A crack in the wall of worry

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Photo by Federico Burgalassi16Jun23Subscribe nowThis week I discuss:Strong reaction to benign outcomesMacro developments – US CPI, FOMC, China dataEM Central Banks – little expected for most, a lot expected from TurkeyTurkey Update – Project CredibilityMarket monitorsThis week’s events were clearly sufficient to temporarily tip the balance in favour of the wall of EM FX Carry, as interpretations of the US inflation picture skewed dovish diminishing worries that sticky inflation would lead the Fed to become more aggressive. The reaction this week reflects cracks in the wall of worry that has been holding back investors of late. Also key to the moves is the calendar; this week had a lot of event risk, and next week has much less. As I wrote in my early Feb note, we can think of volatility as the likely impact of market-moving events that can happen in a given window of time. You get paid extra for selling vol through events, but you don’t get explicitly paid a higher yield on your carry trades. With the concentration of events this week, appealing medium-term carry trades suffer a brief decline in their implied carry-to-vol ratios. However, once the event risk passes without narrative shifting surprises, short-term implied carry-to-vol ratios rebound. It’s therefore reasonable to expect higher-yielding EMFX to be underpriced into an event and rally on a consensus outcome. So we received the dual boost this week with the negotiation of event risk in a manner that seemed to imply a reduction in tail risk. Happy days. Now we have seen the market reaction, is there anything that …