Emerging market currency arbitrage trades achieve nearly the best returns in a decade! Citigroup remains optimistic about the short-term outlook
This year, the strategy of buying emerging market currencies with US dollars has achieved the highest returns in nearly a decade, and Citigroup is optimistic about the short-term outlook. The Federal Reserve's dovish stance and the cautious attitude of emerging market central banks have supported the exchange rates of developing country currencies against the US dollar. The Bloomberg Emerging Market Arbitrage Trading Index has risen by over 10%, with the Brazilian real outperforming other currencies. Citigroup warns that greater challenges may arise in the second half of next year, as the US economy may enter a rebound phase, and a strong dollar will affect the performance of international assets
According to Zhitong Finance APP, this year, the strategy of buying emerging market currencies with US dollars has achieved the highest returns in nearly a decade. Citigroup stated that there is still room for further development of this trade, at least in the short term. Luis Costa, head of emerging markets strategy at Citigroup, indicated that the Federal Reserve's more aggressive dovish stance, combined with the cautious attitude of emerging market central banks, will continue to support the exchange rates of developing country currencies against the US dollar.
The Bloomberg arbitrage trading index covering eight emerging market currencies has risen over 10% this year, expected to record the largest annual increase since 2017. These trades are funded by short positions in the US dollar. The so-called arbitrage trading is a strategy of borrowing in low-interest-rate countries to invest in high-yield assets and currencies.
The emerging market arbitrage trading index is setting records for the best returns in years.
Costa stated, "The policy stance of most emerging market central banks is also quite cautious—almost neutral in many regions—indicating the sustainability of real policy rates. At the same time, market expectations for a more dovish stance from the Federal Reserve in 2026 must also be considered."
The Bloomberg Dollar Spot Index has fallen 7.8% this year, as the US's tough tariff measures and their chaotic implementation have raised doubts about the stability of the global reserve currency. However, some investors and economists, including strategists from HSBC, have indicated that the ongoing dollar sell-off increasingly resembles a "bubble" on the verge of bursting, suggesting that the dollar may be nearing a bottom.
The arbitrage returns of the Brazilian real have outperformed other currencies, appreciating over 20% against the US dollar this year. Citigroup remains optimistic about the Brazilian real, as the market still expects the Brazilian central bank to adopt a cautious policy stance.
However, Costa warned that this outlook will become more severe in the second half of next year. A loose financial environment and fiscal policy could push the US economy from a soft landing phase into a rebound and re-inflation phase.
Costa stated, "In this potential scenario, the US Treasury yield curve will be steeper, and the dollar will be stronger, which may pose greater challenges for the performance of international assets, including emerging markets."
Last month, Citigroup strategists also recommended buying Turkish lira against the US dollar through three-month forward contracts
