EM FX Carry Trade Update - January 20, 2020

Chart: Saxo Bank Global Risk Indicator
Hyper-generous liquidity provision by the Fed over the end of 2019 and now into early 2020 has the market celebrating the implications for global financial conditions as all major central banks are in easing mode. A prominent risk in the near term is that the Fed signals that it would like to slow the pace of balance sheet expansion, and another risk further out is that the global growth bounceback that is already thoroughly priced into risk assets fails to materialize. For now, however, our Global Risk Indicator is still near its all-time high – a level that by definition is difficult to maintain because it is based on deviations from a moving average, meaning that in a theoretical world of totally unchanged conditions in the underlying indicators (actually close to what we have seen for more than a month) would eventually see the indicator move to zero/neutral.

Carry trade performance*
The stronger US dollar is providing some headwinds for carry trades, but only modestly so, as the lowest yielding majors, EUR and JPY, have been relatively weak, while the CHF and SEK have proven less attractive as funding currencies as the Swiss national Bank last week was put back on the watchlist of possible currency manipulators by the US Treasury, sending EURCHF to new cycle lows, and SEK has enjoyed a bit of resilience as the Riksbank pulled its policy rate out of negative territory in 2019 and back to zero – where it has signaled it is likely to remain as far over the horizon as markets care to imagine.

EM currency performance is varied, to say the least, as China allowing/forcing its currency to trade stronger saw it posting the strongest performance over the last month in our universe, with some Asian EM exporters (IDR, MYR) impacted by that move while others (THB, KRW) weren’t. Elsewhere, LatAm currencies are all over the map, with MXN a notable strong performer, perhaps as it features one of the world’s highest real interest rates (CPI running around 3% while the policy rate has so far only been cut to 7.25%) Turkey is in a different place, now that it has cut its policy rate to 11.25% and thus below its most recent inflation print of 11.8% year-on-year. Brazil is struggling on fears that the US-China trade deal could divert a considerable portion of soybean demand from Brazil to the US.

Current carry available*
The chart below simply shows the forward carry for owning the USD versus funding currencies and the returns on higher yielding EM currencies versus the US dollar. EM policy rates will likely continue to drop if the financial conditions and currency volatility backdrop remain muted, but we still posit that the interest rate spreads are almost as low as they can go here, and any expansion would likely be on the return of market volatility and new concerns about the global outlook.

*Note that all performance calculations are done as carefully as possible to include trade spread costs and market conditions at the time but actual results will inevitably vary depending on the timing of rolling forward positions and other factors.