One of the Hottest Short-Dollar Trades Just Fell Into the Red
(Bloomberg) -- A rebound in the dollar has exposed the risky underside of a long-winning and ever-popular bet on developing nations.
After climbing as much as 4 percent this year, a Bloomberg currency index that measures carry-trade returns from eight emerging markets, funded by short positions in the greenback, has given up all its 2018 returns.
The culprit is the rising U.S. currency. The Bloomberg Dollar Index has risen about 2.8 percent from mid-February, when it was at a more than three-year low, buoyed by higher yields, rising inflation expectations and Europe’s easing growth momentum.
The "sharp rise in U.S. front end yields has increased the cost of shorting the dollar," Michael Sneyd, currency strategist at BNP Paribas SA, wrote in a note. "This alone has triggered some short covering and has put pressure on EM currencies that have recently underperformed."
Investors effectively banked on continued dollar weakness this year as they gobbled up emerging-market debt. Foreign holdings of local developing-nation bonds swelled last month to near a record $745 billion, according to data collected by Deutsche Bank AG.
“The EM crowd know that they make money on the escalator and give some back in the lift,” said Kit Juckes, a global currency strategist at Societe Generale SA in London. “Their problem here is that they know, too, that this is late in the cycle and most of their gains have to be carry rather than spot moves, so they are skittish.”
Money managers can take solace from BNP Paribas data that suggest a large number of over-stretched shorts in the U.S. currency have now been cleared.
“Dollar strength tends to outweigh EM fundamentals,” said Paul McNamara, a London-based fund manager, who oversees about $11 billion in emerging-market investments at GAM UK Ltd. “We’ve been funding EM out of other currencies since the third quarter of 2017.”
©2018 Bloomberg L.P.