High interest rate differential + low volatility! Goldman Sachs strongly supports foreign exchange arbitrage trading: welcoming the best window in 26 years, the yen remains the best funding currency.

Goldman Sachs Group stated that in the global foreign exchange market with a daily average trading volume of $9.5 trillion, arbitrage trading - one of the most widely used trading strategies - is currently experiencing the most attractive market environment since 2000. Goldman Sachs strategist Stuart Jenkins wrote in a report that the importance of long arbitrage trading in Group of Ten (G10) foreign exchange markets has reached almost the highest level since 2000. He stated that Goldman Sachs currently prefers to conduct arbitrage trading using the Japanese yen, Swiss franc, or euro as funding currencies in the coming months, borrowing low-yielding currencies and investing in high-yielding currencies. Several factors have contributed to the significant increase in the attractiveness of arbitrage trading. Goldman Sachs stated that interest rates in major developed economies have stabilized at relatively high levels with significant differences between them, creating exceptionally wide interest rate differentials for investors. At the same time, volatility in the foreign exchange market has dropped to historically low levels. An index from JPMorgan Chase shows that foreign exchange market volatility is currently hovering around its lowest levels since 2020. In this environment, year-to-date returns on G10 foreign exchange arbitrage trades have been around 8%, outperforming global bonds, gold, and Bitcoin, but still lagging behind the stock market. Jenkins wrote in a report released on Thursday, "It is the stability of G10 country interest rates in the current range - with reduced actual volatility due to interest rate differentials, and market expectations for limited future policy action - that allows G10 foreign exchange arbitrage returns to rise synchronously while volatility remains low." Hedge funds and asset management institutions typically use arbitrage trading to profit from interest rate differentials between different markets, as long as exchange rates remain stable, this strategy can continue to be profitable. However, this strategy also comes with risks. Since arbitrage returns accumulate gradually, losses due to exchange rate movements can occur rapidly within minutes. Therefore, sudden market volatility may lead to rapid closure of arbitrage positions and amplify market fluctuations. Barclays Bank warned this week that the current calmness in the foreign exchange market does not align with the high level of global economic uncertainty. The bank stated that its models show that future volatility in the foreign exchange market is more likely to rise than to decrease. Currently, the yield on 2-year US Treasury bonds is still above 4%. In comparison, the yield on German bonds with the same maturity is around 2.6%, Japanese bonds around 1.4%, and Swiss bonds around 0.1%, creating one of the most significant interest rate differentials among developed economies in recent years. Goldman Sachs also believes that the Japanese yen remains the ideal funding currency for arbitrage in the long term. At present, the Japanese yen to US dollar exchange rate is still near its lowest point in almost 40 years. Although Japanese authorities may intervene in the foreign exchange market at any time, Goldman Sachs expects the yen to continue to weaken unless there are changes in the macroeconomic environment. Goldman Sachs also sees an investment opportunity in going long the US dollar against the Swedish Krona. Markets Live strategists also pointed out, "The arbitrage returns available in going long the US dollar against the Swedish Krona positions are quite substantial." Additionally, in a so-called "risk-neutral" scenario, Goldman Sachs recommends buying the euro against the Swiss franc, as this currency pair has one of the highest "arbitrage return/volatility" ratios in major currency combinations. Furthermore, Goldman Sachs is also bullish on going long the Australian dollar against the New Zealand dollar. Jenkins stated, "We believe that earning arbitrage returns in the G10 foreign exchange markets, while being able to effectively isolate asset risk withdrawals, or even serve as a certain hedge, is an attractive allocation choice for multi-asset investment portfolios."