Goldman Sachs believes conditions for currency carry trades are the most attractive they have been since 2000, as wide interest rate differentials and subdued foreign exchange volatility create favourable opportunities for macro investors and hedge funds, according to a report by Bloomberg.
In a research note, Goldman strategist Stuart Jenkins said the current environment offers one of the strongest backdrops for G10 currency carry strategies in more than two decades. The bank expects investors to continue funding trades in traditionally low-yielding currencies such as the Japanese yen, Swiss franc and euro while investing in higher-yielding markets.
Carry trades, a staple strategy for macro hedge funds and institutional investors, involve borrowing in currencies with low interest rates and investing in those offering higher yields. The strategy performs best when exchange rates remain relatively stable, allowing investors to capture the interest rate differential.
According to Bloomberg data, G10 carry trades have returned around 8% so far this year, outperforming global bonds, gold and Bitcoin, although equity markets have delivered stronger gains.
Goldman attributes the renewed appeal to the combination of elevated but divergent policy rates across developed economies and historically low currency volatility. Foreign exchange volatility has fallen close to its lowest levels since 2020, reducing one of the key risks associated with carry strategies.
The bank said central bank policy expectations have also become more stable, creating an environment in which interest rate differentials can be harvested without the significant currency swings that often undermine carry returns.
The strategy nevertheless remains vulnerable to sudden market shocks. Sharp increases in volatility can trigger rapid unwinding of leveraged positions, leading to significant moves across currency markets. Barclays recently cautioned that current foreign exchange volatility appears unusually subdued given ongoing geopolitical and macroeconomic uncertainty, suggesting volatility could increase from current levels.
Interest rate differentials continue to favour carry strategies. Two-year US Treasury yields remain above 4%, compared with around 2.6% in Germany, 1.4% in Japan and close to 0.1% in Switzerland, providing some of the widest funding spreads among developed markets.
Goldman continues to identify the Japanese yen as its preferred long-term funding currency, arguing that the currency is likely to remain under pressure unless Japan’s macroeconomic outlook changes materially.
Among its preferred trades, the bank favours long US dollar positions against the Swedish krona. In more risk-neutral portfolios, it also sees opportunities in going long the euro against the Swiss franc and buying the Australian dollar against the New Zealand dollar, citing attractive carry relative to expected volatility.
For hedge funds and other macro investors, the combination of persistent yield differentials and relatively calm currency markets is providing one of the strongest environments for carry trading in years. However, as history has shown, the strategy’s success depends heavily on volatility remaining contained, leaving investors exposed should market sentiment deteriorate abruptly.
