Carry on in the G10 while you still can – TDS

Mark McCormick, North American Head of FX Strategy at TDS, suggests that since the initial jolt from Brexit, the major currency markets have been living in a sweet spot for risk.

Key Quotes

“Recent US data has shown that recession fears were overdone while the Brexit shock is still likely to see policy makers inject further stimulus to smooth the transition. In Japan, voters granted the Abe administration fresh support to push on with Abenomics 2.0. News reports indicate a JPY20 trillion stimulus package is in the works. The combination of these factors has helped risk sentiment recover, boosting the search for yield and carry.

Since May, the carry basket has outperformed both the broad USD and the momentum basket. This is also consistent with price action in the majors with AUD and NZD leading gains in the G10 since mid-Q2. With the Fed likely to maintain its neutral tone next week, the BoE, RBNZ and RBA possibly seen easing next month and Japan expected to introduce another round of macro economic stimulus to boot, we think carry could have a few more weeks left to run. That said, with global growth unlikely to accelerate above trend and market uncertainties likely to persist into H2, we believe G10 carry basket are unlikely maintain their strength for long.

This backdrop has probably led to a few crowded trades in the G10 that are likely to get squeezed on a shift in the macro environment. We think US data and Fed pricing is the first trigger that could shakeup market pricing. There is large outstanding longs in CAD, JPY and CHF but also a build-up in AUD and NZD over the past month. The market also remains underweight USD relative to the past three years, increasing scope for squeeze on better US data.

Besides the Fed, we think policy and data events from Japan and the UK could also trigger a shift in sentiment. For one, those looking for helicopter money in Japan may be disappointed while a turn in UK data could lead to a rise in risk aversion as economic impact of Brexit unfolds. Most European currencies are cheap but also that AUD and NZD are expensive. NZD looks the most overdone and we continue favour shorts on the crosses.”