FX carry trade unwinding: Don’t play trader
As readers will be aware, the global unwinding of the FX carry trade has led to some extreme bouts of volatility. This appears to have generally been good for a lot of banks and other market makers; but it has been absolutely catastrophic for many of their clients, especially in some emerging markets.
There will inevitably be investigations into what has gone on and it seems certain there will be accusations of mis-selling.
For instance, in Mexico there has been substantial fallout from the collapse of Controladora Comercial Mexicana (Comercial). This was the country’s third largest retailer in terms of sales, and it operated numerous supermarkets and restaurants. It also put on a lot of carry trade positions using options. As these went horribly wrong, Comercial is reported to have taken a $2 billion hit – not enough to win our new version of Go for broke, but it is still extremely sizeable. Apparently, $1 billion of the loss was related directly to a long peso punt.
Not surprisingly, Mexico’s National Banking and Securities Commission is looking into the issue. And with many other Mexican companies also reporting FX losses that would seem to have no hedging purpose, this story could get extremely ugly.
According to the Royal Bank of Canada, similar losses will be reported by corporates in other LatAm countries. “The relatively low volatility and seemingly one-way currency moves that we witnessed in EMFX over the past few years presumably led some corporate treasuries to seek easy money by taking positions in out-of-the-money FX derivatives, betting EM currencies would continue strengthening,” the bank writes.