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.

While still profitable, FX carry trades have become more cyclical and less of a diversifier. They now exhibit a high correlation (~0.5 beta) with the S&P 500 and offer significantly lower yields (7% vs. 11-12% previously), increasing their risk profile in a potential market downturn.

With foreign exchange implied volatility at five to six-year lows, traditional directional bets are less attractive. The carry trade, which profits from interest rate differentials, has consequently become the 'only game in town,' delivering strong returns as investors search for yield in an unusually calm market environment.

Despite endless debate on the dollar's direction, the most profitable FX strategy is the simple carry trade, which has generated 6-12% year-to-date returns. In a pro-cyclical, low-volatility environment with wide yield gaps, focusing on yield differentials is more effective than making binary calls on major currencies.

Unlike equities, FX carry strategies tend to perform better in high-inflation, rising-rate environments. This is because FX carry currently has a pro-inflation bias, making it a resilient strategy amidst stagflationary fears, which the speakers believe are currently overblown.

A strengthening US dollar doesn't negate the FX carry trade. The optimal strategy shifts to using low-yielding currencies like the Euro, Swiss Franc, or Yen as funders to buy high-yielders, insulating the trade from direct USD strength and capturing cross-currency differentials.

The market's stress test for carry trades has inverted. Before the Treasury's buybacks, the concern was if high-yield assets could withstand rising US rates. Now, the risk focus has shifted to the stability of low-yield funding currencies, like the Swiss Franc and Yen, which are vulnerable to unconventional policy surprises.

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.

Contrary to the historical norm where volatility rises with a strengthening dollar (risk-off), the market is now experiencing higher volatility as the dollar falls. This unusual 'dollar down, vol up' dynamic suggests a pro-cyclical market backdrop and has major ramifications for how FX options and risk reversals are priced.