Deutsche Bank: Yield and Carry Trades to Dominate Forex Markets

The search for yield is the dominant theme in foreign exchange markets this year, with carry trades poised to continue performing well in a stable global economic environment, according to analysts at Deutsche Bank AG.

Yield Overrides Geopolitics

In a note published Friday, George Saravelos, head of currency strategy at Deutsche Bank, stated that yield has been the primary force behind currency movements in 2026. He observed that risk-adjusted carry has been the most important factor, overshadowing major events including a war in the Middle East, leadership changes at the Federal Reserve, and large shifts in technology stock valuations.

Major Currency Outlook

Deutsche Bank provided an outlook on several key currency pairs, highlighting the role of interest rate differentials and growth expectations.

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• U.S. Dollar: A hawkish repricing of Federal Reserve policy has been the most significant positive driver for the dollar. However, Saravelos noted that a more substantial rally would require markets to price in rate hikes of 75 to 100 basis points or more, which would re-establish the dollar's status as a high-yielder.
• Euro: The bank does not see a strong reason for the euro to fall further, citing potential upside risks to European growth expectations that could support the currency.
• Japanese Yen: The yen continues to face pressure from its low front-end yields compared to other major currencies. However, the report suggested that Japan’s efforts to promote domestic investment could eventually strengthen the currency, citing Japan’s 2014 Government Pension Investment Fund reform as an example of how changes in domestic flow expectations can generate significant FX movements.

Strategic Implications for Investors

Given the current market dynamics, Deutsche Bank's strategists expressed a preference for using the Swiss franc rather than the Japanese yen for funding carry trades. This approach seeks to capitalize on the interest rate differentials that are currently the main focus for currency investors.