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Keep calm and carry trade in summer FX lull

Are the dog days of summer arriving in the currency market, and if so, how far will investors have to go to find some action?

Research from MUFG describes “a lack of conviction” among traders over the direction of developed world currencies, with options data “indicating a reversion back toward balance” and “abnormally low volatility” for G10 currencies.

Derek Halpenny, European head of global markets research, finds that FX — a volatility measure for major currencies — is at lows seen on just three other occasions since 1999.

Such a climate is ideal for carry trades, where investors borrow in low-rate currencies to fund bets in higher-yielding alternatives.

“No doubt this fourth occasion of abnormally low levels of volatility will end due to another event but in the meantime such financial market conditions tend to be favourable for high-yielding emerging market FX,” says Mr Halpenny.

“The Mexican peso (MXN) is a good example of this. The continued monetary tightening by Banxico has fuelled very strong buying with USD/MXN now back at levels not seen since May 2016. Yield is king until that next event emerges to unsettle these favourable market conditions.”

Also on MUFG’s watchlist: Russia’s rouble, the Turkish lira and the South African rand.

The yen is likely to be vulnerable to the move back toward carry trades, so while emerging markets heat up, the Japanese currency could be facing some unseasonably chill winds.

michael.hunter@ft.com