It’s Up to Central Banks to Rescue EM Carry Trade, Nedbank Says

JOHANNESBURG (Capital Markets in Africa) – The emerging-market carry trade is running out of steam, and only central banks can resurrect it, according to Nedbank Group Ltd.

Unless policy makers give markets a new liquidity injection, investors who borrow dollars to buy higher-yielding emerging-market assets may see a repeat of last year, when the wager resulted in the worst losses since 2015, Mehul Daya and Neels Heyneke, Johannesburg-based strategists at Nedbank, said in a client note. The next month will be crunch time, with at least five central banks due to announce policy decisions.

A slowdown in global trade, one of the sources of dollar liquidity, has boosted the greenback, weighing on emerging-market currencies since the beginning of February, according to the Nedbank strategists. A Bloomberg index tracking carry-trade returns of eight major emerging-market currencies has dropped 2.6 percent in that period.

“Global trade and the global economy are in need of a liquidity injection, and the major challenge for investors is whether current stimulus packages will be effective in countering this contraction in liquidity due to slower global trade,” they wrote. “If policy makers fail to provide meaningful stimulus, i.e., fail to do more than ‘jawbone,’ the world would be set to enter the next major risk-off/deflationary environment.”

Among major central banks announcing policy decisions this month are the Bank of Japan, the Federal Reserve, the Bank of England and the South African Reserve Bank, with the European Central Bank’s next meeting set for April 10.

“Expect the rand and other high-beta emerging market currencies to remain under pressure until the major central banks add enough liquidity to reverse this receding tide of liquidity,” Daya and Heyneke said. If liquidity doesn’t improve, they recommend a defensive investment strategy: overweight cash versus bonds, equities and credit.

These are the key upcoming central-bank meetings:

• March 15: Bank of Japan. An increasing number of economists see additional stimulus as the Bank of Japan’s next policy step, while they are unanimous in forecasting no change at this week’s board meeting
• March 20: Federal Reserve. The Fed’s post-meeting statement will likely have only small tweaks. However, the minutes and post-meeting press conference could give an indication of two important items. First, the timing of the end of quantitative easing; and second, discussion around new potential policy tools
• March 21: Bank of England. Two BoE officials, including the usually hawkish Michael Saunders, indicated they are in no hurry to tighten policy amid the fog of Brexit
• March 28: South African Reserve Bank. A month ago, derivatives traders were positioning for a rate hike in Africa’s most industrialized economy. But with inflationary concerns easing, the market is now predicting the next move is down, though probably not at this month’s meeting