Barclays Capital’s FX strategy team has recently published an article entitled “Carry trades: market regimes, positioning risk and petrodollars,” in which it discusses whether last week’s setback to carry trades is temporary or if an even bigger correction is around the corner.
A framework is presented in which to analyse the performance of carry trades against different macro backdrops and conclude that the sharp drop in oil prices since Q4 last year was a more important contributor to the outperformance of carry trades than is generally acknowledged, says the firm.
The article also argues that the magnitude of JPY-funded carry trades has reached levels that could raise concerns about systemic risks and the possibility that an unwinding of positions could dangerously feed on itself. Some triggers are identified that could lead to general unravelling of carry trades, but downplay the JPY-specific worries.
While Barclays Capital thinks the macro environment will likely remain benign for carry trades for a little while longer, the firm concludes that the risk-reward trade-off has deteriorated. Barclays Capital recommends that investors who are still long-carry seek protection. For investors who are looking for a cheap way to position for the risk of a transition from a benign to a more hostile environment for carry trades, the firm recommends a basket of short NZD/CHF and long USD/JPY spot positions.