Yield to Remain Key Driver for Currency Markets, Deutsche Bank Says

The search for yield is expected to remain the dominant force in foreign-exchange markets for the remainder of 2026, making carry trades a resilient strategy amid a stable global economy, according to a research note from Deutsche Bank AG published Friday.

The Dominance of Carry Trades

Analysts led by George Saravelos, Deutsche Bank's head of currency strategy, observed that yield has been the single most important factor driving currency movements this year. This focus on risk-adjusted carry has persisted despite significant market events, including geopolitical tensions in the Middle East, leadership changes at the Federal Reserve, and large swings in technology stock valuations.

The note argues that as long as the global economy avoids major shocks, investors will likely continue to prioritize currencies offering higher interest rate returns. This environment has been highly supportive of carry trade strategies, which involve borrowing in a low-yield currency to invest in a higher-yielding one.

Outlook for Major Currencies

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Deutsche Bank provided an outlook for several key currency pairs based on the theme of yield differentials:

• U.S. Dollar (USD): The dollar's primary support has been the market's "hawkish repricing" of Federal Reserve policy. However, for a more substantial and broad-based dollar rally, Saravelos noted that the market would need to price in an additional 75 to 100 basis points in rate hikes, which would re-establish the dollar as a high-yielder.
• Euro (EUR): The bank does not see a compelling reason for the euro to fall significantly further, citing "potential upside risks to European growth expectations" that could provide support for the common currency.
• Japanese Yen (JPY) and Swiss Franc (CHF): The yen continues to face downward pressure from its low front-end yields relative to peers. While Japan's initiatives to promote domestic investment could eventually strengthen the yen, Deutsche Bank stated a preference for using the Swiss franc over the yen as a funding currency for carry trades.

The Impact of Domestic Flows

The report highlighted that shifts in domestic investment flows can create significant currency movements, even if policy implementation is gradual. Analysts pointed to Japan’s 2014 Government Pension Investment Fund reform as a historical example where changing expectations about domestic capital allocation led to a notable impact on the foreign exchange market.