Emerging Market Carry Trades Face Challenges Amid Trade Tensions and Dollar Strength

Key Points:

* Emerging market investors are growing wary of carry trades due to tariff threats and the prospect of a stronger dollar.
* Latin American currencies, often used in carry trades, face pressure from domestic fiscal issues and potential trade disputes with the US.
* Yen-funded carry trades are vulnerable due to the Bank of Japan's monetary policy trajectory and the increased attractiveness of investing in Japan.
* The risk of a stronger dollar reduces its appeal as a funding currency, hindering carry trades.
* Investors are advised to exercise caution and consider relative performance within emerging markets for returns.

Details:

Carry trades involve borrowing at low interest rates in one currency, such as the yuan or yen, and investing those funds in markets with higher rates. However, this strategy becomes less attractive when the dollar strengthens or trade tensions intensify.

Latin American currencies, including the Brazilian real and Mexican peso, are facing pressure due to domestic fiscal issues and the possibility of tariffs imposed by the US. The yuan and Mexican peso are particularly vulnerable to tariff threats.

The Bank of Japan's surprise rate hike in July triggered a sell-off in yen-funded trades, while the Mexican peso has been under pressure since last year's election result.

Investors are seeking alternative strategies, such as comparing relative performance within emerging market currencies. Goldman Sachs favors high-yielding Latin American currencies over Asian peers, while Pictet recommends a cautious approach.

Investors are advised to differentiate and consider macroeconomic factors when selecting carry trades, as high real rates and potential central bank rate cuts may offer opportunities.

Upcoming Economic Data Releases:

* China's manufacturing PMI and Singapore's unemployment rate data (Monday)
* GDP data from Philippines, Saudi Arabia, Hungary, and Mexico (Thursday)
* Czech Republic's GDP report (Friday)
* Trade data from Mexico (Monday), Colombia (Thursday), Thailand, South Africa, and Turkey (Friday)
* Central bank policy decisions from Hungary (Tuesday), Brazil, Chile, and South Africa (later this week)