Despite frequent global market volatility due to risk events, the carry trade strategy—buying high-yielding major currencies while selling low-yielding ones—is experiencing its strongest performance in years. This resurgence reflects a combination of factors, including low volatility in foreign exchange markets, significant interest rate differentials among developed economies, and the Japanese yen's failure to gain safe-haven support from the Middle East conflict.
The substantial interest rate gaps between G10 developed economies have made carry trades involving these currencies more attractive, a stark contrast to the near-zero global interest rate environment during the COVID-19 pandemic. According to calculations by Citigroup, if an investor had bought the five highest-yielding G10 currencies while selling the five lowest-yielding ones this year, the return to date would be slightly above 4%, even without using leverage.
Kristjan Kasikov, Head of FX Quantitative Investment Solutions at Citi, noted, "Since the global financial crisis, (developed market carry trades) have hardly made any money, so the current rally we are seeing is quite unusual. This is particularly noteworthy in a year filled with uncertainty and shifting market sentiment."
Interest rate differentials have returned to the forefront of market dynamics, supporting several major currencies. Australia and Norway are currently in rate-hiking cycles, with policy rates above 4%; the UK's benchmark rate is slightly below this level. In contrast, Japan's benchmark rate remains below 1%, and Switzerland's is at 0%. Year-to-date, the Australian dollar has appreciated nearly 9% against the US dollar, the Norwegian krone has gained 10%, and the British pound is up 1%. Meanwhile, despite intervention by Japanese authorities, the yen continues to weaken against the dollar, weighed down by high energy costs.
Morgan Stanley expects the pound to remain stable against the dollar but foresees stronger competition from the Australian dollar and Norwegian krone, as these are considered "higher-quality carry trade candidates."
Stephen Jen, CEO and Co-CIO of Eurizon SLJ Asset Management, pointed out that the low-interest-rate environments in Japan and China, relative to the United States, are further driving carry trade activity. "FX carry trades have been very popular. It's not just short-term traders; the yield differentials are now sufficiently wide that even long-term capital and corporate treasury departments can profit from them," he stated.
Kaspar Hense, Senior Portfolio Manager at RBC BlueBay Asset Management, mentioned that while the firm maintains long positions in the Australian dollar and Norwegian krone, the primary reason is these countries' status as commodity exporters, which benefits from rising raw material prices.
The strong performance of carry trades also reflects the overall calm in foreign exchange markets, despite energy price spikes and government bond sell-offs triggered by the Middle East war. Volatility typically works against carry trades, as exchange rate fluctuations can erode gains from interest rate differentials. Investors suffered significant losses in 2024 when a sudden surge in the yen during a quiet summer market not only wiped out carry trades but also triggered a global equity sell-off.
Currently, a tech-driven rally in equities is helping to suppress volatility in both stock and foreign exchange markets. The three-month volatility for the euro-dollar pair, the world's most traded currency pair, is now around 5.6%, down from a high of 7.8% in March. This metric exceeded 9% during the tariff shocks of April 2025 and was above 12% in June 2022 when global central banks were aggressively raising rates.
Volatility for the dollar-yen pair is also at low levels. Although recent Japanese intervention spurred a yen rebound, traders used the opportunity to sell the yen at higher levels, minimizing the impact on carry trades. Kristjan Kasikov observed, "The diminished safe-haven appeal of the yen means that even a significant spike in risk aversion in March did not truly undermine carry trade performance—historically, this would have caused a noticeable shock."
Historically, the yen and Swiss franc have served as funding currencies for carry trades, but the logic for high-yielding G10 currencies is more complex. Despite the Australian dollar's high interest rate, Alvise Marino, FX Strategist at UBS, suggested its recent strength is not driven by traditional carry trade dynamics. "If investors simply wanted to capture the interest rate differential between two currencies, they would more likely buy currencies like the Brazilian real or the South African rand," he explained.
He added that the interest rate differentials among G10 countries mean that Australian investors holding US assets can now achieve positive returns even after hedging against dollar depreciation risk. This increases their willingness to hedge currency exposure, creating fund flows favorable to the Australian dollar. This dynamic is expected to persist as US equities continue to rally, especially against a backdrop of widespread expectations for a weaker US dollar.
Kit Juckes, Chief FX Strategist at Société Générale, concluded, "The real challenge for overseas investors holding US assets is the cost of hedging currency risk. Therefore, it's easy to understand why currencies with lower hedging costs due to lower domestic interest rates—such as the Norwegian krone and the Australian dollar—are currently performing well."
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