Real carry factors (adjusted for inflation) are currently outperforming nominal carry factors across G10, EM, and global FX. This dynamic is a pattern historically observed in the early stages of inflationary developments, making it a key forward-looking indicator for macro traders.

Initially, the market viewed the Euro/Sterling pair through the lens of interest rate spreads. However, as geopolitical conflict extends, the risk of a stagflationary environment for the UK increases. This shifts the dynamic, potentially weakening Sterling against the Euro despite central bank actions.

The success of the current EM FX carry trade isn't driven by wide interest rate differentials, which are not historically high. Instead, the strategy is performing well because a resilient global growth environment is suppressing currency volatility, making it profitable to hold high-yielding currencies against low-yielders.

The firm's analysts anticipate persistent core inflation in select emerging markets, suggesting an end to easing cycles. This contrasts sharply with clients who expect further disinflation driven by pressures from China and energy prices, marking a key area of disagreement on the global economic outlook.

For FX carry strategies, inflation is a more critical driver than growth. This is because inflation forces divergent central bank responses, creating the yield dispersion that carry trades exploit. Growth only becomes the dominant factor during a recessionary shock, when carry strategies typically collapse.

While broad emerging market currency indices appear to have stalled, this view is misleading. A deeper look reveals that the "carry theme"—investing in high-yielding currencies funded by low-yielding ones—has fully recovered and continues to perform very strongly, highlighting significant underlying dispersion and opportunity.

The conflict has shifted the FX regime from pro-cyclical to risk-off, making the US dollar attractive as a high-yielder, defensive asset, and energy exporter. Beyond the dollar, the primary theme is pairing energy exporting currencies (like AUD, NOK, BRL) against energy importing currencies (like EUR), which are most vulnerable.

The post-Cold War era of stability is over. The world is returning to an 'Old Normal' where great power conflict plays out in the economic arena. This new state is defined by fiscal dominance, weaponized supply chains, and structurally higher inflation, risk premia, and volatility.

War-induced oil shocks will create elevated inflation prints that persist for months, even if the conflict resolves today. This data lag handcuffs the Federal Reserve, preventing preemptive rate cuts and creating a minimum six-month pause on supportive action, which puts a ceiling on risk asset valuations.