JPMorgan believes currency carry trades could lose appeal

Volatility and the Fed's rates policy may weaken potential.

The appeal of currency carry trades may wane in the long term due to increased volatility and the prospect of a dovish turn by the Federal Reserve, according to JPMorgan Chase & Co.

Carry trade baskets – where investors borrow in low-yielding currencies and invest in higher-yielding ones – have posted significant losses in the past month, analysts including Meera Chandan wrote in a note. They also flagged concerns around the more resilient side of the trade involving Group-of-10 currencies.

“Ultimately, forces against global FX carry are multiplying,” the analysts wrote. Potential losses will arise “if softening of US inflation is confirmed and then followed by a dovish Fed in the future.”

Traders have been hunting for new pockets of returns as volatility increased after election results stunned markets from Mexico to India. Returns on the Mexican peso-Japanese yen carry trade index recorded the biggest weekly drop since the start of the pandemic after Claudia Sheinbaum emerged victorious in Mexico’s elections earlier this month.

“Overall, the long-term case for FX carry is compromised, even for G-10 if the number of Fed cuts priced this year and early next year increases,” the analysts wrote. “However, we don’t rule out moderate short-term gains if the dust settles in EM and whenever US releases surprise to the upside.”