EM Carry Trade Appeal Boosted by Easing FX Swings, Analysts Say

Emerging market (EM) carry trades are becoming more attractive due to a significant easing in currency volatility, according to analysts at Mizuho Securities and Goldman Sachs. EM currency volatility has fallen approximately 1.3 percentage points this quarter, outpacing G7 currency volatility, with the ratio between the two indexes reaching its lowest point since 2013, per JPMorgan data. This reduction in risk, combined with a rangebound dollar, suggests continued support for EM carry strategies.

Analysis

The appeal of emerging-market (EM) carry trades is strengthening due to a significant reduction in currency volatility, a view supported by analysts at Mizuho Securities and Goldman Sachs. According to data from JPMorgan Chase & Co., EM currency volatility has declined by approximately 1.3 percentage points this quarter, a more rapid decrease than that observed in Group-of-Seven currencies. This divergence has pushed the ratio between the two volatility gauges to its lowest point since 2013. The outlook for a rangebound US dollar is expected to sustain this low-volatility environment, thereby reducing the inherent risks of the carry trade strategy and bolstering its attractiveness to investors seeking yield.

Key Decisions for Investors

• Investors should consider increasing allocation to emerging market carry trade strategies to capitalize on the improved risk-reward profile driven by historically low relative currency volatility.
• It is critical to monitor the EM-G7 currency volatility spread and the stability of the US dollar, as a sharp reversal in these indicators would signal a deterioration in the conditions supporting this trade.
• The current environment presents a tactical opportunity to overweight positions in high-yielding EM currencies where the cost of hedging or the risk of adverse FX movements has materially decreased.