USD wins when carry meets politics – TDS

Global carry trade withers away leaving markets cling to the US Dollar as the best hedge to rising risks, TDS strategists note.

Global politics reshapes the market risk sentiment  

“The grip of the 'doom loop' continues to tighten ever so slightly. Markets are witnessing typical behavior of a complex, adaptive system. What starts with a seemingly idiosyncratic event in a specific country, morphs into a problem for everyone else. The events in South Africa, India, Mexico, and now France are not isolated. They are connected and starting to reshape the market sentiment.”

“This is an outcome we have been recently discussing, especially as FX vols have been lulled into a dreamlike state. Everything is fine — until it's not. The unwinding of the carry trade has been a major talking point with clients recently. A successful carry trade needs two conditions: rate divergence and low volatility. Both are moving against it, leaving the USD as the best hedge to rising risks.”

“We also note that long-term valuations play a critical role in carry unwinds. Our slow-moving composite framework, LFFV, points to overvaluation in most of the popular carry trades like MXN, BRL, COP, HUF. What's more, EUR headwinds keep building, underscoring rising political uncertainty and a jump in OAT-Bund spreads. We continue to expect an H2 break below 1.05 in EUR/USD.”