DB FX Daily: Can US Out-Cycle Euro-Area; Bull Runs in Carry End in Tears

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FX Daily: Can US Out-Cycle Euro-Area; Bull Runs in Carry End in Tears

Can US Start To Out-Cycle Euro-area?

Today's payrolls report will bring even more focus on the relative cycles of the US versus the Euro-area following yesterday's ECB decision. In the FX Strategy Weekly, we showed that the momentum of positive data surprises has clearly been on the side of the Euro-area, rather than the US, in recent weeks. Typically, data surprises mean-revert, and so the likelihood is that over the coming few weeks, the US will be exposed to more positive data surprises than the Euro-area. So even if today's payrolls report comes in below-consensus, it may not necessarily be the beginning of a phase of negative data surprises from the US. Moreover, 2-year interest rate differentials have moved significantly in favour of the Euro-area and against the US in recent weeks, suggesting that markets are already positioned for relative cyclical strength in the Euro-area. FX markets are similarly placed, with our positioning indices pointing to growing long EUR/USD positions. We would therefore position for the possibility of the relative cycles starting to weigh on EUR/USD in the coming few weeks.

Don't Forget That Bull Runs in Carry Trades End In Tears

One of the main lessons from last week's carry trade unwind was that it occurred just as the market was lowering its guard on the possibility of a carry unwind. Indeed, a week earlier, the market was very concerned that the February BoJ meeting was going to trigger a carry unwind (this was indicated by the options market). Yet, as soon as the BoJ meeting passed, the concern of a possible unwind receded and carry trades rallied, only to sharply unravel soon after. We would bear this in mind, and would look for the next downleg in carry trades to occur once the market has lowered its guard (once again). The options market could provide a useful guide in this respect, as a decline in volatility could be a signal of just that. Aside from these short-term observations, one needs to keep an eye on the bigger picture. The last thirty years has shown that G10 FX carry trades follow a cycle of returns; 4-8 years of positive returns followed by 1-2 years of very negative returns. The current positive has lasted a record 8 years, and so we think the time is ripe for a negative year (see chart).