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.
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.
2024: The wasted year
Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
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.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
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.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
