BNY says tighter global financial conditions and weaker risk appetite are pressuring emerging market (EM) FX carry trades. Positioning in carry trades seems to have peaked, and high-yielding currencies are seeing outflows.
Latin American currencies look especially vulnerable because holdings are high, which raises the risk of a sharp unwind. The report adds that further interest rate rises may be needed to reduce the chance of disorderly moves.
Global Portfolio Positioning And Allocation Trends
EM allocations in global portfolios remain low. The report notes that low weightings, cheaper valuations, and supportive exchange rates—especially in APAC—could help drive a gradual increase in allocations.
The key factor to watch is US-driven changes in financial conditions. The report says support from expectations of US Federal Reserve easing may be close to its limit if US data strengthens.
The outlook for FX carry trades is worsening as global financial conditions tighten. After January’s US jobs and inflation reports came in hotter than expected, markets have reduced expectations for near-term Federal Reserve rate cuts. That argues for caution when holding high-yielding EM currencies.
We are most concerned about Latin American currencies, where our positions grew large after strong performance through much of 2025. The Mexican peso has already weakened beyond 18.00 per US dollar this month, a level not seen in about six months. That may be an early sign of an unwind. We should consider buying put options on the peso or the Brazilian real to hedge against a steeper drop.
Positioning And Hedging Considerations
The main challenge for EM will be US-led adjustments. With the Fed likely to stay on hold, the US dollar may have more room to rise. The risk of a “disruptive unwinding” means we should expect higher volatility in these currency pairs in the coming weeks.
Even so, we see better opportunities in Asia, where positioning is less crowded and valuations look more attractive. For example, India’s manufacturing sector remains strong, with January PMI rising to a four-month high of 56.9. This could support a strategy of being long selected Asian currencies while holding short positions in Latin America.
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