|Carry returns consistently positive since 2012|
Vasileios Gkionakis, head of global FX strategy at UniCredit, says around the end of August and start of September last year, the great market re-allocation toward more risk began to emerge. He says investors took comfort that central banks were responding effectively to tail-risks and decided to start reducing cash levels by putting their money to work.
Risk-taking took centre stage and so the carry trade started to benefit once again, says Gkionakis.
During September and October, this was a natural response to central bank action, but in November and December it was compounded by improvement in the economic data across the board that alleviated worries over China and the US hard landing.
There is more good news for carry trade investors. Not only did returns pick up but the volatility of carry started dropping steadily.The 12-month rolling volatility of UniCredits carry basket stood at an annualized 12% in June, but fell to 8% during the last quarter of 2012. Therefore, with spot returns rising and volatility falling, the resulting rise in risk-adjusted returns underpins the notion that the great reallocation towards a risk-on environment is well under way, according to Gkionakis.
Extending the analysis to include 16 EM currencies in the carry basket, UniCredit found similar results, with returns rising and volatility falling.
The key to whether it continues is global risk appetite, and whether the current optimism can be maintained.
There are good signs that some of the greatest worries over the world economy are waning. The ECB has for now allayed fears over the break-up of the eurozone, while the Chinese and US economies appear to be over the worst.
Crucially, if that optimism holds, it will prompt investors to put their money to work.
Investors cash positions are still elevated, notes Gkionakis, and as risk appetite rises, they will not want to miss yet another rally and will therefore deploy resources to riskier positions.Typically when this happens, carry strategies benefit significantly, he says. Indeed, judging by the size of the gains made in currency pairs such as AUDJPY, not to mention NZDCHF, ahead of the financial crisis, the carry trade is a bandwagon that investors will be eager to jump on.
If it continues, expect more gains in the likes of AUD and NZD and RUB, INR and MXN in the emerging world while JPY and CHF are likely to come under significant downward pressure.That last prospect will go down very well with policymakers at the Bank of Japan and Swiss National Bank.