In Citi’s Steven Englander’s latest note, he notes that every major FX trade in place right now is a carry trade in one form or another, differing only in their scope and in the risk they entail. This has 5 significant implications…
This note argues that every major FX trade in place right now is a carry trade in one form or another, differing only in their scope and in the risk they entail. Consider the following trades that encompass the vast majority of FX trades in place:
1) In Asia, long CNH, short USD
2) In G3, long USD, short EUR and JPY
3) In G10 long AUD and NZD, short G3
4) Globally, long EM, short G3
In the short term, we think 2) remains the most robust because acutely disappointing economic outcomes will likely induce ECB and BoJ action. If anything, FX moves are lagging moves in vol-adjusted carry. Fear of more aggressive Fed tightening is the likely driver of higher volatility but this would push spreads further in favor of the USD, offsetting some of the impact of higher volatility. Hence, these carry trades are not as vulnerable as 3) or 4) to Fed-induced volatility. However, we saw earlier this year that long USD against EUR and JPY is sensitive to generalized position unwinds, at least temporarily.
On a 2-4 month horizon 3) and 4) are the most vulnerable because we expect investors to become much less certain that the Fed pricing pace will be as shallow as the market now expects (link), and they would be hit doubly by any backing up of volatility. We look to payrolls and FOMC this week and next as potential triggers for an unwind of these trades, but we think there will be more sensitivity once QE is ended and the unemployment rate falls below 6% — most likely in early November.
This post was published at Zero Hedge on 09/03/2014.