(Bloomberg) — The surge that sent US Treasury yields to the highest in decades is threatening carry trades that had become the go-to strategy for emerging-market investors this year.
Citigroup Inc. closed its carry basket that included long positions in the South African rand, Mexican and Colombian pesos and Turkish lira against the Canadian dollar and Swiss franc. The move came after a strong US PMI report, a weak 5-year Treasury auction and geopolitical headlines stoked volatility in markets, according to a Thursday note.
“We have shown in the past that carry typically does poorly during high volatility and high crowding periods,” analysts wrote.
The so-called carry trade consists in borrowing in a low-interest-rate currency to invest in a higher-yielding one, profiting from the difference in rates. It’s become popular this year, with carry trades funded by the US dollar on their longest quarterly winning run since 2008.
But concerns around global inflation fueled by higher oil prices are starting to force a rethink. A Bloomberg index measuring cumulative carry returns for eight major developing-nation currencies is set for its biggest monthly decline since March, down almost 1%. Favored currencies for the trade, like the Colombian and Mexican pesos, have underperformed since the Federal Reserve hiked interest rates last week, down by 6.6% and 2.6%, respectively.
Bank of America Corp. is among those turning increasingly cautious on developing-world currencies, warning that positioning is getting stretched.
“For carry to keep performing, we need rates volatility to head lower and, ideally, US rates to remain range-bound,” Raghav Adlakha, a strategist at Bank of America Corp, said in an interview. “If that happens alongside oil below $100, then the theme can come back.”
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