A note from JP Morgan argues that the recent volatility spike has dealt a major blow to the FX carry trade, which had been the dominant FX strategy over the past 12-18 months.

JPM point to unwinding of carry trades, first triggered by the MXN sell-off post-elections and then accelerated by the sharp JPY rally, having erased year-to-date carry returns. Estimates suggest 65-75% of carry positions have been unwound.

Looking ahead JPM argue that it is unlikely that carry trading will regain its previous prominence for a few key reasons:

  1. Carry dispersion is expected to continue narrowing, amplified by the Fed's accelerated easing cycle and similar moves from EM central banks. This reduces the carry reward.
  2. The higher volatility environment, upcoming US election risk, and signs of a broader economic slowdown make the macro backdrop less conducive to the pro-cyclical carry strategy.

In contrast, valuation and rates-momentum strategies have recently outperformed the carry trade.

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Break up song: