Citi Says Biggest Carry Trade Rally in Years Has Longer to Run

Citi's head of emerging-market strategy, Luis Costa, predicts that the significant rally in emerging-market currency carry trades against the dollar, which has already delivered some of the decade's best returns, has further upside in the short term. This positive outlook is driven by expectations of a more dovish Federal Reserve and continued caution from emerging-market central banks, both bolstering developing-world currencies.

Analysis

According to Citigroup's head of emerging-market strategy, the carry trade involving long positions in emerging-market (EM) currencies against the U.S. dollar has significant short-term potential to extend its recent rally, which has already produced some of the most attractive returns of the last decade. The primary driver for this outlook is a perceived policy divergence between a pro-actively dovish U.S. Federal Reserve and comparatively cautious EM central banks. This dynamic is expected to continue bolstering the value of developing-world currencies relative to the dollar, sustaining the profitability of the carry trade for the immediate future.

Key Decisions for Investors

• Investors may consider maintaining or initiating long positions in a basket of emerging-market currencies against the U.S. dollar to capitalize on the continued strength of this carry trade in the short term.
• The trade's thesis is highly dependent on monetary policy, so investors should closely monitor forward guidance from the Federal Reserve and key emerging-market central banks for any signs of a shift from their respective dovish and cautious stances.
• Given the explicit 'short term' nature of the forecast, it is prudent to actively manage position sizing and establish clear exit strategies to mitigate risks associated with a potential reversal in central bank policy or market sentiment.