LatAm FX Carry Trades Show Resilience Amid Fed Repricing, BNY Says

Investors in Latin American foreign exchange markets are finding that the appeal of carry trades remains intact, even as the Federal Reserve’s policy path undergoes a significant repricing, according to a recent analysis by BNY. The bank’s strategists note that while higher-for-longer US interest rates typically pressure emerging market currencies, several structural factors in the region are providing a buffer.

Carry Trade Dynamics in a Shifting Rate Environment

The carry trade, a strategy where investors borrow in a low-yielding currency to invest in a higher-yielding one, has been a cornerstone of LatAm FX positioning. BNY’s assessment highlights that currencies like the Mexican peso and Brazilian real continue to offer attractive yield differentials over the US dollar. Despite the market’s repricing of Fed rate cuts — now expected to begin later and be shallower than previously forecast — these differentials have not collapsed.

This resilience is partly attributed to proactive monetary policy by regional central banks. Brazil’s central bank, for instance, has maintained a hawkish stance, while Mexico’s Banco de México has also kept rates elevated to combat inflation. This has preserved the interest rate advantage that attracts carry flows.

Fed Repricing: The Core Risk Factor

The primary headwind for LatAm FX is the persistent repricing of the Federal Reserve’s monetary policy. When US interest rates remain high, the dollar strengthens, and the cost of hedging or funding carry trades increases. BNY’s analysis suggests that while this creates a ceiling for further FX gains, it has not yet triggered a broad selloff.

The bank points out that the current environment is different from previous tightening cycles. Many LatAm economies have stronger external balances, higher reserve buffers, and more credible inflation-targeting frameworks. These fundamentals reduce the vulnerability to sudden stops in capital flows.

Implications for Investors

For investors, the key takeaway is that carry trades in LatAm FX still offer a positive risk-reward profile, but with a narrower margin for error. The resilience is not a signal of immunity. Any unexpected acceleration in US inflation or a more hawkish Fed could quickly shift sentiment. BNY advises focusing on currencies with the strongest carry and most credible central bank backing, while maintaining active risk management.

The Mexican peso, supported by nearshoring flows and fiscal discipline, and the Brazilian real, buoyed by high real rates and a robust trade surplus, are cited as relative outperformers. However, political risks and commodity price volatility remain wildcards.

Conclusion

BNY’s analysis underscores a nuanced picture for LatAm FX: carry trade resilience is holding, but it is being tested by the ongoing Fed repricing. The region’s improved fundamentals provide a buffer, but they do not eliminate the risk of a sharper correction. For now, the carry remains compelling, but investors should stay vigilant as the global rate landscape continues to evolve.

FAQs

Q1: What is a carry trade in foreign exchange?
A carry trade involves borrowing a currency with a low interest rate and using the proceeds to buy a currency with a higher interest rate, profiting from the interest rate differential. In LatAm, investors often borrow in USD or JPY to invest in MXN or BRL.

Q2: Why is the Fed repricing important for LatAm FX?
The Fed repricing refers to market expectations shifting toward higher US interest rates for longer. This strengthens the US dollar, increases the cost of funding carry trades, and can lead to capital outflows from emerging markets, pressuring their currencies.

Q3: Which LatAm currencies are most resilient for carry trades?
According to BNY, the Mexican peso (MXN) and Brazilian real (BRL) are among the most resilient due to high real interest rates, strong external accounts, and credible central bank policies. However, all carry trades carry risk, especially during periods of global rate volatility.