Yield Differentials Drive Forex Markets in 2026, Deutsche Bank Says

The search for yield is the primary force shaping foreign exchange markets in 2026, making carry trades a top strategy for the year, according to a new analysis from Deutsche Bank AG.

In a note to clients Friday, strategists led by George Saravelos, the bank's head of currency strategy, argued that this dynamic is expected to persist in a stable global economic environment.

Yield Dominates FX Markets

According to the report, risk-adjusted carry has been the most significant factor behind currency movements this year. This focus on yield has overshadowed major market events, including geopolitical conflicts in the Middle East, leadership changes at the U.S. Federal Reserve, and large valuation shifts in technology stocks.

Carry trades, which typically involve borrowing in a low-interest-rate currency to invest in a higher-yielding one, have performed well as a result. Deutsche Bank expects this trend to continue.

Major Currency Outlook

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Deutsche Bank provided its outlook on several major currencies based on the prevailing yield-driven environment:

• U.S. Dollar (USD): A hawkish repricing of Fed policy has been the most important positive factor for the dollar. However, Saravelos noted that for a more substantial rally, the market would need to price in an additional 75 to 100 basis points or more in rate hikes, which would re-establish the dollar's high-yielder status.
• Euro (EUR): The bank does not see a strong reason for the euro to fall further, citing potential upside risks to European growth expectations that could lend support to the currency.
• Japanese Yen (JPY): The yen continues to face pressure from its low front-end yields compared to other major currencies. A potential strengthening factor could be Japan's efforts to promote domestic investment, which could alter capital flows.

Carry Trade Strategy

In light of its analysis, Deutsche Bank stated a preference for using the Swiss franc (CHF) over the Japanese yen for funding carry trades.

The bank pointed to Japan’s 2014 Government Pension Investment Fund reform as a historical example of how changes in domestic flow expectations can generate significant FX movements, even if the policy's implementation takes longer to materialize.