Why strategists believe that a major break is not over

It is too early to give the all-clear for the rapid unraveling of “doing trade,” the strategist has said, warning investors that the unwind still has more room to open.

Carry trades refer to operations where investors borrow in currencies with low interest rates, such as the Japanese yen, and reinvest in higher-yielding assets elsewhere.

Foreign exchange strategies have become very popular in recent years, mainly because investors expect Japan to remain low and Japanese interest rates to remain low.

However, yen-funded carry trades started aggressively last week, as interest rate hikes by the Bank of Japan strengthened the yen – and led to a dramatic sell-off in global markets.

Richard Kelly, head of global strategy at TD Securities, said he would be “extremely hesitant” to announce the end of a trade deal, despite suggestions from some economists that the retreat may be over.

“I would push back a lot of that narrative. You don’t have real data for trade prices that we know,” Kelly told CNBC’s “Squawk Box Europe” on Friday.

“I still have a lot to relax, especially when you see that the yen is undervalued. That will change the valuation in the next one to two years. That will have a spillover effect.”

Economists say it is difficult to accurately assess the scale of yen trade, with estimates varying. Some analysts, using Japan’s foreign investment portfolio, say that if it does trade it could reach $4 trillion, Reuters reported.

Analysts at TS Lombard, however, said in a research note last week that investors may have to find up to $1.1 trillion to pay if they do trade debt.

“If you look at our model now, it’s similar to some of the sentiments you see in the market, they’re telling you that you have to buy back into the carry trade. You have to buy into MEX and Brazil and some of these higher assets (and) start to decrease several fund currencies,” Kelly said.

“I think that is probably wrong. I think there is a structural change. The (Bank of Japan) will still need to tighten, if it is still fundamentally undervalued, the Fed begins to ease – which will change some of these interest rate differentials in the wrong direction,” he said.

“So, I will not buy again into some assets (emerging market) high-yield. I will probably look to go if it is long, still in the sort of long dollar environment. I think that the trade is right, but it is structural rather than high frequency data that near.

Kelly’s comments came as market participants braced for key US inflation figures to get a better picture of the health of the world’s largest economy.

The US producer price index, a measure of wholesale prices, is scheduled to be released on Tuesday and the consumer price index will be released on Wednesday. The reading could prompt the Federal Reserve to start cutting interest rates as early as next month.

A sharp sell-off in risk assets last week was partly driven by weaker-than-expected US economic data. The numbers have left investors worried that the Fed may be behind the curve in cutting interest rates to stave off a recession.

“I actually think that the massive and violent correction that we got last week is actually quite healthy because it forces investors to focus on what the real Japanese strategy is,” Jesper Koll, expert director at Monex Group, told CNBC’s “Squawk Box Asia” on Tuesday.

“The real Japanese strategy is not just fast trading, borrowing near zero interest rates in Japan and investing in high-yielding assets. Real Japanese investment trade is benefiting from corporate restructuring, the first sustainable growth in real wages is now coming. So, focus on the domestic economy rather than the froth economy that comes with zero interest rates,” Koll said.

Analysts at Barclays said systematic selling pressure appeared to have not exhausted itself and it was “too early” to relax.

“Investors are likely to remain on edge over the week ahead, with liquidity set to remain thin and risk allocation light. We expect volatility to remain elevated, which should continue to hurt EM doing business,” said analysts at Barclays in a published research note. Week.

“We would not recommend removing this step in EM rates and look at selective opportunities given the uncertainty surrounding the US economy,” he said.

Not everyone is worried about the long-term impact of a carry trade break. Some economists believe that most of the immediate disruption from the funded carry trade has already been played out.

“Our basic case remains that today’s bad data is more likely to be a temporary distraction than the start of a serious slowdown, which suggests that the new rebound in riskier assets and currencies will continue,” Jonas Goltermann, deputy chief market officer. economist at Capital Economics, said in a research note published on Friday.

“As for the much-discussed trade relaxation, our understanding is that most of the immediate disruptions on the front are now in the past, but we expect that if they continue to gain new benefits and, perhaps, they will advance again in the coming months and 2025,” said Goltermann.

– CNBC’s Michael Bloom and Dylan Butts contributed to this report.