Seven straight quarters of gains
On Aug. 23, Bloomberg reported that dollar-funded carry trades in emerging markets posted positive returns for a seventh consecutive quarter, the longest winning streak since 2008.
Using Bloomberg’s index of carry trades across eight emerging-market currencies, the strategy has returned about 22% since the end of 2024. Over the same stretch, U.S. Treasuries returned 5.9%, emerging-market sovereign dollar bonds returned 14%, and emerging-market corporate debt returned 10%.
Why investors keep leaning into the trade
Cathy Hepworth, who leads PGIM’s emerging-market debt team overseeing $1.5 trillion, was asked which theme she had the most conviction in. Her answer was: 「carry, carry, carry」. In her words, 「this is a carry world,」 because 「there is a huge amount of money looking for yield.」
The structure of the trade is straightforward. Investors borrow in lower-yielding currencies such as the U.S. dollar, yen or euro, convert that funding into higher-yielding currencies such as the Turkish lira, and buy bonds or money-market funds to collect the rate gap. In Turkey, that interest return can exceed 40%.
Returns have come from rates and FX moves
Bloomberg said the interest-rate differential is the foundation, but foreign-exchange moves have done a lot of the work as well. The dollar has weakened against emerging-market currencies outside Asia, while also becoming cheaper against other low-yield funding currencies such as the euro and Swiss franc.
Colombia stood out the most. A 12% bond return was paired with a 45% spot appreciation. In Turkey, the lira fell 26% against the dollar, yet yields above 32% on 10-year local-currency bonds still kept investors in profit.
Over the past 12 months, dollar-funded carry trades made 48% on the Colombian peso, 23% on the Turkish lira, 21% on the Brazilian real, 19% on the Mexican peso, and 18% on the South African rand.
Yen volatility tested the trade, but less than before
The report reviewed a sequence of events around the funding side of the market. In early July, carry flows had already shifted from developed markets toward emerging-market positions, and the dollar had fallen out of favor. On July 23, the yen dropped to a more than 40-year low. In early August, the U.S. and Japan carried out what the report described as a historic joint currency intervention.
When the yen surged in August 2024, it shook markets globally and Bloomberg’s emerging-market FX carry risk-premium index fell 4%. This time, the same index dropped only about 1% after the intervention. Bloomberg attributed that smaller move to a change in funding currencies: the yen had given way to the euro, Swiss franc and dollar.
Thierry Larose, a portfolio manager at Swiss asset manager Vontobel, said 「the threshold for disorderly unwinds is higher than we thought a few weeks ago.」 He is still running carry trades, but avoiding the yen.
The intervention also failed to change the yen’s own position. By mid-August, the currency was back in the 159-160 range. Hedge-fund short positions in the yen had been cut by half from intervention-time levels to 59,526 contracts, but some carry traders used the rebound to rebuild shorts at better levels. On Aug. 17, the emerging-market currency index hit a record high of 1906.98.
Positions were still being added this week
The U.S. Treasury said on Wednesday this week that it would step up long-bond buybacks. Daniel Von Ahlen, head of macro strategy at TS Lombard, wrote in a client note that 「the U.S. government’s tolerance for rising bond yields appears low, and that is catalyzing long emerging-market carry trades.」 He added that the firm’s emerging-market FX carry mechanism indicator had 「improved again, reinforcing our confidence.」
What the market is watching now
The first issue is when the Federal Reserve moves. Bloomberg said that is the single biggest risk to the trade. Kamakshya Trivedi, Goldman Sachs’ chief FX and emerging-markets strategist, said 「improving inflation is enough for the Fed to stay on hold,」 while warning that a rise in long-end yields is the near-term threat. As long as that move is not too fast, emerging-market currencies with high real rates can still deliver positive returns.
Ning Sun, senior emerging-markets strategist at State Street, put it more bluntly: U.S. data has not weakened enough to reverse the risk appetite that is supporting carry trades.
The second issue is crowding. The report explicitly said the strategy could become a victim of its own success if too much money ends up on the same side of the trade.
The third is how long high rates can last. Bloomberg said one pillar of support has been that central banks in Latin America and Eastern Europe have kept policy rates elevated to contain post-pandemic inflation. Tensions in the Middle East and high energy prices have also made a shift to easing harder.
In positioning terms, Alejo Czerwonko, chief investment officer for emerging-market Americas at UBS, favors funding in euros and Canadian dollars while going long the South African rand and Mexican peso. Hepworth at PGIM is focused on frontier markets in sub-Saharan Africa, as well as Turkey, Colombia and Brazil.