Opening Hook
Dollar sentiment has turned. ING’s latest FX commentary notes that “dollar bears have retreated” as markets price fewer Fed cuts and as risk appetite moderates. (ING FX: Dollar Bears Retreat)
At the same time, traditional carry targets are slipping. The South African rand, one of 2025’s earliest outperformers, has been “subdued amid dollar strength,” losing ground despite high local yields. (Reuters)
Carry trades aren’t unwinding in crisis — they’re unwinding by recalibration.
Macro Context — Higher for Longer Isn’t Just a Slogan
The global yield landscape now clusters at elevated levels:
The Fed has pivoted cautiously and is in no hurry to cut further.
The ECB and BoE are easing slower than expected — reducing rate differentials that once fueled carry.
Emerging market central banks, from Brazil to South Africa, are pausing or delaying cuts to prevent currency weakness from feeding into inflation.
The yen remains the cheapest funding currency — but even Japan is signaling a shift as inflation expectations creep higher.
The setup is simple: spreads are tighter, volatility is higher, and carry requires more precision.
Current Dynamics — EMFX Shows the Strain
Other carry-heavy currencies face similar dynamics:
Brazilian real (BRL): Volatile around fiscal debates heading into 2026.
Mexican peso (MXN): Less decisive than earlier in the year as U.S. yields remain sticky.
Hungarian forint (HUF): Facing pressure as European growth drags.
Carry trades thrive on calm conditions and predictable policy. Neither is available in abundance right now.
Investment Bearings — How to Play the New Regime
USD: Renewed strength suggests underweighting EMFX-beta trades until global data stabilize.
Selective EMFX: Countries with strong fiscal anchors (Mexico, Indonesia) remain viable — selectively and with tighter stops.
Funding currencies: Yen remain cheap but vulnerable to policy surprises; CHF offers lower spreads but more stability.
Local rates over FX: If currency risk dominates, local-currency bonds offer carry without full FX exposure.
Volatility is a tax: Higher implied vol reduces effective returns — carry now demands tactical timing, not passive positioning.
Closing Takeaway (Strategic Lens)
Carry trades don’t vanish — they mutate. In a higher-for-longer world, yield still matters, but the premium investors earn is now balanced by rising uncertainty. The winners in 2026 will be those who can tell real carry from leveraged vulnerability.
