EM FX Carry Trade Update September 23 2019

Forex 5 minutes to read

John Hardy

Head of FX Strategy

Summary:  Carry trading conditions remain about as supportive as we have ever seen them, but a firm USD after the FOMC meeting, as well as ongoing USD liquidity concerns, don't fit very well here for going long EM carry trades here. As well the US-China trade negotiations may not produce much next month, judging from recent signals from the two sides


Emerging market carry trades performed poorly over the last week, even as general risk conditions have remained quite supportive. But the news stream of the last week has proven fairly negative for EM FX on a zany roller coaster ride in global oil markets in the wake of the attacks on key Saudi production facilities, an FOMC meeting that proved less dovish than expected and supported the US dollar, and even unwelcome developments on the US-China trade talk front, as Trump expressed a lack of interest in any "partial deal" shortly after the Chinese delegation announced a cancellation of plans to visit Montana and Nebraska next month. Still, the remarkable thing here, as noted in our global risk indicator chart below, is that risk sentiment remains extremely elevated, with no signs of strain despite the above.

Chart: Saxo Bank Global Risk Indicator
Our global risk indicator remains solidly in the green, though the recent spike in improvement has backtracked slightly. From these levels, risk for carry trades can come from any direction: namely, further strength in the US dollar if the market feels that the Fed is behind the curve in cutting rates and/or is not yet on top of USD funding pressure, confidence in the global growth outlook worsens, and finally, if the US-China trade negotiations lead nowhere next month.

Source: Bloomberg and Saxo Bank Strategy and Research

Carry Trade Short Term Performance
This week we pop in a 1-week and 1-month performance chart for some perspective on how poor the most recent week has been relative to the prior month for many EM currencies. Note the pronounced weakness in South American currencies, led by Brazil and Chile, where both central banks slashed rates recently, Brazil by 50 basis points last week to the lowest ever at 5.50% and Chile also cutting by 50 basis points to 2.00% - a rate that looks very low relative to Chile's vulnerability via its external debt load and its economy's dependence on copper exports. 

Carry trade performance*
The relative USD strength of late, and a recent backup in US bond yields have helped the USD higher versus the negative yielding funding currencies, while hopes for an orderly Brexit have boosted sterling.
Source: Bloomberg and Saxo Bank
Among higher yielding currencies, the 1-month returns are still mostly positive (especially versus the basket of negative yielders), despite the last week of weak performance noted above. 
Source: Bloomberg and Saxo Bank
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.Carry has become harder to come by in recent months as nearly every central bank globally in the tradeable FX universe is actively lowering rates.
Source: Bloomberg and Saxo Bank
*  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.
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 is not intended to and does not change or expand on this. 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-hk/legal/disclaimer/saxo-disclaimer)

Saxo Capital Markets HK Limited
Rooms 2001-02, 20/F York House
The Landmark
15 Queen's Road Central
Hong Kong

Hong Kong S.A.R

Saxo Capital Markets HK is a company authorised and regulated by the Securities and Futures Commission of Hong Kong. Saxo Capital Markets HK Limited holds a Type 1 Regulated Activity (Dealing in securities); Type 2 Regulated Activity (Dealing in Futures Contract) and Type 3 Regulated Activity (Leveraged foreign exchange trading) licenses (CE No. AVD061). Registered address: Rooms 2001-02, 20/F York House, The Landmark, 15 Queen's Road Central, Hong Kong

By clicking on certain links on this site, you are aware and agree to leave the website of Saxo Capital Markets, proceed on to the linked site managed by Saxo Group and where you will be subject to the terms of that linked site.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc.

Please note that the information on this site and any product and services we offer are not targeted at investors residing in the United States and Japan, and are not intended for distribution to, or use by any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation. Please click here to view our full disclaimer.