In the global currency market right now, everybody is in everybody else’s business.
In a note on Tuesday, Steve Englander, Global Head of G10 FX Strategy at Citi, argues that every major foreign exchange trade in place right now is a carry trade.
Simply put, a carry trade is one where a trader sells one asset and uses the proceeds to buy another, in this case selling one currency to buy another.
Englander says these are the four trades currently in place:
- In Asia, long CNH, short USD
- In G3, long USD, short EUR and JPY
- In G10 long AUD and NZD, short G3
- Globally, long EM, short G3
As Englander sees it, there are five main risks to these trades. Among these risks is that the “yield advantage” — which is the reason why you’d put on a carry trade at all — is at multi-year highs when adjusted for volatility.
This chart from Englander illustrates this point nicely. The red arrows show the difference between what U.S. and Japanese treasuries imply the yen is worth against the dollar, with bonds implying the yen is worth about 110 against the dollar, while spot prices currently peg the yen at about 102.
And this difference is even more dramatic when looking at the dollar versus the euro.
Englander also notes that these trades are “highly dependent” on what policymakers do: the first trade depends on Chinese policymaker tolerance of CNH appreciation and positioning; the second on explicit easing measures by the ECB and BoJ; and the last two trades stay intact only if the Fed normalization path is extremely shallow, meaning only if the Fed raises rates slowly once it begins that process.
And while discussing the positioning of currency trades is all very “inside baseball,” this stuff matters because nothing can impact an economy more drastically than a big swing in the value of its currency.
We often focus on the prices of stocks and bonds, but the reality is as the largest market in the world, big changes in the currency market send big shocks through the global economy.
Englander says the U.S. jobs report this Friday and the Fed’s next monetary policy announcement on Sept. 17 could be potential triggers to unwind these trades, but “more sensitivity” in these trades is likely after the Fed ends its QE program, which is currently expected to wrap up in October.
Just something to keep in mind.