EM FX Carry Trade Update October 31, 2019 EM FX Carry Trade Update October 31, 2019 EM FX Carry Trade Update October 31, 2019

EM FX Carry Trade Update October 31, 2019

Forex 5 minutes to read
John Hardy

Head of FX Strategy

Summary:  We may have seen at least a temporary peak in conditions that are supportive of EM carry trades over the last week as complacency reached remarkable levels rarely recorded by our Global Risk indicator. The most interesting test for recent EM strength and conviction that the US Fed will remain on top of the situation would be a weak couple of months US economic data.

A number of recent developments have supported EM trades, including large-scale new easing from the Fed, both in terms of the three rate cuts administered since the summer and the fresh expansion of the Fed’s balance sheet to the tune of $60 billion per month in T-bills on top of the large repo operations aimed at countering liquidity problems in the US banking system, at least in part driven in turn by the US . And no doubt about it, a weak US dollar is normally associated with heavy gains in EM currencies and assets. But we struggle with a bit of cognitive dissonance here if the US economy is indeed heading toward a recession, which would require more Fed easing. Up to this point, the market has largely celebrated the easier Fed, but at some point, a slowing economy is normally associated with widening credit spreads and safe-haven seeking, conditions not normally associated with positive EM asset/currency performance.

Chart: Saxo Bank Global Risk Indicator

Our global risk indicator recently peaked out at its highest reading since the remarkable conditions that prevailed for much of 2017 in which everything risk-correlated, particularly EM, did very well. This time around we have a hard time believing that similar conditions can endure on our suspicion that the US is heading for at least a minor recession, which is normally associated with weaker financial conditions, widening credit spreads, etc., basically all of the things that normally provide headwinds for EM assets and currencies.

An added wrinkle is the prospect of a US-Trade deal. Yes, US President Trump, as he eyes his 2020 re-election campaign, is likely very willing to walk back some of the US tariffs and make a narrow, transactional deal based on Chinese promises for large-scale agricultural and other purchases, but we see will be no profound, deeper deal between the two rivals, and a recent Bloomberg article even suggested that even the narrow deal could be endangered. Stay tuned for that and stay tuned for how the market treats US incoming data, especially of the weak variety.

Source: Bloomberg and Saxo Group

Carry Trade Short Term Performance
The shorter-term performance of EM currencies remains generally very positive over the last month, but the last week has seen a smaller contribution as risk conditions suffered a bit of a stumble after the FOMC meeting. BRL was the star performer over the last week as it has accomplished a major pension reform deal that will markedly improve the budget sustainability. ZAR and CLP are sharply lower on idiosyncratic reasons – ZAR we discuss below and CLP due to disruptive protests and the risk that the country will have to widen deficit spending to respond to public demands. With a policy rate below that of the US, holding CLP offers nothing in the way of carry rewards for traders unless it is held versus an even lower yielding funding currency.

Source: Bloomberg and Saxo Group

A snapshot of specific EM credit spreads
The chart below shows a snapshot of the credit spreads for four EM currencies’ USD bond and their US counterparts over time and relative to the USD exchange rate. Most EM currencies have seen tightening credit spreads as financial conditions have been very favourable – supporting the recent strength in EM. But South Africa’s credit spreads have taken a sharp turn for the worse here after it recent published its latest budget, which will include very large costs linked to shoring up troubled power provider Eskom, a move that has prompted fears that South Africa’s debt could be downgraded and triggering a sharply weaker rand this week.

Source: Bloomberg and Saxo Group

Carry trade performance*
Among the funding currencies, the JPY has been the best behaver in remaining weak against the broad market – at least until its strengthening move in the wake of the FOMC meeting. Sterling has been a funding currency to avoid as hopes that a path to a soft Brexit remain on track and No Deal is unlikely have fed a considerable rally - though it could be faced with a flat period from here as we await for the December 12 election result.

Source: Bloomberg and Saxo Group

Among the EM currencies, most have turned the corner over the last month from prior weak performance, including BRL noted above. We are writing this report with USDCLP at a new 15-year high.

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. Note the further collapse in carry available for TRY longs after the recent massive 250 basis point rate cut and more likely on the way, provided TRY is stable. Brazil cut its policy rate this week by another 50 basis points from the old record low to a new one of 5.00%.

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.


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
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