Adapted from an article by Marc Cogliatti, Principal, Global Capital Markets – UK, Validus Risk Management
Original Source: Hellenic Shipping News (https://www.hellenicshippingnews.com/emfx-carry-trading-in-august-picking-the-right-region/)
Title: August Outlook for EMFX Carry Trades: Regional Strategies in a Changing Global Climate
The foreign exchange markets have witnessed dynamic shifts this year, with carry trades in Emerging Market (EM) currencies showing mixed results depending on both external global influences and specific regional factors. August emerges as a key month for recalibrating currency strategies, particularly for investors targeting EMFX carry trades. Diversifying by region and choosing currencies based on a blend of monetary policy stability, geopolitical risk, and inflation trends can make a significant difference in the overall performance of an FX carry trade portfolio.
While global growth anxieties, commodity price fluctuations, and interest rate cycles continue to shape the environment, local factors are proving just as decisive in determining which EM currencies perform better. In this context, understanding the broader macroeconomic trends, regional monetary policy divergence, and risk-reward dynamics becomes crucial for any investor engaging in EMFX carry trades.
This article presents detailed insights into the current state of EM carry trades, examining performance metrics, identifying top-performing currencies, and assessing regional environments that are either conducive or detrimental to these strategies. Insights are drawn primarily from Marc Cogliatti’s recent outlook.
Overview of EMFX Carry Trade Performance
Carry trades involve borrowing in low-interest currencies and investing in high-yield currencies to generate returns from the interest rate differential. The success of such strategies depends not just on the size of the interest differential but also on currency volatility and capital inflows.
Through the first seven months of 2023 and into August 2023, carry trade performance has been nuanced:
– EMFX carry strategies have been broadly profitable in 2023.
– Several currencies have delivered high yields supported by relatively stable exchange rates.
– Performance among regions, however, has varied significantly, with Latin America leading and Asia lagging.
Top Performers: Latin America
Latin American currencies continue to dominate 2023’s EMFX carry trade leaderboard. Stable macroeconomic management across many Latin American central banks and proactive tightening of interest rates early in the inflation cycle have made currencies in this region attractive to carry traders.
Key Latin American market highlights include:
– **Mexican Peso (MXN):**
– One of the strongest EM currencies against major peers since January.
– The conservative stance of Banxico (Mexico’s central bank) with a headline rate of 11.25 percent supports substantial carry returns.
– Relatively low volatility, aided by fiscal prudence and strong U.S. trade ties.
– **Brazilian Real (BRL):**
– Benefited from a Selic rate of 13.75 percent during most of the year, one of the highest in the EM universe.
– Brazil’s early and sharp rate hikes in response to inflation shielded the currency from significant downside.
– Political stability under President Luiz Inácio Lula da Silva has improved investor confidence.
– Recent cuts in the central bank’s policy rate did little to erode the BRL’s appeal, given lingering high real yields.
– **Colombian Peso (COP) and Peruvian Sol (PEN):**
– COP has been volatile but produced strong positive carry returns due to high interest rates exceeding 13 percent.
– PEN has experienced less volatility and consistent positivity supported by conservative monetary policy and commodity exports.
These Latin American currencies benefitted from both large nominal and real interest rate differentials and relatively calm political environments. The region’s commitment to tighter monetary policy has lent itself well to positive carry returns, especially when coupled with high interest income and managed inflation pressures.
Asia: Underperformers in the Carry Trade Landscape
Asia has lagged behind in the carry trade resurgence. Despite being a traditionally stable area for EM investment
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