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Business News/ Market / Stock-market-news/  Euro and the emerging markets carry trade unwinding
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Euro and the emerging markets carry trade unwinding

With concerns around emerging markets starting to rise, some of the capital is getting repatriated to Europe, leading to gains in the euro

Since 18 August, the euro has rebounded sharply against the dollar, gaining more than 4.5%. The euro is now trading at 1.14 levels against the US dollar. Photo: BloombergPremium
Since 18 August, the euro has rebounded sharply against the dollar, gaining more than 4.5%. The euro is now trading at 1.14 levels against the US dollar. Photo: Bloomberg

Mumbai: With foreign investors selling out of emerging markets and taking capital home, there is a surge in the euro, which in turn is leading to further unwinding of so-called carry trades linked to the European currency.

A carry trade is a trade based on interest rate differentials and is typically carried out in currencies of home markets where interest rates are low and the currency is perceived to be cheap.

In the case of the euro, the weakness in the European economy and the European Central Bank’s decision to launch a quantitative easing earlier this year had pushed the euro down against the dollar. In 2014, the euro fell 12% against the dollar. It depreciated by another 9% till the start of August. Given the low interest rates in the euro region and the cheap currency, a lot of capital from Europe found its way into emerging markets. At least that is what the recent moves in the currency markets suggest.

With concerns around emerging markets, particularly China, starting to rise, some of this capital is getting repatriated to Europe, leading to strength in the European currency, which in turn is leading to further unwinding of carry trades.

“Carry trade unwinding is happening. Euro strength against most currencies shows that most of the carry trades were funded in euro," said Samir Lodha, managing director at QuantArt Market Solutions, a currency consultant.

Since 18 August, the euro has rebounded sharply against the dollar, gaining more than 4.5%. The euro is now trading at 1.14 levels against the US dollar.

“The moves are sharp and it doesn’t seem to be stopping here. Further unwinding of carry trades is likely," said Lodha, adding that this will lead to strengthening of the euro.

A similar trend could play out with the Japanese yen which has also gained 3% against the dollar since 18 August.

The surge in these currencies, particularly the euro, is now being seen as one reason for the recent selling pressure across emerging markets, including India, as carry trades tend to be highly sensitive to appreciation in the carry currency.

This is precisely what has been happening in the last few days, said a banker at a foreign bank requesting anonymity due to company policy. He added that at least half the offshore carry trades into India were linked to the euro, which are being affected by the strength in the European currency.

On Monday, Indian equity markets plunged 6% following a global sell-off. Provisional data indicated that foreign investors withdrew more than 5,000 crore in trade on Monday.

“Unwinding is already underway, which explains the sharp move in the euro and the Japanese yen, while Asian currencies have weakened. However, we could be at the last leg of this unwinding," said Ananth Narayan, regional head of global markets, south Asia, at Standard Chartered Bank.

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Published: 25 Aug 2015, 10:29 AM IST
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