Carry Trade: Supportive backdrop holds – OCBC

OCBC analysts Sim Moh Siong and Christopher Wong highlight that the US Dollar (USD) is currently range-bound due to stable US inflation and a lower likelihood of a September Federal Reserve (Fed) rate increase. This supportive backdrop, combined with positive risk sentiment, should contribute to the continued strength of carry trades.

However, they caution that rising long-term US yields, stemming from AI-related financing and fiscal deficits, pose a significant risk. The market's reaction to a modest US Consumer Price Index (CPI) report and Middle East developments was relatively subdued, with Federal Reserve forecasts adjusting, indicating a 40% probability of a September rate hike, down from 50%.

Most Federal Open Market Committee (FOMC) members are expected to view the July CPI report as satisfactory but require further assessment of August data before deciding on a September policy move.

Following the inflation release, US Treasury yields fell, and the USD weakened, but the trend quickly reversed. The yield curve steepened, and the USD remained largely unchanged. Overnight, the rally in risk assets, fueled by robust AI infrastructure earnings and investment themes, was the main market development. Despite oil market volatility and potential FX intervention risks for the Japanese Yen (JPY), a broadly range-bound USD and constructive risk sentiment should continue to bolster carry trades.

The primary threat to this positive market environment is further increases in long-term US yields, driven by AI financing needs, persistent fiscal deficits, and sustained economic growth.