As we discussed last week FX market volatilities have decreased to their lowest levels since those seen in the carry market prior to the financial crisis in 2008. Back then, the carry market was characterized by strong trends in several currencies generating low FX volatilities which combined with substantial rate differentials between currencies made carry a profitable strategy. Today the situation is very different. FX markets are currently tightly rangebound with no particular trends and falling FX volatilities. They therefore provide a false impression by appearing instead to reflect a lack of conviction among investors rather than low uncertainty levels. In addition rate differentials among most major currencies remain too narrow to be worth exploiting using carry strategies given current political and economic uncertainties. Therefore, despite low realised volatilities the volatility adjusted carry between higher yielding and traditionally low yielding currencies such as the JPY and CHF remain well below comparable levels prevailing in the 2006/07 “carry market” making carry trades unappealing. Moreover, at least four of the most traded currencies have zero interest rates making it less likely a low rate would be negative for a specific currency. Indeed, while FX market volatilities remain low, under current conditions we would refrain from taking carry positions as low rate differentials between currencies are still too narrow to justify the risks of negative surprises capable of eliminating any potential carry return. However, were we to expect a more significant recovery in the global economy next year supporting risk appetite, there may be a case for reconsidering the carry trade once again. We will explore this topic further in next week’s FX Ringside where will publish our thoughts and trades for 2013.
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SEB tech team