DB FX Daily : Tracking the Path of G10 Carry Corrections

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[B]DB FX Daily : Tracking the Path of G10 Carry Corrections[/B]

FX Daily: London
Tracking the Path of G10 Carry Corrections
Today's Key Data and Events
- GBP UK PPI for July, 0.3% m/m input 0.2% m/m core output expected (8:30 GMT)
- USD US retail sales for June, 0.1% m/m headline 0.2% m/m ex-auto expected (12:30 GMT)
- NZD NZ retail trade for June, 0.8% m/m headline 0.8% m/m ex-auto expected (22:45 GMT)
- GBP UK RICS housing market survey for July (23:01 GMT)

Upcoming Event Risks
- Aug 15: Norges Bank rate decision
- Aug 23: BoJ rate decision
- Aug 31: Jackson Hole Symposium
- Sept 6:: ECB rate decision

As volatility in the money markets added to the ongoing concerns over subprime mortgages and credit late last week, baskets of carry trades which had managed to hold at levels 4-5% below their July peaks pushed lower to mark a new low for this drawdown. As of late Friday a basket of G10 carry trades (long NZD, AUD, GBP and short JPY, CHF, SEK) had declined 5.1% from the peak on July 24th. A basket of carry trades including EM currencies (EUR Balanced Harvest) had dropped 5.6% from the peak. With both drawdowns pushing beyond the 5% barrier they join company with previous large corrections such as seen in 1998 and early 2006 where the drawdown often lasted longer rather than the short corrections such as seen earlier this year in February/March. The chart at left below tracks the paths of the ten largest G10 carry drawdowns along with the current episode. In this context, the pace of the current drawdown appears relatively rapid so far. The chart also reveals that during the larger carry corrections, the initial pace of declines was unable to be sustained as the market move further from the peak. With central banks now acting to reduce the volatility in the money markets perhaps the pace of correction could slow though the reasons driving the recent demand for cash (i.e. concerns over subprime exposures and credit risk) may not fade too quickly and potentially cap carry recoveries in the short-term.

Turning away from carry baskets and to a recently volatile currency pair such as EUR/JPY, rate spreads relationships appear to provide some fundamental backing to the correction lower as seen in the chart at right below. But much of the spread movement was likely driven by financial market volatility having a larger relative impact on EUR rates rather than JPY rates. Should movements in rates become less volatile some focus may shift on to whether either the BoJ or the ECB with rate decisions due over the coming weeks are likely to shy away from raising rates in a turbulent environment.


Trevor Dinmore
Strategist
(+44) 20 754-71796
[email]trevor.dinmore@db.com[/email]