Trade Beloved by Hedge Funds Axed by BNP Over Election Jitters

(Bloomberg) -- BNP Paribas Asset Management is rethinking its affinity for the carry trade, cutting positions in emerging-market currencies as volatility picks up ahead of the U.S. election.

Momtchil Pojarliev, head of currencies at the money manager, sold his holdings in the South African rand earlier this month to avoid a big position around the Nov. 3 match-up between President Donald Trump and former Vice President Joe Biden. He earned 3% to 4% from the bet and expects to add the currency again at key price levels.

Carry trades -- -- which use borrowed dollars to buy securities denominated in higher-yielding currencies -- proved a lucrative wager earlier this year. But the strategy, a bread-and-butter source of returns for macro hedge funds, has recently taken a hit. Fears around a delayed election outcome and an uptick in coronavirus cases in Europe have fueled pent-up haven demand for the greenback, prompting investors to sell riskier peers. Gauges of price swings in the foreign-exchange market have also started to creep higher, with more turbulence expected around the U.S. vote.

“Into the elections, I expect high volatility, which is not a good thing for a carry trade,” said Pojarliev. “Long term I like it, but it’s not a good time to have a long on because there will be better opportunities to get back in at better levels.”

Pojarliev decided to take profits on the rand, while lowering holdings in other emerging-market currencies, even as they strengthened versus the U.S. dollar in early September.

That proved a smart move. MSCI Inc.’s emerging-market currency gauge last week posted the worst performance since March, while an index of the greenback touched a two-month high. The dollar is heading for its first monthly gain in six.

“The broad dollar was over-sold toward the end of August and a short dollar was a consensus call,” he said. “This was a warning sign to us that a rebound in the dollar is coming, so we were looking for levels to take profits on our EM FX long exposures.” The trigger point proved to be Federal Reserve Chairman Jerome Powell’s speech at Jackson Hole, and the central bank’s subsequent meeting, he said.

Risk in Focus

The Bloomberg GSAM FX carry trade index is down about 2.6% this quarter. That compares with a loss of 0.4% for momentum, or trend-based buying, and an almost 1% gain for the value strategy where traders buy undervalued currencies and sell their overvalued counterparts.

However, there could be some opportunities for investors looking to enter the carry trade after the recent rout in developing-market currencies. Pojarliev expects to repurchase the rand when it touches 17.50 per U.S. dollar. And after cutting his Mexican peso position by 50% earlier this month, he began buying pesos again on Friday.

Still, Goldman Sachs Group Inc. strategists say they are also approaching the carry trade with caution in the current environment.

“With risks still in focus, equities still volatile, and the broad dollar on the move, it is likely too early to engage fresh emerging market high-yield longs,” strategists including Kamakshya Trivedi wrote in a note to clients Wednesday.

©2020 Bloomberg L.P.