There hasn’t been any real shift in the market narrative for global markets since our post at the beginning of the year, in which we noted the supportive backdrop in financial conditions for emerging market currencies and risk appetite in general. Less supportive for the EM carry traders has been the fundamental story as the global growth story has generally failed to improve despite important signs of stability in some of China’s numbers, though that country has chosen not to indulge in the mass mobilization of a huge credit impulse as was the case in past cycles.
Emblematic of the mismatch in EM performance versus the growth backdrop is one of the ex-Asia star performers over the last month of FX action, the Mexican peso, as Mexico continues to show signs of stagnation. As noted below, the strongest performers were a select group (or we should say, an oddly select group) of exporting Asian EM currencies hanging on to the coattails of the strong Chinese renminbi, which saw its most notable strengthening move in almost two years ahead of and just to the other side of the US-China “phase one” trade deal signing last week. Some of our cautious outlook on EM from here noted in this outlook stems not only from what we see as over-complacent conditions for risk, but also as we suspect China may see little interest in driving its currency higher from these levels.
YTD EM Carry trade performance in 2020.
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 lowest yielding G10 currencies. This basket returned nearly 15% in 2019 – a performance that was certainly enhanced by the fact that 2019 got under way near the very bottom of the plunge in risk appetite on fears that a too tight Fed would end the bull market and trigger a recession. We suspect 2020 will fail to provide these heady returns for EM carry trades, though it is off to an excellent start at around 1.4% YTD, which projects to an unlikely annualized return of 32.25% - note that we used the MSCI EM equity index in USD terms as the benchmark this time.