Carry Trade Funding Rotates Out of USD Into Euro and AUD as Colombia and Brazil Currencies Advance

The shift follows sustained dollar strength that raised funding costs for traditional USD-EM carry trades. Invesco and AllianceBernstein have reduced dollar-denominated positions while Morgan Stanley advised clients to benchmark EM exposure against a multi-currency basket. Citigroup explicitly recommended long BRL versus both EUR and AUD, citing interest-rate differentials that remain wider than those available against the dollar.

Primary data from central banks show Colombia and Brazil maintaining real policy rates above 6 percent after inflation adjustment, still among the highest in major EMs. This differential supports continued inflows even as the dollar index trades near cycle highs. The rotation lowers immediate pressure on EM central banks to defend currencies but transfers exposure to euro-area and Australian monetary policy decisions.

The move also reflects documented changes in bank positioning: BIS locational banking statistics through Q1 2026 already recorded a 12 percent decline in cross-border USD claims on EM non-banks. If sustained, the pattern compresses USD liquidity premia in EM debt markets while increasing sensitivity of local yields to ECB and RBA signals.

Next quarter data on EM portfolio flows and forward positioning will reveal whether the rotation accelerates or reverses when the FOMC next signals its rate path.