Carry Trade: Supportive backdrop holds – OCBC

OCBC’s Sim Moh Siong and Christopher Wong note that in-line United States (US) inflation and a modestly lower probability of a September Federal Reserve (Fed) hike have left the US Dollar (USD) broadly range-bound while risk assets continue to rally. They argue this constructive environment, together with improved risk sentiment, should keep carry trades supported, though warn that higher long-end US yields driven by AI-related financing and US fiscal deficits remain a key risk.

Carry trades supported by stable USD

"Market reaction was relatively muted following an in-line US CPI report and mixed developments in the Middle East. Fed pricing shifted modestly, with the probability of a September rate hike easing to 40% from 50% after the inflation release. Most FOMC members are likely to view the July CPI print as acceptable but will want to assess August inflation data before making a September policy decision."

"The initial market response saw US Treasury yields fall and the USD weaken. However, the move quickly reversed, with the yield curve twist steepening and the broad USD finishing the session little changed. The standout development overnight was the continued rally in risk assets, supported by strong AI infrastructure-related earnings and investment themes."

"A broadly range-bound USD and constructive risk backdrop should continue to support carry trades, despite ongoing volatility in oil markets and lingering FX intervention risks for JPY. The main risk to this positive market environment is a further rise in long-end US yields, driven by substantial AI-related financing needs, persistent US fiscal deficits, and the resilience of US economic growth."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor. Know more.)