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Traders borrowing U.S. dollars to fund investments in other currencies should beware, with analysts expecting the greenback to strengthen and advising a shift to borrowing the euro instead.
“U.S. rates and the U.S. dollar may get a pop from an expected jump in April inflation,” Barclays said Monday in a note titled “Carry on, but don’t fund with USDs.”
Over the medium term, Barclays expects the U.S. inflation risks are to the upside, making it likely the greenback will continue to strengthen. Barclays expects the U.S. dollar index (DXY) to rise 5 percent by year end, with a 7.3 percent rise over 12 months.
So far in the second quarter, the U.S. dollar carry trade hasn’t performed well, Barclays noted, with both high- and low-yielding currencies trading sideways against the greenback amid concerns about slowing Chinese growth and rising geopolitical risks, especially over the Russia-Ukraine conflict. Higher geopolitical risk typically causes the U.S. dollar to strengthen as investors seek safer havens.
“A stronger U.S. dollar need not mean the carry is over, but with the ECB (European Central Bank) turning to policy easing, we see better funding opportunities in the euro,” it said.
Other central banks, such as the ECB, the Bank of Canada and the Reserve Bank of New Zealand, are also becoming more dovish than the U.S. Federal Reserve, she noted.
“The dollar will benefit as this shift in bias is expected to put pressure on these currencies,” Lien said.
But she isn’t as certain that the euro is due to decline much further. While the ECB is likely to take easing measures next month, the moves are likely to be small, with only a limited impact on the currency, she noted.
Full article: Are the dollar’s carry trade days numbered? (CNBC)