Dodging Negative Yields Just Got Costlier on Trade Volatility

LAGOS (Capital Markets in Africa) – Investors looking to escape $15 trillion of negative yielding debt may want to err on the side of caution before buying a dip in emerging-market currencies.

In the wake of an escalating trade war and China’s decision to weaken the yuan on Monday, the risk-adjusted carry on five major crosses in the developing world has slumped to the lowest since early January, falling below this year’s average. The gauge is a measure of how much return investors get for every unit of risk they assume by holding a currency.

The drop comes even as investors ramp up bets from further monetary easing by the world’s largest central banks. It’s also a sign that another dose of cheap money may not be enough to compensate traders for risks as tension between the world’s largest economies escalates.

“We’d recommend fading any tactical bounce and expect risk assets to remain under pressure,” Morgan Stanley strategists including James Lord wrote in an emailed note to clients.

Beijing on Monday allowed the yuan to fall past 7 per dollar, a key level defended by the authorities in the past. It pinned the blame on U.S. protectionism, raising worries that it was opening a new front in the trade battle with the U.S. China later took steps to limit the currency’s weakness.

The flare-up in the trade war proved a crude awakening to many investors who had been bolstered by the U.S. Federal Reserve’s rate cut on July 31, and had been ignoring these kinds of risks amid a hunt for yield. The market value of the Bloomberg Barclays Global Negative Yielding Debt Index closed at $15 trillion on Monday, showing the force that had been driving investors into riskier assets.

As a sign of the exuberance, a JPMorgan Chase & Co. measure of expected emerging-market currency volatility held little changed in the last two weeks of July, even as a similar measure for developed nations showed an increase in bets for gyrations. The risk-adjusted carry metric, which touched 0.69 on Tuesday, is still above levels seen at the height of a similar sell-off last year.

Investors are now pricing in a roughly 30% probability for a 50-basis-point rate cut by the Fed on Sept. 18. The European Central Bank is expected to unveil its easing plans, including a potential return to net asset purchases, at a meeting on Sept. 12. Whether more monetary stimulus will be enough to make emerging-market assets attractive again is uncertain.

“This calculus may prove correct eventually, which is why it’s hasty to turn defensive across all asset classes when headlines break,” JPMorgan strategists including John Normand, who turned underweight emerging-market currencies last week, said in an emailed note. But as U.S. President Donald Trump threatens to levy further tariffs, “the risk of miscalculation is high,” they said.

Source: Bloomberg Business News