Carry trades are roaring back into favour, with hedge funds and asset managers ramping up allocations to high-yielding emerging market currencies amid a sharp drop in FX volatility and fading fears over aggressive US trade policy, according to a report by Bloomberg.
An index tracking cumulative carry returns – measuring long positions in EM currencies like the real, peso, and lira funded by shorts in low-yielders – hit a seven-year high in late May, according to Bloomberg data. The strategy has found new life as markets recalibrate to a “risk-on” backdrop, with trade tensions softening and inflation pressures moderating in key EM economies.
Leveraged investors have increased long exposure to the Mexican peso to a nine-month high, based on CME positioning data, while other top picks include the Chilean peso and South Korean won, according to Pictet Asset Management’s senior fixed income manager, Ali Bora Yigitbasioglu.
“Given the cooling rhetoric around tariffs and a more stable macro backdrop, carry currencies are well-positioned to outperform,” Yigitbasioglu said, highlighting Chile and Korea as particularly attractive targets ahead of political events such as South Korea’s 3 June presidential election.
A key driver of the renewed interest: FX volatility has dropped sharply, with JPMorgan’s global currency volatility index falling to 8.7% – down from 11% in April. That has reinvigorated the appeal of carry trades, which thrive in low-volatility environments where returns from interest rate differentials are less likely to be eroded by sharp currency moves.
The yen, long a traditional funding currency for carry trades, saw renewed attention after a pause in its rally following a surprise rate hike by the Bank of Japan earlier this year. But with dollar rates still elevated, hedge funds are increasingly exploring alternatives. The euro and yuan are now being deployed more frequently on the funding side, as both regions face downside rate risks.
“We see the yuan emerging as a compelling funding currency amid a likely easing cycle in China,” said Ju Wang, head of Greater China FX and rates strategy at BNP Paribas.
Goldman Sachs and ING have flagged Brazil’s real as one of the top long positions, citing its attractive real yields. At RBC BlueBay, senior portfolio manager Anthony Kettle supports funding EM longs out of the dollar, despite its higher cost, given a weakening trend in the greenback.
Meanwhile, Invesco’s Wim Vandenhoeck has leaned into a euro-funded long in the South African rand, expecting further euro weakness as the ECB moves closer to its eighth rate cut. His book also includes exposure to the Brazilian real and Turkish lira, both funded in USD.
