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Yield Is the Dominant Driver for Currency Markets, Deutsche Bank Says
The search for yield has become the primary force driving foreign exchange markets this year, with carry trades expected to maintain their strong performance in a stable global economy, according to a Friday note from Deutsche Bank AG.
Yield Overrides Market Volatility
George Saravelos, head of currency strategy at Deutsche Bank, wrote that interest rate differentials have been the most significant factor behind currency movements in 2026. This dynamic has persisted despite several major market-moving events, including:
- A war in the Middle East
- Leadership changes at the U.S. Federal Reserve
- Large valuation shifts in technology stocks
Saravelos noted that risk-adjusted carry has proven to be a more dominant theme for investors than these broader geopolitical and macroeconomic developments.
AdOutlook for Major Currencies
For the U.S. dollar, the hawkish repricing of Federal Reserve policy expectations has been the most important positive driver, the bank stated. However, for the dollar to achieve broad-based gains and regain its status as a high-yielder, Saravelos believes the market would need to price in rate hikes of 75 to 100 basis points or more.
Deutsche Bank sees limited reason for the euro to weaken significantly or for the dollar to rally further, citing potential upside risks to European growth forecasts. Meanwhile, the Japanese yen continues to face pressure from its low front-end yields relative to other G10 currencies. The bank noted it prefers using the Swiss franc over the yen for funding carry trades.
Looking ahead, Deutsche Bank suggested that Japan's policy efforts to encourage domestic investment could eventually provide a tailwind for the yen. Saravelos pointed to Japan’s 2014 Government Pension Investment Fund reform as a historical example of how shifts in domestic capital flow expectations can generate significant currency movements, even if the policy's full implementation takes time.