Key Highlights

• ZAR and PEN most at risk from carry unwind
• RBNZ and RBA holds not turning around flows yet
• CEE/EMEA leading EM FX gains

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Currencies which have flipped from underheld to overheld amid carry interest could mean revert

EXHIBIT #1: PEN AND ZAR SCORED HOLDINGS SINCE Q2 2025

_Source: BNY

Our take

Over the past month, our flows show strong alignment between currency flow strength and underlying yields. Our iFlow Carry indicator has moved to the highest levels year to date, led by selling of low-yielding currencies in APAC and smaller European funders like the SEK. Admittedly, the correlation (ranked basis) is currently not at the highs seen in 2023, but given the strength of flow in higher-yielding Latin America and EMEA names, there is clear interest in using FX positions to reflect the current improvements in risk appetite. We highlight PEN and ZAR in particular – both currencies have moved from underheld at levels equivalent to last year’s rolling average, to moderately overheld. If carry interest reverses, we believe these two currencies will also face the biggest risks because sentiment will turn before they are able to establish a significantly positive holdings buffer, backed by profitability.

Forward look

We acknowledge that tariff-related risk will probably not be as significant a driver of sentiment as in April so these pro-carry flows could continue, but the broader macro outlook is weak and most central banks will seek to resume an easing cycle when possible. Furthermore, there are domestic considerations at play, especially in South Africa, which could start to generate volatility in underlying bond markets. PEN is already starting to struggle to maintain positive holdings, and we note that the currency was significantly underheld even during periods of outstanding general Latin American FX performance. We continue to make a case for EM duration over the longer term, but FX exposures will be more dynamic and hedge ratios should rise as easing cycles become clearer. The direction of travel for the Fed will be particularly supportive for such FX-hedged positions into Latin American bonds.

Antipodean holds not enough to turn around flows

EXHIBIT #2: DAILY FLOWS YEAR TO DATE IN AUD AND NZD

_{Source: BNY}

Our take

Before the global financial crisis, AUD and NZD were considered the favored carry currencies, especially funded out of low-yielding names in APAC. However, equilibrium rates have fallen quite sharply over the past two decades as the commodity super-cycle ends and positioning has not been as favorable. Even when the RBNZ had the highest rates among G10 economies, overall holdings struggled to break into positive, though AUD has had periods of sufficient holdings gains. Year to date, we can see that flows in both currencies have been very well aligned. The strongest period of inflows was in the immediate aftermath of “Liberation Day” (Exhibit #2). Given the cross-border nature of the flows, we suspect that they are more aligned with hedges being unwound. Improved real yields as inflation falls is also not sufficient to generate interest in cash bonds – a surprise considering AUD’s favorable ratings and market liquidity in ACGBs.

Forward look

We continue to see AUD and NZD becoming better aligned with APAC currencies over the longer term. Australia has turned around its balance of payments, while New Zealand’s efforts in raising real rates through fiscal retrenchment is also conducive to bond performance. Commodity terms of trade will remain weak, but sustained gains in the currencies of APAC goods exporters – be it through carry unwinding or valuation realization – will be reflationary for Australia and New Zealand through the external demand channel. Domestic productivity challenges continue to drive caution from the RBA amid their surprise hold and the RBNZ’s outlook, but tradables inflation will also start to bottom out and support antipodean real effective exchange rates.

APAC vs. EMEA/LatAm divergence clear

EXHIBIT #3: HOLDINGS IN APAC FX AND EM APAC EQUITIES

_{Source: BNY}

Our take

Breaking down current flow vs. holdings by region, we can see EM as a whole is flat, with APAC from a marginally underheld position over the past month being offset by purchases across the other high-yielding regions. The main difference is that the overheld position of LatAm FX has proven resilient, anchored by MXN and BRL, while EMEA has demonstrated significant volatility over the past quarter, with PLN swinging from comfortably overheld to sharply underheld, whereas ZAR moved in the opposite direction. Meanwhile, we maintain our view that within G10, relative value plays are prevailing, with the dollar being able to sit on funding and carry legs in equal measure. There is sufficient evidence of inflation declines across EM to justify higher real yields anchoring EMEA and LatAm currencies, even though we think owning duration offers better risk-reward. However, we do not believe APAC FX is the best funding leg and this is where the biggest carry unwind risk lies.

Forward look

The iFlow Carry indicator highlights that client conviction is far stronger in adding to hedges or funding out of APAC FX compared to owning duration. Policy paths may support such views, with Malaysia the biggest example as the BNM cut rates for the first time in five years. However, the marginal impact of monetary easing is very limited amid an external demand shock. This week, new fiscal initiatives were launched in China and Thailand to support domestic prices while mitigating any potential adverse impact from tariffs. Compared to the ECB for example, APAC central banks are less concerned about disinflationary pass-through, and in some respects a stronger currency could even stimulate consumption and lower import prices. Given current valuations, we continue to see APAC FX offering better risk-reward for currency rotation, and a near-term carry unwind will disproportionately help currencies such as THB, TWD and HKD.

Bottom line

iFlow indicates the current alignment between currency yields and flow performance is strong. This is mostly because low yielders are facing sustained hedging risk, but the improving performance of MEA and LatAm currencies points to yield demand as well. Even with stable risk improvement, the advent of global easing cycles means carry positions will prove difficult to maintain. We continue to look for opportunities to fade current EM interest, while G10 economies with short-term preferences for unchanged rates – such as the ECB and RBA – will find their positions difficult to maintain.

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