Emerging-Market Carry Trades Set for Worst Quarter Since 2011

LAGOS (Capital Markets in Africa) – A strategy that made emerging-market investors money in the previous five quarters is getting upended by a stronger dollar and the prospect of a prolonged trade war.

A Bloomberg currency index that measures carry-trade returns from eight emerging markets, funded by short positions in the dollar, has slumped 8.9 percent since end-March, set for its worst quarterly loss since the three months through September 2011.

After rallying since 2016, what’s turned the strategy on its ear this quarter is the dollar’s recovery toward an 11-month high. In a typical carry trade, speculators borrow in a currency they expect to depreciate or remain little changed to secure the lowest borrowing costs, using the proceeds to buy assets with higher yields.

The MSCI Emerging Markets Currency Index dropped to the lowest level since November on Tuesday as China vowed to retaliate “forcefully” against President Donald Trump’s threatened tariffs on another $200 billion in Chinese imports. Since April, investors have been selectively punishing markets — including Turkey and Argentina — where policy makers have failed to do enough to stem deteriorating trade balances and accelerating inflation.

“The emerging-market sell-off will continue in the coming six to 12 months” amid slowing global growth, said Per Hammarlund, the Stockholm-based chief emerging-market strategist at SEB SE. “The slowdown has reduced risk appetite and strengthened the U.S. dollar and it will continue to fan fears of an EM external-debt debacle. The brewing trade war is adding to the gloom, weighing heavily on risk appetite.”

The most vulnerable developing markets are those with large external financing needs, high short-term external debt or weak government finances, Hammarlund said. These include Turkey, South Africa, Brazil, Malaysia, Indonesia and Argentina, he said.

The sell-off isn’t a buying opportunity yet, according to Commerzbank AG. The dollar and Treasury 10-year yield have more room to gain in the coming weeks, and investors should delay entering emerging markets until later in the third quarter, strategists Heike Hauer and Maximilian Kettner wrote in a note to clients. South Africa’s rand and Russia’s ruble were the worst performers Tuesday as commodities slumped for a fourth day.

“For now, we remain particularly sceptical on commodity-sensitive emerging markets,” the Commerzbank strategists wrote.

Source: Bloomberg Business News