Key Highlights

• iFlow Carry reached positive statistical significance for the first time in 2025
• EMEA leads LatAm in high-yield inflows
• Hedging of low-yield exposures stronger than high-yield purchases

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iFlow Carry touches positive statistical significance; mean reversion now in play

EXHIBIT #1: IFLOW CARRY – RANK CORRELATION BETWEEN FLOW AND 10Y YIELD, WITH STATISTICAL SIGNIFICANCE BANDS

_Source: BNY

Our take

For the first time in 2025, our iFlow Carry indicator has reached positive statistical significance. This indicates that the strength of flow in a currency is now strongly aligned with the 10-year yield of the currency’s home sovereign bond market. We believe this marks the culmination of risk recovery since the second half of April, when the initial “Liberation Day” reciprocal tariffs were suspended. While there are still many unknowns regarding trade, such as the fragile U.S.-China truce and lack of progress on deals with key U.S. trade partners such as the European Union and Japan, the market clearly holds trade resolution as the base case and the second half of the year will not yield shocks beyond what is priced. Improving upon this position could prove difficult.

Forward look

By definition, when iFlow Carry reaches strong positive alignment, the strategy is crowded. Yesterday, we noted how positive statistical significance is also present on a holdings basis, implying that the best-held currencies were also the highest-yielding currencies, and vice versa. Combined with the status of flows, it means that the market is now further liquidating already light holdings in low-yielding currencies, and adding to relatively elevated levels of holdings in high-yielding currencies. This is clearly unsustainable, and we now believe FX exposures should now look into fading the theme, especially if incremental positive risk drivers become increasingly hard to realize.

LatAm flow interest underperforms while developed market funders clearly under pressure

EXHIBIT #2: TOP AND BOTTOM 5 RANKED CURRENCIES BY YIELD, VS. MONTHLY SMOOTHED FLOW

_Source: BNY

Our take

If the carry trade is to reverse, the most exposed currencies are those with high yields that are also seeing strong levels of inflows, as these are the most “crowded” positions. Exhibit #2 ranks the currencies by yield and matches flow strength. We can see that ZAR, COP and TRY are driving carry interest, while TWD and SEK are the low-yielders facing the highest levels of hedging or funding pressure. CHF and JPY are also facing light outflows. In contrast, CNY is a low-yielding currency, but it is seeing additional inflows (and based on asset flows, these are not hedges being unwound). For high-yielders, the lack of interest in MXN and BRL is striking given real rates are quite comfortable in these economies. As highlighted in our Investor Trends report this week, these two currencies are already comfortably overheld and we believe investors are unwilling to add to exposures.

Forward look

We expect carry interest to begin fading towards the rest of the quarter. The currencies most at risk of a strong reversal are those whose flow rank is very well aligned with yields. Amongst the high-yielders, however, we can only identify ZAR and TRY as being in this category: the two currencies are in the top five measured by yield and in the top 10 by flow strength. In extremes, the highest-yielding currencies will be the strongest sold, which means the two currencies could face the strongest reversals. We are paying particular attention to the ZAR, as yesterday’s passage of the budget marks another event risk favorably navigated. With policy credibility and rate expectations already strongly priced, barring significant uplift in global growth and terms of trade for commodity producers, it is difficult to justify additional re-rating in ZAR.

Fading the funders stronger than adding carry

EXHIBIT #3: HAVENS VS. HIGH-YIELD FLOW (ASSUMING A 65:35 RATIO BETWEEN LATIN AMERICA AND EMEA CURRENCIES)

_Source: BNY

Our take

Out of the five yielding currencies we track, four are also in bottom 10 measured by flows: SEK, TWD, CHF and JPY. This is further confirmation that current “carry/risk on” sentiment is still being driven by defensive plays being taken off, or the addition of hedges due to the surprising resilience of inflation data, which in turn is preventing further narrowing in rate differentials which would normally reduce hedging need. The suspension of tariffs led to strong gains in equity markets of savings-heavy economies covering the aforementioned currencies and hedging ratios are probably higher than what was desirable due to hopes of structural allocations away from dollar exposures.

Forward look

Exhibit #3 shows that flow strength for high-yielders has merely returned to pre-Liberation Day levels and stable, but “haven currencies” (defined as JPY, CHF and SGD) were also net bought heading into that period, indicating caution was already in place in early Q2 due to trade and growth concerns. If risk appetite does begin to weaken, we believe the burden of adjustment will fall disproportionately on low-yielding currencies being bought rather than high-yielders facing sales. This means that markets should position themselves for renewed strength in CHF, JPY and other currencies seen with sustained surpluses and weak domestic demand. Furthermore, we believe that contrary to traditional reaction functions, central banks and fiscal authorities will see the loss of exports to the U.S. as permanent and shift towards a domestic investment stance. This means that currencies will need to re-rate in real terms. Ideally real effective exchange rate (REER) strength will materialize through higher inflation, but initial currency strength as savings are repatriated to fund said domestic investment is unavoidable.

Bottom line

We believe the tactical recovery in risk appetite is close to running its course. iFlow Carry turning statistically significant and positive in both flow and holdings terms is a clear sign that carry-seeking flows are now becoming crowded, led by material outflow or hedging interest amongst low-yielding currencies of current account surplus economies. Positioning-based unwinding is normal mean reversion, but the new global macro regime will likely challenge the ability of carry trades to exhibit the same level of resilience during previous cycles. In a world which values fiscal strength, low-yielders are in a standout position to use available resources to rebalance economies away from trade. Germany’s stimulus decisions this week have shown the way and continue to encourage asset inflows. In time, we expect peers to emulate such fiscal plans, and the buying of low-yielders will become an asset performance and growth play, rather than simple carry unwinding.

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