Live Markets: Rising FX volatility spells trouble for carry trades

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RISING FX VOLATILITY SPELLS TROUBLE FOR CARRY TRADES
Implied FX volatility, a measure of how much traders expect currencies to fluctuate in the future, has started to rise, and Barclays currency strategists Marek Raczko and Leonardo Crimella believe there is scope for a further increase. 
A measure of developed market currency volatility .DBCVIX dropped to its lowest since mid-2021 in July but has started to slowly creep up. 
"Our proprietary model shows that the probability of an increase in FX volatility remains high due to the dollar appreciation trend and increased interest rate volatility/cross-country dispersion," write Raczko and Crimella. 
Barclays believes the movement into a higher volatility regime should weigh on FX carry strategies, where investors borrow in a low-yielding currency, such as the yen or Swiss franc, to buy higher-yielding ones, such as the Mexican peso or Brazilian real. 
"Our analysis suggest that any increases in FX vol are likely to be persistent, hence clients should refrain from fading idiosyncratic sell-offs in carry currencies," Barclays says. 
"In the current environment, we do not see value in chasing global carry trades, as EM FX spot values are likely to reprice."
(Samuel Indyk)
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