Global investment bank JPMorgan published a report last week by global market strategist Yuxuan Tang, exploring the viability of carry trades amid widespread interest rate cuts. The report highlights that as central banks, including the U.S. Federal Reserve, reduce rates, carry trades — which rely on borrowing in low-yielding currencies to invest in higher-yielding assets — are becoming less effective. JPMorgan noted:

Given the evolving global interest rate landscape and the specific characteristics of each funding currency, investors may need to be more selective regarding taking FX risks in their funding strategies.

The report dives into the dynamics of key funding currencies, including the Japanese yen (JPY), Swiss franc (CHF), and Chinese yuan (CNH). Historically, JPY has been a dominant funding currency due to its near-zero interest rates. “This led to a massive buildup in carry trade positions, one of the largest in decades. A significant portion of these positions was funded with JPY, the only major currency with interest rates near zero at that time — estimates of JPY-funded carry trade positions ranged from USD 2 to 20 trillion at the peak. Some positions also used the Swiss franc (CHF), offshore Chinese yuan (CNH), and the euro (EUR) as funders.”

However, the situation has shifted since July. “These carry trade positions started to quickly unwind since July 10th (when the Bank of Japan intervened in currency markets) and accelerated after the BOJ’s unexpected rate hike on July 31st.” This has significantly reduced the appeal of JPY as a funding currency. At present, JPMorgan’s models suggest that “price distortions from carry trades have largely been squeezed out,” leading to the recommendation to avoid JPY for carry trades and consider long positions in the currency instead, given its expected appreciation over the next 12 months.

In the case of CHF, while it remains a viable option for carry trades, JPMorgan notes that bullish risks could emerge due to the Swiss National Bank’s cautious monetary stance and Switzerland’s economic challenges. Investors are advised to implement risk management strategies for CHF carry positions to mitigate potential currency appreciation. For the CNH, JPMorgan recognizes its low volatility, but the outlook remains bearish due to China’s economic slowdown and geopolitical risks.

JPMorgan advised:

Overall, the returns from carry trades are expected to diminish as central banks of high-yield currencies begin cutting rates. We think it is prudent to consider a partial reallocation of funding back to an investor’s base currency.

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