Weak Dollar Reprises Its Role as Carry Trade Funder

June 2025 | Financial Desk

As the U.S. dollar enters a phase of relative weakness amid expectations of rate cuts from the Federal Reserve, global investors are once again turning to it as the preferred funding currency for carry trades. With higher-yielding markets from Asia to Latin America attracting capital, the dollar’s depreciation is reinforcing its classic role in global currency strategies.

The Dollar's Slide: A Renewed Opportunity

After a multi-year period of strength, the dollar index (DXY) has slipped nearly 6% year-to-date in 2025, as dovish signals from the Fed continue to weigh on yields. Analysts expect at least two rate cuts by December, bringing U.S. interest rates closer to 4.25%—down from their 2023 highs of over 5.5%.

“The dollar is no longer the fortress it once was. With U.S. inflation cooling and the Fed shifting gears, the greenback has returned as a cheap source of funding,” says Rajesh Taneja, FX Strategist at ICICI Securities.

The resulting interest rate differential with emerging markets is fueling a fresh wave of carry trade activity—borrowing in low-yield currencies like the USD to invest in higher-yielding ones like the Brazilian real, Indian rupee, or Mexican peso.

Why the Dollar Still Dominates as a Funding Currency

Despite the emergence of the euro and yen in previous cycles, the dollar remains the dominant carry trade funding currency because of:

• High liquidity and global acceptance

• Lower volatility relative to emerging market currencies

• Deep debt and derivatives markets denominated in USD

“It’s simple economics. A weakening dollar makes it cheaper to borrow, while the return from high-yielding currencies gets magnified. Investors chase that spread,” notes Laura Chen, Currency Strategist at Nomura Global Markets.

According to BIS data, over 60% of global cross-border debt is still dollar-denominated, highlighting its structural role.

Target Currencies: Where the Flows Are Heading

With global yield divergence widening, certain currencies have emerged as top targets for carry trades:

• Brazilian Real (BRL): Policy rate at 10.25%, stable political climate

• Indian Rupee (INR): High growth, real rates positive, central bank support

• Mexican Peso (MXN): Rates above 9%, strong manufacturing exports

• Indonesian Rupiah (IDR): Rising foreign reserves, inflation under control

“These currencies offer a perfect storm of yield, growth potential, and improving macro stability,” says Nikhil Mehta, Fund Manager at Kotak Global Alpha Fund. “That’s gold for carry trade investors.”

Risks and Volatility in the Carry Trade Comeback

While the renewed carry trade strategy looks attractive, it’s not without risks. Geopolitical uncertainty, abrupt Fed policy shifts, or unexpected inflation spikes could trigger sudden unwinding of positions.

Emerging markets, though relatively resilient, still carry structural risks such as:

• Political instability (e.g., elections in Latin America)

• Commodity price swings

• Exchange rate interventions by central banks

“The carry trade is often called the 'picking up pennies in front of a steamroller' strategy. Returns are smooth—until they’re not,” cautions Ana Rodriguez, FX Analyst at BNP Paribas.

Impact on Global Financial Markets

The dollar's weakness and the resurgence of the carry trade are also influencing broader asset classes:

• Emerging Market Bonds: Seeing stronger inflows as investors search for yield

• Commodities: A weaker dollar often supports commodity prices, benefiting exporters

• Equities in Emerging Markets: Re-rated higher due to foreign capital inflows and cheaper debt

Additionally, global central banks are recalibrating their policies in response to volatile capital flows driven by these trades.

Investor Outlook: Tactical Opportunities Ahead

For investors, the dollar’s depreciation presents a tactical window for returns, especially in diversified global portfolios. Hedge funds and global macro strategies are expected to continue building long positions in high-yielding currencies while shorting the USD.

Key investor actions to watch:

• Short-term FX ETFs targeting EM currencies

• High-yield bond funds in emerging markets

• Currency-hedged instruments to manage downside risks

“If dollar softness continues and global risk sentiment stays positive, the carry trade theme could dominate the rest of 2025,” concludes Michael Reaves, Portfolio Strategist at BlackRock.

Conclusion: Dollar Weakness Brings Classic Strategy Back to Life

The global macro environment of mid-2025 is creating a textbook setup for the resurgence of carry trades. As the dollar weakens and yield differentials persist, seasoned investors are tapping into this age-old strategy with fresh conviction. While risks remain, the current trend signals a renewed cycle where the U.S. dollar plays financier to the world once again.