Deutsche Bank: Yield to Remain Dominant Driver for FX Markets

Yield will remain the dominant force in foreign exchange markets for the remainder of the year, with carry trades likely to continue performing well amid a stable global economy, according to a Deutsche Bank AG note released Friday.

George Saravelos, the bank's head of currency strategy, wrote that risk-adjusted carry has been the most significant factor behind currency movements this year. This focus on yield has persisted despite major market events, including geopolitical tensions, leadership changes at the U.S. Federal Reserve, and large shifts in technology stock valuations.

Currency-Specific Outlook

For the U.S. dollar, a hawkish repricing of Fed policy has been the main positive catalyst, Saravelos noted. However, Deutsche Bank believes a much broader dollar rally would require the market to price in 75 to 100 basis points or more in additional rate hikes, which would re-establish the currency's high-yielder status.

The bank does not see a strong case for the euro to fall further, citing potential upside risks to European growth expectations. Meanwhile, the Japanese yen is expected to remain under pressure from its low front-end yields compared to other major currencies, though Japan's efforts to promote domestic investment could provide some support.

Ad

Strategy and Context

Given the current environment, Deutsche Bank's note stated a preference for using the Swiss franc over the Japanese yen as a funding currency for carry trades.

As a historical precedent, the strategists pointed to Japan’s 2014 Government Pension Investment Fund reform. That event demonstrated how changes in domestic investment flow expectations can generate significant currency movements, even if the policy's implementation takes longer to materialize.