The other side of the carry trade
Markets remain enamoured with the carry trade. The summer slump in volatility continues to endure and amongst the environment of falling G10 rates, it is the higher yielding emerging market and commodity currencies that are seeking out bids. It is easy to see those high yielding currencies that the market is holding, however, what about the other side of that carry trade – what currencies are being used to fund this yield seeking trade?
The prime candidates are ordinarily the Swiss Franc, Japanese Yen, and the Euro. Let’s analyse each in turn with specific reference to its role as the shorted component of the carry trade. The Franc, whilst yielding literally nothing, could still be an expensive trade. With the US administration’s cross hairs pointed at any nation intervening in FX markets, the SNB’s lack of FX purchases has allowed the Franc to appreciate. So whilst the Franc from a yield-only perspective might be the currency of choice, market dynamics might prevent its utilisation.
Another defensive currency, the Japanese Yen, has faced upward pressure. Exposed due to the swift lower in the Dollar this year, the Yen’s rally could also limit its inclusion as the funding currency of choice for carry trades. Especially with the dissenting votes seen from the BoJ last week and a potential rate hike on the cards for October, investors may be wary to fund such trades against the Yen. Political dynamics will also prove key to government spending and monetary policy in turn. Lastly the ECB, having adjusted rates lower consistently throughout this year, the Euro must have been a prime candidate to fund many emerging market carry trades. But the question must be asked with the ECB’s easing cycle now seemingly on hold, which currency will be next to fund such trades or will the carry trade come to a logical conclusion?
Discussion and Analysis by Charles Porter
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