Investors Exit Emerging-Market Carry Trades as U.S. Yields Rise

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  • Carry-trade index headed for biggest drop since November
  • ETF that tracks EM local-currency debt posts record outflow

Investors who piled into emerging-market bonds this year in search of higher returns are starting to head for the exit.

Bets on higher-yielding currencies from Brazil to Poland are unwinding at the fastest pace in almost a year as soaring U.S. Treasury yields undermine the attraction of riskier government debt. A BlackRock Inc. exchange-traded fund that tracks emerging-market local-currency debt suffered its biggest daily outflow on record on Thursday.

“This week the depreciation pressure on emerging markets has intensified and there seems to be less discrimination, as some investors are likely reducing positions,” said Sebastien Barbe, head of emerging-market research and strategy at Credit Agricole CIB.

The strategy of borrowing in U.S. dollars to invest in currencies tied to high interest rates has been a favorite among investors this year, pushing the index of carry-trade returns to a three-year high last month. This week’s jump in U.S. Treasury yields, fueled by speculation the next Federal Reserve chairman will be more hawkish and President Donald Trump’s tax cuts may materialize, is eroding the appeal of that trade.

A Bloomberg gauge of the carry trades in eight developing-nation currencies has tumbled 1.8 percent over the past week, heading for the steepest weekly drop since Trump’s election as president in the week ending Nov. 11.

To be sure, this week’s losses came as rising political risks in Turkey and South Africa dented the appeal of those countries’ currencies, with both down more than 3.6 percent for the week. That doesn’t mean the carry trade is over, said John Roe, the London-based head of multi-asset funds at Legal & General Investment Management.

“Now is not a good time to go into the carry trade,” he said “But it doesn’t feel like a good time to panic either.”

Investors pulled a record $218 million from the biggest ETF that tracks emerging-market local debt on Thursday, the largest outflow since the fund was created in 2011. The fund has doubled in size to $6.7 billion this year, prompting warnings from analysts at Bank of America Merrill Lynch that outflows could exacerbate losses in developing-nation assets if risk sentiment suddenly sours.

Investment funds tracking emerging-markets local bonds and equities also posted redemptions over the past week, analysts at Bank of America Merrill Lynch said in a report, citing EPFR Global fund flow data. The flows are the first sign higher U.S. Treasury yields are causing a pause in the “lust for yield,” they wrote.

— With assistance by Ksenia Galouchko

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