US DOLLAR BACK IN PLAY, CARRY TRADES SEEN SUFFERING

US DOLLAR BACK IN PLAY CARRY TRADES SEEN SUFFERING

LAST NIGHT WE TALKED ABOUT CARRY TRADES FOR A MIN BUT NOW I WANT TO EXPLAIN TO YOU WHAT THEY ARE AND HOW THEY WORK AND HOW MARKETS MOVE BECAUSE OF THEM.

REMEMBER CARRY TRADES IS A STRATEGY WHERE BY YOU BORROW MONEY AT A LOW INTEREST RATE TO BUY A BETTER ASSET THAT WILL PAY YOU HIGHER RETURNS. OK SO NOW KNOWING THAT LET’S IMAGINE THE 5 TRILLION DOLLAR A DAY FOREX MARKET BALANCING THESE TYPES OF TRADES WHERE A GOOD PERCENTAGE OF MONEY IS FLOATING AROUND IN BETWEEN 2 PLACES. LET’S READ WHAT HAPPENS TO THESE CARRY TRADES WHEN THE USD MAKES A JUMP.

The US dollar and Treasury yields are trending higher as investors foresee an interest rate increase come December.

Pricing in this anticipated Fed hike comes after the central bank stayed its hand last month following an episode of market turmoil. You could forgive investors for having a sense of déjà vu, as this backdrop across a number of asset classes is similar to what transpired during the second half of 2015.

But there’s a difference this time around that has big implications for foreign exchange, according to Société Générale global strategist Kit Juckes.

“This time, I suspect that we have seen the low for government bond yields on average for the cycle,” he wrote in a note to clients October 14. “Bond investors are suffering from fatigue as policy-makers question the usefulness of further rate cuts and as inflation stops falling.”

The upshot here is that so-called carry trades might go comatose.

As bond yields in advanced economies grind higher, this undermines the attractiveness of foreign exchange carry trades-ones in which the expected returns of a position are driven more by interest rate differentials on shorter-dated sovereign debt than by the change in one currency’s spot value relative to another. Typically, these carry trades involve a long position in an emerging market currency while borrowing in an advanced economy’s currency to fund the position.

OK SO STOP AND GET A VISUAL AND THEN READ THAT LAST PARAGRAPH AGAIN.

“High valuations of riskless assets have been driving equity and other higher-returning assets up, which has supported EM inflows into Asia ex-Japan, in particular,” Redeker’s team wrote. “Should bond yields break higher from here, then previous inflows [into emerging markets] are likely to turn into outflows. High-yielding, foreign-capital-requiring currencies are likely to weaken (ZAR, TRY and COP).”

This process may already be underway, with JPMorganChase & Co’s Emerging Market Currency Index sliding in the first half of October despite a move higher in commodity prices.

YOU SEE WE TALKED ABOUT THIS OVER THE WEEKEND THERE IS A RALLY STILL IN EMERGING MARKETS BUT NOT NECESSARILY IN EMERGING MARKET CURRENCIES.

Redeker notes that not all emerging market currencies will be battered, writing that the Brazilian real and Indian rupee should hold up well.

As the lower-for-longer environment has become increasingly entrenched in the mindset of market participants, it would take only a moderate selloff in sovereign debt among advanced economies to cause investors to shun higher-yielding currencies.

“Since a belief that growth would be slower for longer, inflation lower for longer, and rates low for (almost) ever drove the frenzy for yield and carry that stopped the dollar’s appreciation, a turnaround matters,” writes Juckes. “Across G7, we’re more likely to see a gradual move as the gap between nominal growth rates and nominal ten-year rates closes back up.”

While the Fed has proven resistant to dollar strength, it would take a massive rally in the greenback to prompt the market to price in less than two hikes in 2017, according to SocGen.

“This increases the risk of the dollar rally going further than some expect and perhaps further than is good for the US or global economies,” Juckes concludes.

Morgan Stanley’s Redeker concurs, writing that the “US dollar is back in play”, but cautioning that a greenback rally “is often followed by increasing volatility” in light of the trillions in dollar-denominated debt issued outside the US.

ALRIGHT WE ARE GOING TO CONTINUE WATCH THE US DOLLAR RALLY AND SEE WHERE ALL THIS ENDS UP. I’LL BE BACK WITH MORE EMERGING MARKET NEWS THIS MORNING AND PLEASE DON’T FORGET TO FOLLOW US ON TWITTER AND LIKE US ON FACEBOOK. THANK YOU…ML.

One thought on “US DOLLAR BACK IN PLAY, CARRY TRADES SEEN SUFFERING

  • Memphis

    In the articles closing words we see a picture of sorts painted for us. This stuff is driving capital all over the globe! It needs to be repeated (often) that opinions mean nothing and our decisions must be based on the actual trends playing out. NOT our perception of it, our worse..what we WANT. What we want is ultimately to be right and this means opinions and emotions must be checked at he door.
    So as we continue to follow the global economic forces (no manipulation here) then we might take a closer look at these closing remarks and consider them a good snapshot of the present. Here it is once again for review and please ask yourself if these two individuals being quoted are likely offering us their emotional view, their wish of what they want to take place, or simply their considered assessment of what the objective data is SAYING.
    Blessings, Memphis

    “This increases the risk of the dollar rally going further than some expect and perhaps further than is good for the US or global economies,” Juckes concludes.

    Morgan Stanley’s Redeker concurs, writing that the “US dollar is back in play”, but cautioning that a greenback rally “is often followed by increasing volatility” in light of the trillions in dollar-denominated debt issued outside the US.

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