The US Federal Reserve’s liquidity provision into year-end and expansion of its balance sheet from the August 2018 lows by over $400 billion finally saw a more marked effect on the US dollar into year-end as the Fed joined the other G3 banks (BoJ and ECB) in providing balance sheet expansion. Providing further support for what already seems as-good-as-it-gets conditions, the Chinese central bank chopped banks’ reserve requirement ratios 50 basis points at the beginning of the year to support the economy there and the lowering of the USDCNY rate to well below 7.00 suggests China is happy to support its currency in this environment as it is set to sign the “Phase One” trade deal with the US soon.
One small note of caution on the emerging market outlook that we have noted before is the degree to which emerging market policymakers have taken advantage of their popularity and the reach for yield to lower their policy rates. With relatively weak growth levels in most of these economies, we are presented with an unusual situation in which the inflows are not associated with any massive new boom in credit as was the case in the wake of massive Fed easing in 2008-09 and at other times in the past. If the global growth outlook doesn’t begin improving in the New Year, further upside may prove rather limited and downside volatility more aggravated if animal spirits weaken.
EM Carry trade performance in 2019
Below is a snapshot from a Bloomberg tool for measuring FX carry performance. We chose the four highest yielding of the more liquid emerging market currencies at the beginning of the year versus the four negative yielding G10 currencies (with SEK now the odd one out, having hiked to zero at the end of 2019!). We can see that EM FX carry traders had a banner year in 2019 with a single leverage return on this carry basket of nearly 15%. With 20-20 hindsight, this shouldn’t be a major surprise, given the spectacular returns for the year across risk assets in general and the rush lower in the USD in the final weeks of the year.