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The Carry Trade Is Not Dead – It’s Just Evolved

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My Seeking Alpha article last week on the Mexican peso’s post-rate cut rally prompted this response by a reader:

“Capturing the interest rate differencials across currencies used to be an fx trade, but global monetary accomodative policy has taken the juice out of the carry trade for fx traders. The carry trade has increasingly become a fixed income trade where real money has more tolerance for fx volatility in order to capture higher global yields. To that extent, currencies will in fact benefit where there is a belief that local rates are too high.

I don’t expect further rate cuts, Ulysses. I think the 50bp was an attempt at normalization, perhaps partially due to the increase in real money flows into Mexico that were screaming that rates were too high. The irony that you point out about a stronger peso can probably be attributed as much to the ratings upgrade and correlation with a recovering US dollar. Mexico’s reputation for strong policymakers as well as the convergence of business cycles with the USA, makes it a good laggard candidate to get some beta on the USA. That said, it’s a bit overbought and needs to consolidate if it is going to push much lower.”

To the extent that the Mexico exchange-traded fund, which goes by the ticker EWW, correlates with the peso, it looks like this overbuying has already been priced in. Whether looking at this in terms of absolute price or in terms of returns, the March 8 rate cut coincided with a brief bump in the EWW price which has now reversed course, while the peso remains up. This gap will have to close at some point. The question is when:

2013.03.18.MXN EWW YTD price

 

2013.03.18.MXN EWW YTD percent

And here’s what the EWW vs. peso relationship looks like over the past year:

2013.03.18.MXN EWW 1 year


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