18 octobre 2016

What is the prevailing factor in the currencies market: dollar direction or carry trade?

The currencies markets have experienced successive wild moves since 2010 (figure 1) due to the following events:

  • 2010-2012: The Euro Zone Crisis weighs on the euro (EUR) exchange rate.
  • 2012-2015: The Japanese yen (JPY) devalues following massive quantitative easing undertaken by the Bank of Japan.
  • 2014-2015: The US dollar (USD) appreciates after the Federal Reserve starts to taper its quantitative easing program up until the first post-crisis hike.
  • Early 2015: The dramatic rise of the Swiss Franc (CHF) following the surprise drop of the EUR/CHF floor at 1.20 in January 2015.
  • Early 2016: A re-appreciation of the JPY as demand for safe havens soars in the context of financial turmoil.
  • Mid 2016: The British Pound (GBP) collapses after the UK votes in favor of Brexit.
  • 2015-2016: The Chinese Yuan (CNY) starts a continuous devaluation against all major currencies. The latter devaluation seems rather consistent with the devaluation of emerging currencies in 2015.

These wild moves seem more idiosyncratic and specific to every country’s domestic politics rather than to the global factors that usually drive currencies. In particular, neither moves of the USD nor carry trades seem sufficient to explain currency moves since 2012. As shown in figure 2, the carry trade theme has been muted since 2012. Furthermore, country-specific factors seem to have outweighed the impact of a strengthening USD as the rise of the CHF since 2010 illustrates.

Meanwhile, the current market environment seems to favor carry trades over the USD direction theme. For as Riskelia’s proprietary indicators show there is no common movement across various USD-related currency pairs (see figure 3). As a matter of fact, the current dynamics seem to favor commodity and emerging currencies at the expense of funding currencies in Europe (EUR, CHF, GBP and SEK).

Finally, a Minimum Spanning Tree (see figure 4) shows that the JPY is grouped together with European currencies, thus adding another major player to the list of funding currencies. Moreover, after years of wild moves driven by domestic political events, carry trades may eventually become the principal factor in foreign exchange markets with funding turning away from the USD and into European currencies. For instance, the yield advantage of the USD is rapidly turning more profitable (figure 5). Hence, the likely depreciation of the single currency might boost competitiveness of the weakest countries in the Euro area while simultaneously reviving inflation. However, only time will tell, if the relative decline of European currencies will be enough to save Europe from economic stagnation…


Figure 1: Effective Nominal Exchange Rates of USD, EUR, GBP, CHF, JPY and CNY.

Figure 2: Citi Fx Carry Beta Index (global currencies carry trade strategy involving G10 and Emerging currencies).

Figure 3: Riskelia’s Trend Signals on EUR/USD, CHF/USD, GBP/USD, AUD/USD, INR/USD and BRL/USD.

Figure 4: Minimum Spanning Tree of all currencies vs. USD. Each market is related to its closest neighbor based on a correlation distance. The closer the distance, the thicker the edge.


Figure 5: Annual interest rates carry on USD/EUR and USD/CHF.