The recent sharp appreciation of the Japanese yen is notable, yet it lacks the force to fundamentally shake the foundations of the emerging market carry trade. Strategists at Morgan Stanley believe that as long as no additional catalysts emerge to trigger broader volatility, this trading strategy retains sufficient resilience.
In a recent research report, the team led by James Lord, Morgan Stanley's Global Head of FX and Emerging Markets Strategy, pointed out that the performance of carry trades is more dependent on the overall trajectory of global currency volatility, the global growth outlook, stock market performance, and the fundamental logic of emerging market economies themselves, rather than on the single variable of the yen's exchange rate.
"Global growth, global equity performance, and bottom-up trends in key emerging markets have a far greater impact on EM carry trades than the yen's trajectory," the team wrote. "On these fronts, we maintain a constructive stance."
Signs of resilience are already visible in the market. Although the Brazilian real and the Colombian peso have depreciated 5.1% and 3.4% respectively against the yen since July 29, they have actually appreciated 0.7% and 2.4% against the U.S. dollar, indicating that the overall pressure on emerging market currencies remains relatively manageable.
Yen Rises to Six-Month High, Rate Hike Bets Intensify
The yen strengthened to 152.89 per dollar on Tuesday, its strongest level since mid-February, before paring some gains to trade around 153.46. The rally is driven by traders ramping up bets on further interest rate hikes by the Bank of Japan, while remaining vigilant about potential additional official actions to support the currency.
The core logic of the carry trade involves borrowing a low-yielding currency and investing the proceeds into higher-yielding assets to capture the interest rate differential. The yen has long served as one of the primary funding currencies for this strategy, and therefore, expectations of BOJ policy tightening pose a potential source of pressure.
Greater Funding Diversification Enhances Trade Structure Resilience
The Morgan Stanley strategists noted that investors are already proactively diversifying their sources of funding, with the euro and the Swiss franc increasingly becoming alternative options for financing high-yield asset positions. This structural shift means the carry trade is less sensitive to fluctuations in any single funding currency, thereby bolstering the overall risk resistance of the strategy.
According to a recent Bloomberg report, emerging market carry trades have recorded their longest winning streak since 2008, indicating persistently high market participation and enthusiasm.
The Morgan Stanley team maintains a positive outlook on emerging markets and advises investors to position opportunistically during pullbacks. "Bottom-up fundamental support, substantial carry returns, and resilient global growth will continue to attract investors to this asset class," the strategists stated.
The team emphasized that the real threat to the EM carry trade stems from systemic shocks capable of inducing broader market turmoil, not from a temporary appreciation of the yen itself. With no notable deterioration in global growth expectations, the fundamental logic underpinning the strategy remains intact.
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