How have dollar funded carry trades—borrowing cheaply in US dollars to invest in higher yielding emerging market currencies and bonds—performed through 2025 and 2026, what factors have driven their unusually long winning streak (including wide interest rate differentials, subdued

Dollar-funded EM carry was exceptionally profitable in 2025 and remained broadly resilient into 2026, but the trade has become more selective and more fragile. A Bloomberg carry measure returned about 17% in 2025—the best result since 2009—while recent reporting describes the dollar-funded version as its longest winning streak since 2008. 1012

What drove the run

• Wide nominal and, in several cases, real yield gaps rewarded borrowing dollars and buying high-yielding EM currencies and local bonds. Turkey remained a prominent example: its lira offered exceptionally high carry, with policy and local-market yields around the 40% area at points, though inflation and managed-currency risk mean that headline yield is not equivalent to expected total return. 75

• A weaker dollar during much of 2025 reduced the FX loss on the funding leg and helped make the dollar a preferred funding currency for EM carry. 9

• Contained FX and rate volatility, resilient global activity, and portfolio inflows into EM debt/FX made the strategy unusually attractive on a carry-to-volatility basis. The same low-volatility environment has supported carry trades more broadly in 2026. 104

• The 2026 picture is no longer a simple “short dollar” trade: as the dollar strengthened, investors increasingly used the euro and Australian dollar as alternative funding currencies for EM positions. 6

Base case for the rest of 2026

The prevailing institutional view is cautiously constructive, rather than uniformly bullish: carry can still generate returns if EM inflation stays contained, global growth avoids a sharp downturn, and FX volatility remains low. EM debt managers have cited economic resilience, lower volatility and carry as support, while emphasizing greater differentiation by country fiscal and political risk. 5

That supports selective exposure—countries with credible monetary policy, positive real yields, adequate external buffers and liquid markets—rather than a broad long-EM basket. Expected EM policy-rate cuts during 2026 also imply that the yield advantage should gradually erode, making currency stability increasingly essential to returns. 14

What could end the rally

• Fed and dollar shock: A more hawkish Fed, sticky US inflation, higher Treasury yields or a dollar surge raises funding costs and can pull capital out of EM. Conversely, rapid EM rate cuts narrow the carry cushion. 1114

• Volatility and deleveraging: Carry strategies earn small, steady returns but are structurally exposed to large discontinuous losses when FX volatility jumps. In August 2024, changing rate expectations and heightened volatility drove a sharp yen-carry unwind; the BIS found that deleveraging and margin pressure amplified the sell-off. 74

• Japan/yen risk: BoJ tightening or official measures that strengthen the yen can force selling across leveraged risk positions, even where the original position is dollar-funded, because portfolios often share leverage, collateral and risk limits. Japan’s 2024 rate increase was central to the prior unwind. 78

• Geopolitics and oil: A broader Middle East/Gulf escalation or oil-price spike would worsen inflation, undermine growth and current accounts for oil-importing EMs, and could prompt tighter policy rather than the easing that carry investors expect. 12

• Food-inflation shock: A potentially strong El Niño raises risks of food-price inflation and slower growth in vulnerable EM economies; Reuters cited an 81% probability of a very strong episode in late 2026. Fertilizer or energy-cost increases would intensify that food-price channel. 12

• China/AI and Asian-equity repricing: A sharp reversal in AI-linked Asian equities could trigger a general risk-off move, tighter financial conditions and EM outflows. It is a plausible contagion channel, but there is insufficient evidence that it is presently the principal driver of EM-carry risk.

• Brazil-specific risk: Election uncertainty and fiscal credibility concerns are already causing investors to pare positions in a previously rewarding Brazilian carry trade. A weaker real would quickly overwhelm earned yield. 3

• Commodity-linked currencies: Softer commodity prices—whether from weaker Chinese demand, global slowdown, or a stronger dollar—would remove an important buffer for currencies such as the Brazilian real, Colombian peso, South African rand and some Asian exporters. Commodity and climate risks remain material through 2026–27. 11

Historical lesson

The relevant comparison is not that 2008, the 2013 taper tantrum, and August 2024 were identical; they were not. Their common mechanism was a rapid repricing of funding costs, growth or risk tolerance that caused crowded leveraged positions to sell simultaneously. Today’s trade is vulnerable to the same sequence: narrowing yield gaps or a stronger funding currency → rising FX volatility → stop-losses/margin calls → forced EM currency and bond selling.

The key indicators to watch are US inflation and Fed expectations, dollar and yen strength, EM implied FX volatility, oil and food prices, EM fund flows, Brazil’s fiscal/election headlines, and whether high-yield currencies continue to depreciate by less than the carry they offer.