Yield Is Key Driver for FX Markets in 2026, Deutsche Bank Says

Yield differentials have become the primary force shaping foreign-exchange markets in 2026, making carry trades a compelling strategy for the remainder of the year, according to a research note from Deutsche Bank AG.

Yield Overrides Market Noise

In a note published Friday, strategists led by George Saravelos, the bank's head of currency strategy, argued 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 a war in the Middle East, leadership changes at the Federal Reserve, and significant volatility in technology stocks.

The performance of carry trades—a strategy that involves borrowing in a low-yield currency to invest in a high-yield one—is expected to remain strong in a stable global economic environment, the bank stated.

Outlook for Major Currencies

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Deutsche Bank provided its outlook on several key currency pairs based on the prevailing yield dynamics:

• U.S. Dollar: The hawkish repricing of Federal Reserve policy has been the main tailwind for the dollar. However, for the currency to see a much larger rally and regain its status as a top "high-yielder," Saravelos noted that the market would need to price in an additional 75 to 100 basis points of rate hikes.
• Euro: The strategists see no strong reason for the euro to fall further. They pointed to potential upside risks to European growth expectations, which could lend support to the single currency.
• Japanese Yen and Swiss Franc: The yen continues to face pressure from its low front-end yields relative to other major currencies. While Japan's efforts to promote domestic investment could eventually strengthen the currency, Deutsche Bank's team currently prefers using the Swiss franc over the yen for funding carry trades.

Context and Strategy

To illustrate how domestic investment flows can influence a currency, the bank referenced Japan's 2014 Government Pension Investment Fund reform. That event, they noted, generated significant FX movements based on shifting expectations of domestic flows, even before the policy was fully implemented.