A note from JPMorgan suggests that the recent spike in volatility has dealt a major blow to carry trades in the foreign exchange market, which have been the dominant strategy in the foreign exchange market over the past 12 to 18 months.
JPMorgan points to the unwinding of carry trades, which were initially triggered by the Mexican peso selloff after the election and then accelerated by the sharp rise in the yen, which has wiped out interest yields since the start of the year. It estimates that 65% to 75% of carry trades have been unwound.
Looking ahead, JPMorgan Chase sees the carry trade as unlikely to regain its former importance for several key reasons:
- Yield dispersion is expected to continue to shrink, exacerbated by the Fed’s accelerating easing cycle and similar moves by emerging market central banks. This will reduce the reward for yields.
- The high volatility environment, upcoming US election risks, and signs of a broader economic slowdown make the macro backdrop less conducive to a pro-cyclical carry strategy.
In contrast, valuation and price momentum strategies have recently outperformed carry trades.
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Breakup song: