With the Fed's interest rate cut dreams shattered and the Middle East's powder keg ignited, carry trade is fleeing emerging markets outside of Asia in a corner of little attention.
Since April 8, high-interest emerging market currencies such as the Mexican peso and the Polish zloty, which have previously hit new highs this year, have fallen sharply and rapidly, erasing all the gains made last year. Among them, the Mexican peso fell the most, retraced 4.7% from its high, and the volatility was staggering.
Since 2022, benefiting from the transfer of the manufacturing industry chain and the attraction of high interest rates, the performance of the Mexican peso has been unbeatable, and it has been called "super peso" by emerging market traders, borrowing financing currencies such as JPY and CNH, and buying high-interest currencies such as MXN and INR has once become the best trade, which has indirectly driven the strength of currencies such as the Indian rupee and the Brazilian real, and this plunge is related to the expectation of recent intensive changes.
1. The long-term and short-end yields climbed, and the U.S. index hit a new high this year
The economic data that continued to exceed expectations knocked the US bond bulls down, and even Powell had to admit that inflation is under difficult downward pressure, and high interest rates will last longer. The two-year Treasury yield climbed to the 5% mark and the dollar index held steady at 106, sending emerging markets a hit.
2. The Middle East crisis has triggered risk aversion
The Palestinian-Israeli conflict has escalated into an Iran-Israel conflict, and although the two sides have died down after a slap in the face, commodity and crude oil prices have priced in potential risks. Risk sentiment deteriorated, and traders re-embraced the dollar.
3. Implied volatility has risen, and the cost performance of carry has decreased
Carry/Vol is the element that traders pay more attention to than the absolute level of spreads. Since April, the implied volatility of the Mexican peso has risen sharply from 1 month to 1 year, the price performance of the carry trade has decreased, and positions have begun to retreat.
Over the weekend, we looked at the latest views of foreign banks and found that all of them have turned in the direction of bullish US dollars, with Nomura believing that the euro could fall to 1.05. Considering that the theme of monetary policy divergence in Europe and the United States is clear, the FOMC meeting in May is likely to be hawkish, and the strength of the dollar is becoming the consensus of the year.
In the author's opinion, despite the yen's record lows, the probability of actual intervention by the Bank of Japan is still low, because the current exchange rate level has not deviated from fundamentals and has not caused systemic risks. USDJPY is steadily moving towards 155. Compared with the depreciating yen, the central parity of the RMB remains stable, and the liquidity of CNH is tight, and the implied volatility is retraced. It is expected that the RMB will continue to fluctuate in a narrow range, and the USDCNY pivot will move upward.
The author of this article: Li Haoran, source: Good Morning Foreign Exchange Market, original title: "2024.4.23 The carry trade is fleeing from emerging markets"
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