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.

In an FX environment dominated by interest rate differentials (a 'carry regime'), traditional cyclical currencies like the Swedish Krona are less effective. A better way to gain exposure to global nominal growth is through high-beta G10 currency baskets against the Swiss Franc, which are currently trading cheap relative to growth.

A world of persistent inflation and hawkish central banks creates a prime environment for carry trades, even with moderating growth. Within the G10, currencies of energy exporters with high yields, like the Australian Dollar and Norwegian Krone, are particularly attractive. Their carry advantage over the US dollar is at its highest level in nearly a decade.

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.

The Norwegian Krone's rally is continuing despite oil prices not reaching new highs. This is attributed to the high absolute level of carry (interest rate differential) attracting inflows, suggesting that a currency can appreciate in a carry-friendly environment even if its rate spreads are not actively widening.

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.

High yield alone is insufficient for a good carry trade. 'Healthy' carry, like in Nokia or Aussie, is supported by strong domestic fundamentals. In contrast, 'unhealthy' carry, like in Sterling, is undermined by factors such as political risk and a weakening labor market, creating a toxic mix.

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.

Instead of directly shorting the US dollar, which can be costly, traders can use the Canadian dollar (CAD) as a more profitable proxy. This approach offers a better "carry" advantage due to interest rate differentials, while still capturing the downside of a weakening USD, especially as the Bank of Canada's policy mirrors the Fed's dovishness.