US Dollar's Stability Masks Rising EM Carry Trade Strength
0h ago|5 min readStandard
Fazen Markets Editorial Desk
Collective editorial team · methodology
us-dollaremerging-markets
Fazen Markets Editorial Desk
Collective editorial team · methodology
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Portfolio Manager Ed Al-Hussainy of Columbia Threadneedle Investments highlighted a nuanced divergence in global currency markets on August 24, 2026. He noted the relative stability of the U.S. dollar against major developed market peers, juxtaposed with significant strength in several emerging market currencies. This strength is primarily fueled by carry trades attracted to higher real yields in economies like Brazil, Mexico, Colombia, and South Africa. The analysis points to a divergence in monetary policy paths, with the Federal Reserve's slower adjustment of interest rate expectations acting as a headwind for the dollar despite strong domestic economic fundamentals including low unemployment and steady growth.
The current currency dynamic represents a shift from the dominant post-pandemic trend where the U.S. dollar acted as a primary beneficiary of Federal Reserve hawkishness and global risk aversion. The last significant, sustained period of emerging market currency outperformance against the dollar, driven by yield differentials, occurred in the 2010-2013 era following the global financial crisis. That cycle ended abruptly with the 2013 "taper tantrum," which saw the Brazilian real lose over 15% against the dollar in a matter of months. The current macro backdrop features U.S. 10-year Treasury yields hovering near 4.0%, with the Federal Funds target rate in a 5.25%-5.50% range. The catalyst for the present shift is a faster repricing of rate cut expectations by other central banks, notably in Europe and Canada, relative to the Federal Reserve. Markets now anticipate these banks will ease policy more aggressively in 2026, narrowing the nominal yield advantage that previously supported the dollar.
Concrete data illustrates the yield advantage driving capital flows. As of late August 2026, Brazil's benchmark Selic rate stands at 10.25%, Mexico's key rate is at 10.75%, and South Africa's repurchase rate is 8.25%. After adjusting for local inflation, the real yield—the nominal yield minus inflation—in these countries remains substantially positive. For example, Brazil's real yield is estimated above 5%, Mexico's near 4.5%, and Colombia's around 4%. This contrasts with a U.S. real yield on the 10-year Treasury, calculated using core PCE inflation, of approximately 1.8%. The dollar index (DXY), which measures the greenback against a basket of six major currencies, has traded in a narrow 104.0-105.5 range over the past month, showing minimal net change. Meanwhile, the Brazilian real (BRL/USD) has gained 3.2% year-to-date, the Mexican peso (MXN/USD) is up 5.7%, and the South African rand (ZAR/USD) has appreciated 4.1%. The dollar has declined 2.1% against the euro (EUR/USD) and 1.8% against the Japanese yen (JPY/USD) over the same period.
| Currency Pair | YTD Performance | Key Policy Rate | Real Yield Estimate |
|---|---|---|---|
| BRL/USD | +3.2% | 10.25% | >5.0% |
| MXN/USD | +5.7% | 10.75% | ~4.5% |
| ZAR/USD | +4.1% | 8.25% | ~3.5% |
| EUR/USD | +2.1% | 3.75% | ~1.0% |
| USD/JPY | -1.8% | 0.10% | <0.0% |
The primary second-order effect is capital flow into local-currency emerging market sovereign debt. Exchange-traded funds like the iShares J.P. Morgan USD Emerging Markets Bond ETF (EMB) may see subdued flows compared to local-currency funds such as the VanEck Emerging Markets Local Currency Bond ETF (EMLC). Multinational corporations with significant revenue exposure to these strengthening EM currencies, such as Coca-Cola (KO) and Procter & Gamble (PG), could see favorable foreign exchange translation effects on earnings. Conversely, U.S. exporters competing with Mexican or Brazilian manufacturers may face margin pressure. A key risk to this trend is its dependence on global risk sentiment; a sharp spike in volatility, measured by the VIX index rising above 25, could trigger rapid unwinding of carry trades as investors flee to the dollar's liquidity. Current positioning data from the Commodity Futures Trading Commission shows asset managers have built substantial long positions in Mexican peso and Brazilian real futures, while hedge funds have increased short exposure to the euro and Japanese yen.
Two immediate catalysts will test the durability of this EM currency strength. The next U.S. Non-Farm Payrolls report on September 5, 2026, will inform the Federal Reserve's pace. A weak report could accelerate dollar selling by pricing in faster Fed cuts. The Bank of Mexico's policy decision on September 25, 2026, is critical; any signal of a dovish pivot could undermine the peso's yield advantage. Traders are watching key technical levels: a break below 104.00 on the DXY index could trigger a move toward 102.50. For the Mexican peso, support resides at 16.50 MXN/USD, with resistance near 16.00. If U.S. inflation data remains sticky and forces the Fed to maintain a hawkish stance longer than peers, the yield differential could re-widen, arresting the dollar's underperformance.
A carry trade is a strategy where an investor borrows money in a currency with a low interest rate and invests it in a currency with a higher interest rate, profiting from the interest rate differential. The current trade involves borrowing in currencies like the Japanese yen or Swiss franc and buying higher-yielding assets in Brazil, Mexico, or South Africa. The risk is that currency movements can erase the interest gain; if the high-yielding currency depreciates against the funding currency, losses can occur.
Nominal yield is the stated interest rate on a bond, like Brazil's 10.25% Selic rate. Real yield is the nominal yield adjusted for inflation, representing the actual purchasing power return for an investor. A country can have a high nominal yield but a low or negative real yield if inflation is even higher. The attractiveness for carry trades depends on high real yields, as they indicate a genuine return after inflation, which is the case in several major EM economies currently.
Historically, strong U.S. growth and low unemployment have supported the dollar by attracting investment and suggesting tighter Fed policy. The current anomaly stems from the market's forward-looking nature. While U.S. data is strong, the Fed's communicated policy path is seen as slower to adjust than other central banks. Markets are pricing rate cuts from the European Central Bank and Bank of Canada sooner and faster, which narrows the yield advantage that supports the dollar, offsetting the positive growth differential.
The dollar's stability is being challenged not by weak U.S. data, but by a faster global repricing of rate cuts that enhances the real yield appeal of emerging market currencies.
Disclaimer: This article is for informational purposes only and does not constitute investment advice. CFD trading carries high risk of capital loss.
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