Volatility Hampers Asian Carry Despite Rising Returns, ANZ Reports

Elevated Currency Swings Make Carry Trades Unattractive in Emerging Asia

Elevated currency swings are making carry trades unattractive in emerging Asia, according to Australia & New Zealand Banking Group, even with returns at the highest levels in nearly four years. The strategy, which involves borrowing in a low-interest-rate currency to buy a higher-yielding one, is getting fresh impetus in the region from elevated oil prices. A Bloomberg index of three-month forward implied yields for seven emerging-Asian currencies rose to 1.36%, the highest since June 2022, earlier this month.

However, it also comes with a JPMorgan Chase & Co. index of emerging-market FX volatility last month hitting the highest in nearly a year. The higher implied yields point to market expectations that central banks may need to tighten policy. While it makes it more attractive from a carry perspective, the uncertain geopolitical environment means the daily volatility in spot moves driven by news headlines can easily negate any yield advantage.

Investors have been increasing bets that central banks will boost rates to tamp down inflation, as the Iran war raises oil costs. If the Strait of Hormuz, a key thoroughfare for energy transit, remains closed or access is limited, prices may start to rise even more, making oil importers like South Korea, Thailand, and the Philippines vulnerable to price acceleration. South Korean won swaps are pricing three quarter-point rate hikes over the next 12 months, while Thai swaps are factoring in a near 25-basis point rate increase over the same horizon. In the Philippines, traders are pricing a 25-basis point rate hike over the next three months.

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Under the current supply-side shock scenario, higher carry may not be a key driver of currency strength, and it is still better to focus on currencies with relatively better fundamentals such as the yuan, Singapore dollar, ringgit, and Hong Kong dollar, according to Stephen Chiu, chief Asia FX and rates strategist at Bloomberg Intelligence.

Emerging-Asian Currency Implied Yields Comparison

Emerging-Market FX Volatility Comparison

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