Emerging-Market Carry Bets Declared ‘Dead’ on Strong Dollar

(Bloomberg) -- A strengthening dollar is reducing the appeal of emerging-market carry trades, which handed investors their biggest monthly loss in 18 months.

An index that measures returns from borrowing in dollars and investing the funds in eight high-yielding currencies, such as the Turkish lira, Brazilian real and Indonesian rupiah, lost 3.3% in September, the most since March 2020. The Bloomberg Cumulative FX Carry Trade Index is now down 1.2% this year.

The gains earlier this year have evaporated as investors sought the safety of the dollar amid China Evergrande Group’s debt crisis and as an impending reduction in the Federal Reserve’s asset purchases caused U.S. bond yields to resume their climb. Out of 24 developing-nation currencies tracked by Bloomberg, 16 appreciated on Friday as the greenback eased for a second day.

“Buying all high-yielding emerging markets versus the dollar is dead,” said Lars Merklin, senior analyst at Danske Bank A/S in Copenhagen. “Dollar strength will be highly persistent.” He prefers an alternative funding currency such as the euro, which fell past 1.16 to the dollar this week for the first time since July 2020.

Emerging-market currencies such as the Russian ruble, whose front-end yields have already risen on central banks’ preemptive monetary tightening, are likely to do better against a stronger dollar, said Peter Kinsella, global head of foreign-exchange strategy in London at Union Bancaire Privee. 

“The euro should be a preferred cyclical funding currency, given its negative-rate profile and high beta to global growth, which is slowing,” Kinsella said.

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