Due to the Strong Dollar... Smith's Wife Withdraws Money from Emerging Markets

Dollar Carry Trade Returns Down Over 5% from September Highs
Slow Rate Hikes in Korea and Asian Countries Raise Risk of Capital Outflows
Biden's Approval Rating Plummets Amid Worst Inflation

[Image source=Reuters Yonhap News]

[Asia Economy Reporter Kim Suhwan] The so-called 'dollar carry trade,' where funds procured at low interest rates in developed countries are invested in high-interest emerging market currencies, is showing signs of a sharp contraction.

As the safe-haven dollar strengthens amid inflation concerns originating from the U.S., carry trade yields have fallen, raising fears that investment funds flowing into emerging markets in Asia, South America, and elsewhere may be withdrawn. With the Korean won also continuing to weaken recently, there is concern about potential capital outflows from Korea.

On the 14th (local time), Bloomberg reported that an index tracking the dollar carry trade yields against major emerging market currencies relative to the U.S. dollar has plunged more than 5% from its peak in September.

The decline over the past two months was the largest since March last year.

"Dollar Carry Trade Liquidation Begins"

According to Bloomberg's data, the carry trade yield investing in the Turkish lira dropped 11% over the past two months, driving the decline in Bloomberg's carry trade yield index. This was followed by the Hungarian forint (-6.8%), South African rand (-6.5%), Polish zloty (-4.7%), and Romanian leu (-2.8%).

Earlier in October, the U.S. Consumer Price Index (CPI) surged 6.2%, the highest since the 1990s, signaling inflationary pressures. This led to expectations that the U.S. Federal Reserve (Fed) would initiate tightening policies such as interest rate hikes.

As a result, the market reflected expectations that the interest rate gap between the U.S. and emerging markets would narrow, leading to the liquidation of positions invested in carry trades, Bloomberg reported. The continued weakness of major emerging market currencies is also analyzed as a result of reduced investment attractiveness in these currencies.

Mitul Kotecha, an emerging markets analyst at Canadian investment bank TD Securities, said, "Concerns over U.S.-originated inflation suggest that the relative interest rate gap between the U.S. and emerging markets will narrow in the short term, negatively impacting carry trade transactions. In particular, the Fed's tapering (asset purchase reduction) will also act as an obstacle to carry trade transactions."

If carry trades in emerging markets begin to be liquidated, foreign investment funds flowing into these countries are inevitably expected to be withdrawn.

The Fed also expressed concerns about potential capital outflows from emerging markets in its semiannual financial stability report released on the 8th. The report stated, "If a tightening environment arises due to interest rate hikes in developed countries and increased risk sensitivity among investors, it could raise debt costs for emerging market governments and corporations, leading to capital outflows."

Slow Interest Rate Hikes in Asia Raise Capital Outflow Concerns

Furthermore, as interest rate hikes are expected to proceed more rapidly in Europe, the Middle East, and Latin American countries than in Asia, there is a possibility that carry trades involving Asian countries will contract relatively more.

Damian Sassower, an emerging market credit analyst at Bloomberg, said, "Benchmark interest rates are rising rapidly in Latin America, Europe, and Middle Eastern countries. Since this year, the investment attractiveness of carry trades targeting Asian currencies has been declining."

Previously, as foreign investors increased investments in Asian countries through carry trades, it was analyzed that Asian stock markets such as Korea and Taiwan were also lifted. If carry trades shrink, these countries' stock markets could face corrections again.

In fact, while the U.S. stock market's major index, the S&P 500, reached an all-time high earlier this month and showed a bullish trend, Korea's KOSPI index has been flat for four months after hitting the 3300 level in July.

Meanwhile, this week, key emerging market central banks in Indonesia, Turkey, the Philippines, and Hungary are expected to hold interest rate decision meetings, drawing attention to whether these countries will raise rates. According to Bloomberg, Indonesia and the Philippines are expected to keep rates unchanged. Turkey's decision is also noteworthy, having cut rates twice consecutively since September.

Inflation Causes Biden's Approval Rating to Plummet

With the worst inflation in 30 years occurring, U.S. President Joe Biden's approval rating is also plummeting.

According to a survey conducted by The Washington Post (WP) and ABC from the 7th to 10th targeting 1,001 U.S. adults (margin of error ±3.5%p), positive evaluations of President Biden stood at 41%, the lowest since his inauguration. Conversely, negative evaluations reached 53%.

Seventy percent of respondents expressed pessimism about the economic outlook, and nearly half attributed the current severe inflation to President Biden. As high inflation became a political issue, officials moved to clarify. U.S. Treasury Secretary Janet Yellen appeared on CBS's 'Face the Nation' that day, emphasizing that the cause of inflation is the pandemic, not policy.

Dollar Carry Trade

Carry trade refers to transactions that generate profits by borrowing funds in low-interest-rate currencies and investing in financial products of countries with high interest rates. Investors who borrow U.S. dollars using America's zero interest rates and invest in other countries through dollar carry trades are sometimes called 'Mrs. Smith.'

This content was produced with the assistance of AI translation services.