Citigroup Inc has observed a significant shift in carry trade strategies, with hedge funds increasingly borrowing US dollars rather than Japanese yen to invest in emerging-market currencies, according to a report by Bloomberg.
This switch follows a retreat from earlier short positions on the yen, prompted by evolving interest rate expectations in both the US and Japan.
Hedge funds began favouring the dollar as their funding currency on 5 August, according to Citi as the greenback traded at its lowest level since March. They have been using it to buy currencies like the Brazilian real and Turkish lira, according to Kristjan Kasikov, Citigroup’s global head of FX quantitative investor solutions.
The shift comes amid increased speculation that the Federal Reserve will implement more than three-quarters of a percentage point in rate cuts this year. Combined with the Bank of Japan’s unexpected rate hike in July, this has upended the traditional carry trade model, which relied on strong US growth and low Japanese borrowing costs.
Kasikov said: “We’ve noticed a significant bearish shift in sentiment toward the US dollar. The growing anticipation of rate cuts has sparked renewed risk appetite.”
Earlier in the year, the dollar had been steadily rising as traders reduced their expectations of aggressive Fed rate cuts. From January to June, a Bloomberg index tracking the dollar gained nearly 5%, while the yen dropped to its lowest level in nearly four decades.
However, August saw a sharp reversal following the BOJ’s rate hike, leading to a surge in hedge fund activity.
Data from the Commodity Futures Trading Commission showed that hedge funds, which had maintained bearish positions on the yen since 2021, turned bullish as the BOJ’s move signalled a potential shift in Japan’s monetary policy.
Despite this flurry of activity, Citi warns that the favoorable conditions for global carry trades may be short-lived, with Kasikov expressing concerns about increased market volatility as the US presidential election approaches, which could negatively impact carry trades.
Kasikov noted: “We’ve been cautious about the FX carry trade for some time. The upcoming US elections are likely to introduce more volatility and risk aversion, which could weigh on the market.”
