As the Fed capitulates on its hiking cycle, it joins other central banks like the ECB and BoJ in dovish territory. On top of that, the pessimism surrounding the US-China trade war seems to have hit its peak – at least for now. Stock markets are responding to this in kind, with US stocks bouncing almost 5% since the start of the month.
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As the Fed capitulates on its hiking cycle, it joins other central banks like the ECB and BoJ in dovish territory. On top of that, the pessimism surrounding the US-China trade war seems to have hit its peak – at least for now. Stock markets are responding to this in kind, with US stocks bouncing almost 5% since the start of the month.
Low Yields Help Carry
This combination of low core yields and a possible turn higher in growth expectations should be favourable towards carry trades. Indeed, over the past year, there has been a strong inverse correlation between G3 yields and the performance of FX carry trades. That is, when core yields are low, carry trades have performed well (see first chart).
The last few months have seen global FX carry trades go sideways, but in earlier months they were delivering 1% returns per month (see second chart). With yields remaining low, I’d expect carry trades to resume their outperformance. A simple global carry basket would rank currencies by their short-term yields, buying the top five and selling the bottom five.
Current Carry Basket Positions
As for the specifics of a carry basket, I like to construct simple ones that go long the highest yielding FX and go short the lowest yield FX. Currently, a global basket would be long the Turkish lira, the Indonesian rupiah, the Mexican peso, the Russian ruble, and the South African rand. It would be short the Hungarian forint, the Swedish krona, the Japanese yen, the euro, and the Swiss franc. As the basket does not contain any US dollars, its performance is not dependent on the direction of the dollar.
Chart 1: FX Carry Helped By Easing Yields
Chart 2: FX Carry Monthly Gains
Bilal Hafeez is the CEO and Editor of Macro Hive. He spent over twenty years doing research at big banks – JPMorgan, Deutsche Bank, and Nomura, where he had various “Global Head” roles and did FX, rates and cross-markets research.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)