EM FX Carry Trade Update October 1, 2019
Head of FX Strategy
Summary: Support for carry trades decelerated sharply over the last week as the US dollar firmed, though against the lowest yielding funding currencies like the Japanese yen, carry trades have just about managed to tread water in places. Further USD strength from here would begin to take the big dollar into new territory, so the USD outlook remains key for the EM currency outlook while yields are likely a bigger focus for the lowest yielding funding currencies.
Emerging market currencies have put in a weak performance this week, largely driven by a stronger US dollar, as the strength in the big dollar has generally spread across the board. We registered a modest pickup in risk measures as well, but sharply stronger bond yields just ahead of this report drove an interesting drop in some of the low-yielding funding currencies, especially the Japanese yen. Whether the USD continues to strengthen is likely the pivotal question for EM currencies, while the funding currencies will look more intently at the bond market to see if the recent spike in yields is an anomaly or could follow through - Japan's yields are the most volatile relative to their recent history as the country has implemented a new tax rate increase as of October 1, the large government pension fund is increasing the allocation for foreign bond purchases, and the Bank of Japan is seen as likely to concentrate on steepening the yield curve (mostly through rate cuts at the front-end it is assumed) or bringing some other form of easing at its meeting at the end of October.
Chart: Saxo Bank Global Risk Indicator
Our global risk indicator was knocked back from levels that are rarely sustained for any length of time (anything above 1) but are not yet cause for worry by any means, but the very recent bounceback of the last couple of sessions looks actually like a suspicious misread from our data provider for the EM credit spread component of our indicator index (we use a JP Morgan EM index) and we may look to replace that indicator because a more granular look at individual EM credit spreads suggests a sharp worsening rather than than indicator's improvement. Stay tuned.
Carry Trade Short Term Performance
We present the shorter term performance of higher carry currencies again this week to point out the general weakness in EM currencies against the hard charging US dollar. Leading the downside is the South African rand, likely due to the exuberance of the correction in precious metals markets this week, particularly platinum. Basically every currency in our EM universe was lower versus the USD over the last week save for the Philippine Peso and the risky Turkish lira is curiously doing its own thing versus the strong USD at the moment as well.
The JPY and CHF have been the weakest currencies of late as US yields backed up a bit, but a very weak ISM Manufacturing print (released after this chart was created) could set bond yields lower, tending to support the lowest yielding currencies - more important US data is up later this week and the funding currencies will likely track the strength in bond markets.
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.
Latest Market Insights
Outrageous Predictions 2023: The War Economy
- The constantly growing global need for energy drives the world's richest to huddle up and launch a R&D project in a size the world hasn't seen since the Manhattan Project gave the US the first atomic bomb.
French President Macron resignsThe political stalemate in France and the rise of Marie Le Pen following the 2022 elections corners President Macron, forcing him to give up on politics and resign from his position. At least for now.
Gold rockets to USD 3,000 as central banks fail on inflation mandateAs markets and central banks realise that the idea that inflation is transitory is wrong, and that prices will remain higher for longer, gold is sent through the roof, hitting a price tag of USD 3,000
EU Army forces EU down path to full unionWith continued challenges in the region and a US military that isn't aggressively enacting its former role as global policeman, the European Union agrees to create its own armed forces, bringing the whole region closer.
A country agrees to ban all meat production by 2030In an effort to become one of the global leaders on the path to net-zero emissions, one country decides to not only put a heavy tax on meat, but to ban domestic production entirely.
UK holds UnBrexit referendumFollowing a recession and domestic pressure, the United Kingdom is thrown into political turmoil that will end with a vote to wind back Brexit.
Widespread price controls are introduced to cap official inflationHistory tells us that with the war economy comes rationing and price controls. And this time is no different, as policymakers introduce strict price controls that lead to a range of unintended consequences.
OPEC+ & Chindia walk out of the IMF, agree to trade with new reserve assetSanctions against Russia have caused widespread turmoil due to US Dollar moves in countries across the globe that don't consider the US an ally. To relieve themselves from this, they leave the IMF and create a new reserve asset.
USDJPY fixed to the USD at 200 as Japan overhauls financial systemFollowing the challenges that faced the Japanese Yen in 2022, the Bank of Japan attempts to keep the currency from sliding. Unsuccessful on the long-term, Japan will launch a reset of its entire financial system.
Tax haven ban kills private equityWith the war economy comes an increased focus on national interests and sovereign nations' ability to assert themselves. In that regard, the OECD countries turn their attention on tax havens and pull the big guns out, banning them altogether.