Why Emerging-Market Carry Trades Are Still Winning in 2026

Emerging-market carry trades have benefited from an unusually cooperative combination of market conditions: large interest-rate differentials, subdued foreign-exchange volatility, a relatively weak dollar funding leg and sustained demand for higher-yielding assets. A Bloomberg gauge tracking eight emerging-market currencies has returned about 22% since the end of 2024 and delivered positive returns for seven consecutive quarters, the longest winning streak since 2008. 183

That performance does not mean the strategy is low-risk. Carry trades typically collect income gradually but can lose money abruptly when a funding currency rises, volatility jumps or investors rush to reduce leveraged positions.

How the emerging-market carry trade works

A dollar-funded carry trade generally involves borrowing or selling dollars, then buying a higher-yielding emerging-market currency or local-currency bond. The return has two main components:

• Carry: the interest-rate or yield advantage earned on the emerging-market asset.
• Currency performance: any gain or loss caused by the EM currency moving against the dollar.

The yield advantage can be attractive, but it is not guaranteed profit. A currency depreciation large enough to offset the interest income can turn a positive carry position into a loss.

Calm currency markets have helped make the trade more appealing. When realized and implied FX volatility are low, investors face smaller day-to-day currency swings and may pay less to hedge their exposure. Bloomberg reported in June that rising dollar volatility and expectations for higher Federal Reserve rates were already putting pressure on the strategy. 9

Why the trade has worked

Wide yield differentials have created a substantial income cushion

High local interest rates are the central attraction. Bloomberg reported that Turkish lira rates and bond yields reached around 40% or higher at points, far above the cost of borrowing in a low-yielding funding currency. That gap can generate significant carry, provided currency losses do not overwhelm the income. 3

Turkey also demonstrates why the headline yield should not be viewed in isolation. Goldman Sachs later expected the lira to depreciate against the dollar at an annualized rate in the mid-20% range, even as policymakers prioritized external-balance stabilization. Faster depreciation can therefore consume a large part of the nominal yield advantage. 10

Low volatility has encouraged risk-taking

Carry positions are more comfortable to hold when currencies move in narrow ranges and global markets remain orderly. The strategy depends not only on the interest-rate gap but also on investors’ willingness to maintain exposure to riskier assets. A sudden volatility shock can force leveraged traders to close positions at the same time, turning a slow income strategy into a fast drawdown.

The August 2024 yen carry-trade unwind is a recent example. The Bank for International Settlements said that changing expectations for interest rates and a volatility spike amplified deleveraging, with currency carry trades—especially those funded in yen—among the strategies hit hardest. 5054

Foreign inflows can reinforce the rally

Capital inflows can support both the currency and the local bond market. In Turkey, international investors returned as elevated interest rates, improving market conditions and reduced geopolitical uncertainty increased the appeal of the trade. Bloomberg reported approximately $30 billion in foreign-exchange carry positions and around $15 billion in foreign investment in domestic-currency bonds, citing people familiar with the flows. 6

This creates a reinforcing cycle: inflows can lift local assets and currencies, improving mark-to-market returns and encouraging further allocations. The same mechanism can work in reverse when investors begin to exit.

The trade has adapted as the dollar changed

The dollar has been an important funding currency, but it is not the only one. When the dollar strengthened in mid-2026, some managers shifted toward the euro and Australian dollar as funding currencies for emerging-market positions. Morgan Stanley also recommended expressing optimism on developing-market currencies against a broader basket that included the dollar, euro and yen. 5

That flexibility has helped preserve the broader EM carry theme even when a pure dollar-funded position became less attractive.

What major institutions are saying

The broad institutional message is positive, but it is not a blanket endorsement of every high-yield currency.

• PGIM: Cathy Hepworth, who leads PGIM’s emerging-markets debt team, described carry as her highest-conviction theme, saying: “Carry, carry, carry.” The comment highlights the strength of the income opportunity, not an absence of currency risk. 3

• Goldman Sachs: Goldman said the global carry backdrop was the most compelling in more than two decades and favored funding trades with currencies including the yen, Swiss franc and euro. 7 Its separate view on Turkey was more cautious: a faster lira slide could substantially reduce the reward from the position. 10

• Morgan Stanley: Morgan Stanley was among the banks that expected the early-2026 rally to continue, but it had already warned that the lira trade was becoming crowded and more vulnerable as depreciation accelerated. 1115

• Bank of America: BofA also saw room for the broader carry rally to extend early in 2026. Its view on Turkey became more defensive when an oil shock threatened to worsen the country’s import bill and accelerate lira losses; Bloomberg reported that BofA and Barclays abandoned bullish lira positions in that environment. 1112

The distinction matters: the consensus has been more constructive on diversified emerging-market carry than on concentrated positions in a single high-yield currency.

What could reverse the gains?

A hawkish Federal Reserve or stronger dollar

Higher US yields or a sharper dollar rally would raise the cost of dollar funding and narrow the effective yield advantage. Even if local rates remain high, the currency move could overwhelm the income generated by the position. Bloomberg identified rising dollar volatility and expectations for higher Fed rates as direct threats to carry returns. 9

A volatility and deleveraging shock

The trade is particularly exposed when investors reduce leverage simultaneously. A risk-off episode can strengthen funding currencies, weaken emerging-market currencies and increase margin pressure at the same time. The 2024 yen unwind showed how quickly those forces can interact. 4350

Yen appreciation or official intervention

A stronger yen can make yen-funded positions more expensive to maintain, while central-bank action can change the assumptions behind the trade. Emerging-market carry remained resilient after joint US-Japan currency intervention in August 2026, but Bloomberg said the intervention had dented the appeal of the yen-funded strategy. 8

Oil and geopolitical shocks

For oil-importing economies, a sudden rise in energy costs can worsen the trade balance and increase pressure on the currency. Turkey’s 2026 oil episode showed how a higher import bill could threaten an otherwise lucrative lira carry position and prompt major banks to retreat. 12

Faster currency depreciation or domestic policy changes

High nominal yields are not enough if policymakers tolerate faster depreciation or if investors begin to question the durability of the policy framework. Goldman’s lira forecast and Morgan Stanley’s warning about crowded positioning show why the currency path matters as much as the interest-rate differential. 1015

The practical takeaway

The EM carry rally is working because several favorable conditions have appeared together: high yields, relatively calm FX markets, strong risk appetite, capital inflows and a funding-currency backdrop that has remained manageable. The result has been an exceptional run—about 22% since the end of 2024 and seven consecutive positive quarters. 18

But the trade is conditional, not permanent. The most useful warning signals are:

• a sustained rise in the dollar or yen;
• higher implied FX volatility;
• changing Federal Reserve or Bank of Japan expectations;
• weaker foreign portfolio flows;
• a sharp rise in oil prices; and
• evidence that local policymakers are allowing faster currency depreciation.

The clearest conclusion from the institutional views is therefore not simply “carry is back.” It is that diversified EM carry remains attractive while volatility and funding conditions stay benign, whereas crowded, single-currency trades—especially the lira—can reverse when the macro backdrop changes.