BNY: LatAm FX Carry Window Opens, but Risks Loom for Investors

Bank of New York Mellon (BNY) has identified a fresh carry trade opportunity in Latin American foreign exchange (FX), but with notable caveats that investors should weigh carefully, according to a recent client note.

What Is Driving the LatAm Carry Trade Opportunity?

The carry trade involves borrowing in a low-yielding currency and investing in a higher-yielding one, pocketing the interest rate differential. BNY notes that several Latin American currencies—such as the Brazilian real, Mexican peso, and Colombian peso—currently offer attractive yields relative to developed-market currencies like the U.S. dollar.

This yield advantage is largely a product of the region’s monetary policy cycle. Central banks in Latin America were among the first to hike rates aggressively during the post-pandemic inflation surge, and they have maintained elevated policy rates to combat persistent price pressures. As of mid-2025, for example, Brazil’s Selic rate stands at 10.50%, while Mexico’s overnight rate is at 11.00%, compared to the U.S. federal funds rate of 5.25%–5.50%.

At the same time, the U.S. Federal Reserve has signaled a potential shift toward rate cuts later this year, which could narrow the rate differential but also reduce the dollar’s appeal. This dual dynamic—high LatAm yields and a softening dollar—creates a favorable backdrop for carry trades, according to BNY’s analysis.

Why BNY Advises Caution Despite the Opportunity

While the carry trade setup looks attractive, BNY cautions that several risks could undermine returns. One key concern is political and policy uncertainty across the region. For instance, Mexico’s upcoming elections in June 2025 could introduce volatility, as markets weigh the potential impact on fiscal policy and institutional stability. Similarly, Brazil’s ongoing fiscal consolidation efforts are being closely watched, with any slippage likely to pressure the real.

Another risk is external vulnerability. Latin American currencies are sensitive to shifts in global risk appetite and commodity prices. A sharper-than-expected slowdown in China—a major buyer of regional exports—could weigh on currencies like the Chilean peso and Colombian peso, which are closely tied to copper and oil prices, respectively.

BNY also highlights the risk of carry trade unwinds. If global risk sentiment deteriorates or if the Fed delivers fewer cuts than expected, investors may quickly exit these positions, leading to sharp currency depreciations. This was evident in 2024 when a sudden repricing of U.S. rate expectations triggered a sell-off in high-yield currencies.

How Investors Can Navigate the Carry Window

Given these caveats, BNY suggests a selective approach. Rather than a blanket bet on the region, investors should focus on currencies with strong fundamentals and central banks that are likely to maintain high real rates. For example, the Mexican peso may benefit from nearshoring trends and a relatively stable fiscal outlook, while the Brazilian real could be supported by high interest rates if the government demonstrates fiscal discipline.

Hedging strategies are also advisable. Options and forwards can protect against downside moves, though they reduce the net carry return. BNY emphasizes that the window is open, but it is not without risk—timing and position sizing are critical.

Conclusion

BNY’s note underscores a genuine opportunity in LatAm FX carry trades, driven by high yields and a potential Fed pivot. However, the bank’s caveats highlight the need for careful risk management, given political uncertainties and external vulnerabilities. For investors, the current window offers potential rewards, but only for those who approach it with discipline and a clear understanding of the risks involved.

FAQs

Q1: What is a carry trade in FX?
A carry trade involves borrowing in a currency with a low interest rate and investing in a currency with a higher interest rate, earning the spread. In LatAm, investors might borrow in USD and invest in BRL or MXN to capture the yield differential.

Q2: Why are LatAm yields so high?
Central banks in Latin America, such as Brazil’s Copom and Mexico’s Banxico, raised interest rates aggressively to combat inflation. Even as inflation moderates, policy rates remain elevated to ensure price stability, creating attractive nominal yields for foreign investors.

Q3: What are the main risks to a LatAm carry trade?
Key risks include political instability, fiscal policy slippage, commodity price shocks, and a sudden shift in global risk sentiment. Any of these can trigger rapid currency depreciation, eroding the carry gains.