LONG EM CARRY

LONG EM CARRY Daniel von Ahlen

◼ Doubts about Warsh’s commitment to a Fed hiking cycle and recent softer US macro data bode well for EM carry ◼ The US administration’s seemingly low tolerance for rising US bond yields catalyses’ the long EM carry trade ◼ Our new EM FX carry regime indicator points to improved conditions for the strategy ◼ We add a long EM FX basket trade (IDR, ZAR, HUF, BRL, MXN, COP, CLP) vs USD to our portfolio Unshakeable EM Carry. EM FX carry has been resilient (delivering around median returns this year), despite the energy shock. For EM carry to perform well, wide rate differentials, upbeat risk sentiment, low FX volatility and a "not too hot, not too cold" macro environment are generally required. We think these conditions are broadly being met at the moment, and we see good risk/reward for being long EM FX carry (we already flagged this opportunity in last week's Asset Allocation report).

Dollar coming under increasing pressure. USD is suffering from Kevin Warsh's reluctance to provide any concrete guidance on how he intends to combat US inflation. The fact that tough rhetoric is not backed up by concrete policy action has prompted markets to question his resolve to commit to a hiking cycle; and this has been heavily weighing on the dollar recently. The news that the US Treasury is essentially intervening in the longer-dated treasury market to cap the recent increases in yields adds to the dollar's woes right now. The intervention indicates little tolerance for higher yields within the administration and could be a prelude for renewed pressure on the Fed not to hike short-term rates.

EM FX carry has been resilient, despite oil shock Still elevated rates in selected EMs

Sources: Bloomberg, GlobalData TS Lombard. Sources: Macrobond, GlobalData TS Lombard.

Fed hawkishness has eased somewhat recently …amid weaker labour market data

Sources: Bloomberg, GlobalData TS Lombard. Sources: Bloomberg, GlobalData TS Lombard.

Recent weaker US macro data reduce the urgency for the Fed to act decisively. The overall soft wage growth evident from July's payroll report (headline average hourly earnings are at 3.2% y/y) and softer retail sales data (see yesterday's Macro Strategy note for a discussion of US consumption fundamentals) intensify the dollar's struggle as these trends will help the doves on the FOMC to make the case that the US labour market is not currently a source of inflationary pressure. Although we are seeing signs that wage pressures are building beneath the surface (AHE ex education and health services are growing more than 4% y/y), that development might not yet dominate thinking within the FOMC. The dollar clearly needs more hawkish US macro data to bounce back from here.

The strategic dollar bear case remains intact. The alienation of US allies (e.g., the Greenland row earlier this year, Trump's shift on South Korea and threats against Oman) and the trends in US governance and institutions do not sit well with investors and encourage them to diversify away from the dollar. This is a structural headwind for the greenback, as are valuations.

Our EM FX carry regime indicator supports the strategy. Our new EM FX carry regime indicator (based on our dollar bull/bear indicator, EM FX risk appetite, global risk sentiment, EM FX implied volatility and EM FX breadth) has improved again which reinforces our conviction on EM FX

Softer headline wage growth in the US More downside for retail sales?

Sources: Macrobond, GlobalData TS Lombard. Sources: Macrobond, Bloomberg, GlobalData TS Lombard.

Macro Strategy | 20 August 2026 2