A note from JP Morgan argues that the recent volatility spike has dealt a major blow to the FX carry trade, which had been the dominant FX strategy over the past 12-18 months.
JPM point to unwinding of carry trades, first triggered by the MXN sell-off post-elections and then accelerated by the sharp JPY rally, having erased year-to-date carry returns. Estimates suggest 65-75% of carry positions have been unwound.
Looking ahead JPM argue that it is unlikely that carry trading will regain its previous prominence for a few key reasons:
- Carry dispersion is expected to continue narrowing, amplified by the Fed’s accelerated easing cycle and similar moves from EM central banks. This reduces the carry reward.
- The higher volatility environment, upcoming US election risk, and signs of a broader economic slowdown make the macro backdrop less conducive to the pro-cyclical carry strategy.
In contrast, valuation and rates-momentum strategies have recently outperformed the carry trade.
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Break up song:
This article was originally published by Forexlive.com. Read the original article here.