LatAm FX Resilience: Carry Trade Dynamics Bolster Currencies Against Strong US Dollar, Says BNY

Latin American currencies are demonstrating notable resilience against a broadly stronger US dollar, supported by the region’s attractive carry trade dynamics, according to a recent market analysis from BNY (Bank of New York Mellon). The report highlights that high interest rate differentials between major LatAm economies and the United States are providing a significant buffer against dollar strength, a trend that has persisted despite global risk-off sentiment.

Carry Trade as a Defensive Mechanism

The core of BNY’s argument centers on the ‘carry’ — the yield advantage investors earn by holding higher-interest-rate currencies. In Latin America, central banks in countries like Brazil, Mexico, and Colombia have maintained relatively high benchmark rates to combat inflation, creating a wide gap with the Federal Reserve’s policy rate. This differential effectively compensates investors for the risk of currency depreciation, making LatAm FX a relatively attractive destination for yield-seeking capital, even when the dollar is strengthening.

BNY’s analysis suggests that this carry support is not merely a short-term phenomenon. As long as the interest rate differential remains wide — which is expected until inflation in the region converges more decisively toward targets — LatAm currencies may continue to exhibit a degree of insulation from the dollar’s upward moves. This dynamic is particularly evident in the Mexican peso (MXN) and the Brazilian real (BRL), which have shown relative stability compared to other emerging market peers.

Implications for Investors and the Broader Market

For global investors, this resilience offers a potential hedge in portfolios heavily weighted toward US dollar assets. The carry trade in LatAm FX provides a source of positive returns that is somewhat decorrelated from equity and bond market volatility in developed economies. However, the strategy is not without risk. A sharp shift in global risk appetite — triggered by, for example, a sudden recession in the US or a geopolitical crisis — could overwhelm the carry advantage, leading to rapid capital outflows and currency depreciation.

The report also notes that the sustainability of this carry support depends on the trajectory of inflation and monetary policy within the region. If LatAm central banks begin cutting rates aggressively in response to slowing economic growth, the yield advantage could erode, weakening the defensive buffer. Conversely, if the Fed maintains higher rates for longer, the differential could narrow from the other side, potentially reducing the attractiveness of the trade.

What This Means for Regional Economies

For Latin American economies themselves, a resilient currency is a double-edged sword. On one hand, it helps contain imported inflation by making dollar-denominated imports cheaper. On the other, it can hurt export competitiveness. BNY’s analysis implies that the current equilibrium — where carry provides support but does not lead to excessive appreciation — is broadly favorable for the region’s economic stability. Policymakers are likely to welcome this balance as they navigate the final stages of their inflation-fighting cycles.

Conclusion

BNY’s assessment underscores a key theme in current global FX markets: the power of carry in an environment of persistent dollar strength. While LatAm currencies are not immune to external shocks, the region’s high interest rates provide a structural advantage that is currently proving effective. Investors and market participants will be watching closely for any shifts in central bank policy or global risk sentiment that could alter this dynamic.

FAQs

Q1: What is a ‘carry trade’ in the context of currency markets?
A: A carry trade involves borrowing a currency with a low interest rate (like the US dollar) and investing in a currency with a higher interest rate (like the Mexican peso). The profit comes from the difference in interest rates, known as the ‘carry’. In the LatAm context, this yield advantage helps support the value of the higher-yielding currency against the dollar.

Q2: Which Latin American currencies are most supported by carry trade dynamics?
A: According to BNY and broader market analysis, the Mexican peso (MXN) and the Brazilian real (BRL) are among the most prominent beneficiaries of carry trade inflows, due to their relatively high interest rates and liquid markets. The Colombian peso (COP) and Chilean peso (CLP) also exhibit similar characteristics, though with varying degrees of volatility.

Q3: What are the main risks to the LatAm carry trade?
A: The primary risks include a sudden shift in global risk appetite (risk-off event), a faster-than-expected pace of interest rate cuts by LatAm central banks, or a sustained rise in US interest rates that narrows the yield differential. Any of these factors could reduce the attractiveness of the trade and lead to currency depreciation.