Carry trades live and die by 3 things; volatility, risk appetite and the direction of monetary policy. Unfortunately, in the current market environment, all 3 of these factors are not favoring carry trades.
Volatility across the financial markets has surged. The VIX which is a measure of US equity market volatility closed last week not far from its 4 year high. Today, the VDAX-New Index which is a measure of European equity market volatility surged 39 percent, the largest rise since 2001. Risk appetite has plunged with equities selling off while central banks around the world are shifting from monetary tightening to monetary easing. Therefore it is not surprising that carry trades are coming close to reporting the biggest drawdown since the inception of the Euro. Even though the Bank of Japan has a monetary policy announcement tomorrow, it should be a non-event as traders focus on equities and whether they recover or extend Monday’s sell-off.