Head of FX Strategy
Summary: Carry trade performance has picked up strongly over the last couple of weeks as global risk conditions have improved, EM credit spreads have tightened and the US dollar has eased lower. Background conditions for EM carry trades have rarely been more complacent than they are currently.
The sharp improvement in risk conditions globally over the last few weeks has driven a strong performance for EM currencies since late August. However long it lasts, the current thaw in US-China trade tensions has helped, as has the market’s increasingly warm reception of central bank easing globally in recent. As well, after a strong signal from China in allowing the USDCNY to power above the psychological 7.00 level in early August, the slide in the CNY versus the USD was halted earlier this month and has partially reversed.
Chart: Saxo Bank Global Risk Indicator
Our Global Risk Indicator gives a clear indication of the general improvement in risk conditions, with tightening EM spreads contributing strongly to the improvement. The next key tests for EM arrive with next Wednesday’s FOMC meeting and policy guidance from the Powell Fed. The next and bigger test will be whether the US and China can get trade negotiations back on track or whether the relationship resumes the long-term worsening trajectory.
Carry trade performance*
Among the funding currencies, the JPY and the CHF began weakening recently on a sizeable backup in global bond yields over the last couple of weeks and are the only notable weaklings against the US dollar over the last month.
12-month carry trade versus performance
Over the last twelve months – which includes both a remarkable meltdown and then recovery in global markets, high carry currencies as a group have performed roughly along the line of more reward for the risk. This is more typical in rallying global risk sentiment rallies and at market tops than in the opposite conditions to be sure. Note that this particular chart gives a rough return estimate for general illustrative purposes only. Returns are shown versus the USD.
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. The forward carry available has dropped for a number of pairs - most impressively the Turkish central bank this week chopped the one-week repo rate by 325 bps to 16.5%.
*Note that all performance calculations are done as carefully as possible to include trade spread costs and market conditions at the time but actual results will inevitably vary depending on the timing of rolling forward positions and other factors.
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As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
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