EM FX Carry Trade Update October 1, 2019

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.