On August 23, Bloomberg reported that the emerging markets carry trade, funded in US dollars, has recorded positive returns for the seventh consecutive quarter, marking the longest winning streak since 2008.
According to Bloomberg's index for eight emerging market currencies for carry trades, this strategy has delivered a cumulative return of approximately 22% since the end of 2024. Over the same period, US Treasuries returned 5.9%, emerging market sovereign dollar debt returned 14%, and emerging market corporate debt returned 10% – the carry trade outperformed US Treasuries by nearly four times.
When asked about her most confident theme, Cathy Hepworth, head of the $1.5 trillion PGIM emerging markets debt team, replied "carry, carry, carry." Her exact words were, "It's a carry world," with a straightforward reason: "There is an ocean of money looking for yield."
The carry trade itself is not complicated: borrow in low-interest currencies like the US dollar, Japanese yen, or euro, convert them into high-interest currencies like the Turkish lira to buy bonds or money market funds, and profit from the interest rate differential. Interest returns in places like Turkey can be as high as over 40%.
How did these seven quarters unfold?
The interest rate differential provides the foundation, but what truly doubled the returns was currency exchange rates. The US dollar has been weakening against emerging market currencies outside Asia, while simultaneously becoming cheaper against low-interest peers like the euro and Swiss franc also used as funding currencies – both sides provided a tailwind. The most extreme case was Colombia: 12% bond returns combined with 45% spot appreciation. Even in Turkey, where the lira depreciated 26% against the dollar, yields on 10-year local currency bonds above 32% kept investors in profitable territory.
Over the past 12 months, the US dollar-funded carry trade earned 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.
There was one real test in between. The backstory we've documented goes like this: in early July, carry trade capital had clearly shifted from developed markets towards emerging markets, with the dollar being neglected; on July 23, the yen fell to a more than 40-year low; in early August, the US and Japan conducted historic joint currency market intervention.
The sharp yen appreciation in August 2024 had once roiled global markets – Bloomberg's emerging market FX carry risk premium index fell 4% at the time. This time, however, the same index fell only about 1% after the intervention. The reason is that capital had already switched funding currencies: the yen's position was taken over by the euro, Swiss franc, and US dollar. According to Thierry Larose, a portfolio manager at Swiss asset manager Vontobel, "the threshold for disorderly unwinding is higher than we thought a few weeks ago"; he continues to execute carry trades but avoids the yen.
The intervention also failed to change the yen's own predicament. By mid-August, the yen had returned to the 159–160 range against the dollar. While hedge funds' yen short positions halved to 59,526 contracts compared to the intervention period, some carry traders actually rebuilt short positions at better prices on the rebound. On August 17, the emerging markets currency index hit a record high of 1906.98.
Investors have been adding positions in the recent week. The US Treasury Department announced on Wednesday that it would increase long-term bond buybacks. Daniel Von Ahlen, head of macro strategy at TS Lombard, wrote in a report to clients, "The US government's tolerance for rising bond yields appears to be very low, which is catalyzing long positions in the emerging markets carry trade," adding that the firm's emerging market FX carry mechanism indicator "improved again, strengthening our confidence."
What is the market watching next?
First is when the Federal Reserve will act. This is the single biggest risk point for the entire trade. Kamakshya Trivedi, Goldman Sachs' chief currency and emerging market strategist, judges that "improving inflation is sufficient for the Fed to stay on hold," but also notes that rising long-end rates are a near-term threat – as long as the rise is not too rapid, emerging market currencies with high real interest rates can still deliver positive returns. Ning Sun, senior emerging markets strategist at State Street, puts it more directly: US data hasn't weakened enough to reverse the risk appetite supporting the carry trade.
Second is crowding. The report explicitly mentions that this trade risks becoming a victim of its own success – there is too much money involved. This is the classic demise of the carry trade: everyone crowds on the same side, and any reverse volatility triggers a stampede.
High interest rates are also a key focus, with the market watching how long they can be sustained. One supporting factor is that central banks in Latin America and Eastern Europe have maintained high policy rates to curb post-pandemic inflation, while the Middle East situation and high energy prices are also preventing them from pivoting to easing. Both conditions are exogenous.
Alejo Czerwonko, UBS Chief Investment Officer for Emerging Markets Americas, prefers using the euro and Canadian dollar for funding and going long on the South African rand and Mexican peso; PGIM's Hepworth is looking at frontier markets in Sub-Saharan Africa, as well as Turkey, Colombia, and Brazil.
