According to Goldman Sachs, arbitrage trading—one of the most widely used strategies in the foreign exchange market, which has a daily trading volume of $9.5 trillion—is facing the most striking market conditions in over two decades.
Strategy analyst Stuart Jenkins wrote in a report that the importance of carry trades in the G10 foreign exchange markets has nearly reached its highest level since 2000. He noted that Goldman Sachs currently favors using the yen, Swiss franc, or euro to fund such trades over the coming months—referring to borrowing in relatively low-yielding currencies and investing in higher-yielding ones.
Several factors are driving the appeal of foreign exchange trading. Goldman Sachs notes that interest rates in major developed economies have stabilized at high and significantly divergent levels, creating an unusually wide yield gap for investors, while currency volatility has fallen to historic lows. An index from JPMorgan shows that forex volatility is hovering near its lowest level since 2020.
Jenkins wrote in the report released on Thursday: “The G10 interest rate range has stabilized—lower real volatility due to interest rate differentials, along with expectations of relatively limited future policy actions—allowing higher G10 rates to coexist with more moderate volatility.”
Hedge funds and asset management firms use arbitrage trading to profit from exchange rate differences across markets, assuming overall exchange rate stability. However, this strategy also carries risks. Since gains accumulate gradually while currency losses can occur within minutes, sudden market volatility may trigger rapid position unwinding, thereby amplifying market fluctuations as a whole.
Barclays also issued a warning this week, noting that the current calm in the foreign exchange market stands in stark contrast to the high level of uncertainty in the global economy. The bank said its models predict that market volatility is more likely to rise than fall in the future.
Goldman Sachs said that, in the long term, the yen remains one of the best financing options. The yen is currently near a 40-year low against the dollar, and although the risk of official intervention persists, Goldman expects the yen to continue weakening unless the macroeconomic environment changes.
Goldman Sachs also favors buying the euro against the Swiss franc, citing one of the highest volatility-to-yield ratios among major currency pairs, as well as buying the Australian dollar against the New Zealand dollar. The interest cost on long positions in the U.S. dollar/Swedish krona has already become quite high.
Jenkins wrote: “We believe that having the option to generate returns through investing in G10 forex within a multi-asset portfolio, while remaining relatively insulated from risk drawdowns or even hedging against them, is a useful strategy.”
