Emerging market investors are turning increasingly wary of carry trades as the threat of tariffs from the Donald Trump administration and the prospect of further dollar gains squeeze returns, Bloomberg has reported.
Latin American currencies, often bought as part of such trades, face pressure from domestic fiscal issues along with the prospect of trade tensions with the US, according to Mackay Shields and Pictet Asset Management.
Carry trades involve borrowing in currencies from countries with relatively-low interest rates, like the yuan or yen, and investing those funds in markets with higher rates.
Yen-funded trades are vulnerable as it’s more attractive to invest in Japan, Robeco Group said, with the local central bank on a rate-hike trajectory.
The risk of a stronger dollar is also reducing the greenback’s appeal as a funding currency, the asset manager said, as the threat of rising inflation from Trump’s policies comes in the way of further interest-rate cuts from the Federal Reserve.
As a result, risk-reward for emerging market carry trades in a basket of currencies tracked by Bloomberg has slumped to the lowest since 2022.
“Higher yielders are going to be less attractive on a volatilityadjusted basis,” said Philip McNicholas, Asia-sovereign strategist at Robeco Singapore.
“And with Trump now making volatility great again, the carry trade is liable to be a place where even angels fear to tread,” he added.
Carry trades have served as a surefire way for emerging market investors to increase returns, but this strategy is fraught with risks during times of volatility.
Mexico and China’s currencies have come under increased pressure as Trump threatened to impose 25% and 10% tariffs, respectively on their goods starting next month.
The lack of moves during Trump’s first days in office helped ease some of the tension. An index of developing currencies jumped last week as the US president failed to announce specific tariffs, adding to gains after he said he’d prefer not to use tariffs against the world’s second-largest economy.
“With Trump in office and further clarification on his tariff agendas yet to be seen, carry trade will continue to be difficult, and we expect market volatility to increase in general,” said Valentina Chen, co-head of emerging market debt at Mackay Shields.
The yuan, Mexican peso as well as Asian and Central European currencies may “experience a relief rally if the eventual tariffs turn out to be not as aggressive as expected, but equally they can experience further downturn if these tariff negotiations turn out to be unproductive,” she said.
Please follow and like us:
