The craze of arbitrage in emerging markets shows no signs of stopping! Wall Street is bullish on the outlook for high-yield currencies in 2026.

Large investors have indicated that after experiencing a successful year with this popular strategy, there is still room for continued expansion of carry trading in emerging markets in 2026. The decrease in forex market volatility and the weakness of the US dollar provide fertile ground for this trading. In this trading strategy, investors borrow low-yielding currencies to buy high-yielding currencies. Data shows that a measure of this strategy has a return rate of around 17% this year, the highest increase since 2009. From Vanguard Group to Invesco, to Goldman Sachs and Bank of America, a series of asset management companies and banks expect the interest rate gap between developed and emerging markets to persist next year, as the Federal Reserve and most other wealthy country central banks are expected to maintain low borrowing costs. In theory, this environment should continue to put pressure on the US dollar, which has already fallen by over 7% in 2025. Gorki Urkiyeita, co-head of Neuberger Berman's emerging market debt team, said: "Arbitrage trading still holds value, especially in high-yielding countries such as Brazil, Colombia, and some African markets." However, he noted that after this year's performance, "opportunities are becoming more selective." Emerging market arbitrage returns surged in 2025 Feast of Returns This year, emerging market stocks, bonds, and currencies have all risen significantly, providing investors with many attractive arbitrage opportunities to choose from. Countries with high benchmark interest rates such as Brazil and Colombia have seen their currencies against the US dollar rise by over 13%. The trajectory of the US economy is a key factor in determining whether this performance can continue. Ideally, investors hope for weak economic growth, which would encourage the Federal Reserve to continue easing monetary policy, thereby weakening the attractiveness of the US dollar against other currencies. A full-blown recession could trigger risk aversion, disrupting this balance; while if the economy performs hotter than expected, there is a threat of rate hikes. Wim van den Hoek, co-head of Invesco's emerging market debt team, said: "With the US dollar softening, arbitrage will still be a source of returns." Van den Hoek is bullish on currencies such as the Brazilian real, Turkish lira, and South African rand. Earlier this month, Brian Dunn, head of foreign exchange options trading for Goldman Sachs Americas, emphasized the attractiveness of shorting the US dollar against the real, rand, and Mexican peso in a podcast. An equally weighted basket investment in these trades has yielded a return of around 20% so far this year. Invesco has been selling the US dollar against the rand, as well as the euro against the Hungarian forint - including arbitrage, this trade has yielded about 11% in returns so far in 2025. Meanwhile, Bank of America is bullish on buying the real against the Colombian peso, a relative carry trade that has earned over 2% in returns. Emerging market returns still outperform all comparable markets Volatility Check Investors are also assessing whether forex volatility will remain relatively calm - a key component of arbitrage trading, as adverse currency movements can quickly erase months of gains. Currently, market expectations for volatility are low, with a J.P. Morgan index measuring six-month volatility of emerging market currencies near a five-year low. However, this may raise concerns among market participants, who cautiously believe that a rebound should have occurred by now. Francesca Fornasari, Head of Currency Solutions at Insight Investment, said: "Volatility is very low in many places. This is my only concern, as this benign situation has to some extent already been priced in." Ashish Singh, Currency Strategist at Bank of America, pointed out a series of factors that could potentially increase currency volatility in the coming months, including the US midterm elections and central bank interest rate policy divergence. Nevertheless, Vanguard Group, the world's second-largest asset management firm, stated that the market turmoil caused by Trump's tariff announcement in April has subsided and is expected to remain under control in 2026. Roger Hallam, Global Rates Chief at the company, said: "We do not anticipate large fluctuations related to policy instability or recession risks. This tends to occur in an environment where emerging market currency performance is decent."