BNY’s Geoff Yu notes that the iFlow Carry index briefly turned negatively significant as investors sold nine of fifteen high-yield currencies, suggesting growing profit-taking after a resilient run. He stresses that central banks are now signaling weaker demand and future rate cuts, warning that if markets pre-empt this H2 shift, emerging-market carry longs could be unwound more rapidly.

Carry resilience challenged by policy shift

"For one session last week, our iFlow Carry index touched negative statistical significance. This means that there was strong inverse alignment between currency sales and their corresponding 10y bond yields (where available). At first glance, the carry trade remains resilient as central banks are almost uniformly hawkish."

"However, over the past week, nine of the 15 were net sold, encompassing all regions and policy/fiscal views. Most of the flows appear to represent some “trimming” or light profit-taking, and only COP [Colombian Pesos] was strongly sold (flow magnitude above 1.0) through the week. However, after a period of resilience through sharp volatility and difficult balance-of-payments conditions, the market appears to have decided that the carry trade’s return profile has run its course."

"Central banks meeting now are signaling that demand is weakening, and rate cuts will follow as soon as conditions allow. Hence, if markets are now looking past resilience to the conflict as a positive driver, the balance of risks will shift to how to stimulate growth thereafter, and lower nominal rates will be a part of that story."

"If the carry theme fully preempts such an outcome for H2 – especially in emerging markets, which account for the bulk of positions – profit-taking on longs could speed up quickly. This dynamic could materialize even before Fed easing pushback moves to the fore."

"Our iFlow Carry indicator has yet to register an extended period of negative statistical significance this year. In addition, the two episodes from last year, encompassing reaction to “liberation day” tariffs in Q2 and AI-related valuations in Q4 – were the only such phases since 2022–2023, when central banks were also moving toward an aggressive tightening cycle, albeit in response to demand expansion."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)