Carry Trade Trends: Increased Bets in Emerging Markets Ahead of Fed Rate Cuts

New York: The resurgence of carry trade is attracting attention among investors in emerging markets. Predictions that the Federal Reserve may initiate interest-rate cuts next month are putting downward pressure on the dollar, enhancing interest in high-yielding currencies.

Money managers from firms like Neuberger Berman Group LLC and Aberdeen Group Plc are increasingly investing in currencies from Brazil, South Africa, and Egypt. This trend is fueled by a declining dollar and reduced volatility, creating a favorable environment for carry trading, where investors borrow in lower-yielding currencies to purchase those with higher yields.

The carry trade, which previously achieved double-digit returns this year before a pause in July due to a dollar rebound, is regaining momentum. Recent weak US job reports have strengthened forecasts that policymakers might need to lower borrowing costs next month to prevent a recession. Analysts from DoubleLine to UBS echo this sentiment, suggesting the dollar’s downturn narrative is “back in play.”

Gorky Urquieta, co-head of emerging market debt at Neuberger Berman, expressed that the risks of a significant dollar resurgence appear limited amid relatively stable growth. He favors carry trades in countries such as South Africa, Turkey, Brazil, Colombia, Indonesia, and South Korea.

In addition, Donald Trump’s unpredictable policies have prompted traders to seek diversification, contributing to the US Dollar Index experiencing its worst first half since the 1970s.

This shift towards emerging markets follows a decade of dominant US performance and has led to a revival of interest in developing-country assets after three years of capital outflows. Global funds focused on emerging market debt have seen substantial inflows, with investors contributing $1.7 billion in the week ending August 6, according to a Bank of America Corp note referencing EPFR data. An index of local bonds has returned over 12%, with 18 out of 23 major EM currencies appreciating against the dollar this year. The reduced expected volatility in emerging currencies compared to Group-of-10 peers is currently at its highest level in 12 years, signaling greater stability ahead for developing markets.

Recent hawkish policies from some central banks in emerging markets have heightened the attractiveness of carry trades, particularly amidst inflation and tariff concerns. For instance, Colombian authorities surprised markets by maintaining borrowing costs at 9.25%. Similarly, India decided to keep interest rates steady, indicating a cautious approach, while Brazil continues to navigate high interest rates of 15%, countering potential trade levies imposed by the US.