most interesting for EM traders, the EM credit spreads have been a major contributor to strong indications of risk appetite, and have absolutely collapsed at an incredible pace to within about 25 basis points of the lowest levels since the global financial crisis. Given that collapse, the short term performance of EM is not particularly impressive, with EM perhaps held back by the stubbornly strong US dollar and the recent back-up in US interest rates. If EM hasn’t put in a particularly noteworthy performance given a nearly historically supportive backdrop, it is hard to see what can support from here, save for some profound breakthrough in trade tensions or a broad upswing in the economic outlook.

Source: Bloomberg and Saxo Group

Carry Trade Short Term Performance
The shorter-term performance of EM currencies was mostly down to the prior month, with some of the Asian exporters possibly bid due to China moving the USDCNY below 7.00 – note solid performance in the CNY (CNH) itself and similar performance in IDR, MYR, KRW. But South America has been socked with ugly losses, concentrated in a wild swing in the Chilean peso after social unrest recently broke out, but now Colombia’s peso now embroiled in a similar situation as a nationwide strike has been called for November 21.

Source: Bloomberg and Saxo Group

A snapshot of specific EM credit spreads
We flashed the chart below the last time around (though this time we add the Chile and Russia charts at bottom), noting the recent back-up in South Africa’s credit spreads on the news of the ESKOM bailout effects on the nation’s budget deficit. Alas, one of the bond rating agencies’ decision not to downgrade South Africa’s sovereign bonds to junk may have saved the credit spread for now and ZAR has remained rather stable. Elsewhere, however, note how many currencies are “underperforming” the positive developments in individual spreads. This could be either a sign of an unrecognized opportunity, a sign that investors are waiting for more supportive signals from the US dollar turning lower, or a warning that EM’s are having a tough time catching a bid in a supportive environment and that policy cuts across EM are wearing on investors’ interesting in the sector. Note that the massive spike lower in CLP has in no way affected the country’s credit spread thus far – and we have seen a considerable bounce-back in the CLP from its weakest levels.

Source: Bloomberg and Saxo Group

Carry trade performance*
Among the funding currencies, the sterling resurgence suggests carry traders should steer clear of funding in sterling if the path to a smooth Brexit remains clear through the December 12 UK election. Elsewhere, the USD has more than held its own against the other negative yielding funding currencies over the last month – especially versus the Euro. 

Source: Bloomberg and Saxo Group

As for EM Currency performance, the Turkish lira has been a darling , while elsewhere the performance has been more mixed, to say the least.

Source: Bloomberg and Saxo Group

Current carry available*
The chart below simply shows the forward carry for owning the USD versus funding currencies and the returns on higher yielding EM currencies versus the US dollar. We have discussed in recent weeks how increasingly little carry is available as many EM central banks have taken advantage of generous financial conditions and low inflation to slash rates. Interesting to note that the two very weak performers in EM of late, COP and CLP, are in countries with some of the lowest policy rates across EM, suggesting little room for error when problems do arise.

Source: Bloomberg and Saxo Group
*  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.

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-gb/legal/disclaimer/saxo-disclaimer)

Saxo Markets
40 Bank Street, 26th floor
E14 5DA
London
United Kingdom

Contact Saxo

Select region

United Kingdom
United Kingdom

Trade Responsibly
All trading carries risk. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more
Additional Key Information Documents are available in our trading platform.

Saxo Markets is a registered Trading Name of Saxo Capital Markets UK Ltd (‘SCML’). SCML is authorised and regulated by the Financial Conduct Authority, Firm Reference Number 551422. Registered address: 26th Floor, 40 Bank Street, Canary Wharf, London E14 5DA. Company number 7413871. Registered in England & Wales.

This website, including the information and materials contained in it, are not directed at, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in the United States, Belgium or any other jurisdiction where such distribution, publication, availability or use would be contrary to applicable law or regulation.

It is important that you understand that with investments, your capital is at risk. Past performance is not a guide to future performance. It is your responsibility to ensure that you make an informed decision about whether or not to invest with us. If you are still unsure if investing is right for you, please seek independent advice. Saxo Markets assumes no liability for any loss sustained from trading in accordance with a recommendation.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the U.S. and other countries. App Store is a service mark of Apple Inc. Android is a trademark of Google Inc.

©   since 1992