On Foreign Exchange
How to make the most of currencies in a portfolio context
Is currency trading cool again? According to a recent piece by Bloomberg, it is! After years of synchronized monetary policy and a relatively stable geopolitical environment, currency trading was becoming a staid affair. Gone were the days of swashbuckling fund managers taking wagers large enough to break central banks.
But Trump’s return to the White House, and his tariff-forward version of big stick diplomacy, have roiled currency markets. To add further to the uncertainty imposed by Trump’s tariff policy, US inflation appears to be sticky (or rising), while other economies like the UK are facing down the risk of a recession.
Controlling currency risk—and thinking about how to potentially profit from this newly elevated volatility—is at the top of investors’ minds.
Academic research reveals a few important facts about foreign exchange. First, macro-economic signals do a very poor job of predicting currency returns. There just aren’t any good models, despite many plausible hypotheses about how things like the current account or purchasing power parity should work. Second, though the uncovered interest rate parity hypothesis holds that the expected price return should converge to offset any differentials in interest rates between currencies, we know this is not borne out empirically.
Our framework for thinking about currencies in a portfolio context is to consider two primary factors:
Carry, which is the best, though imperfect, predictor of returns.
The correlation of a given currency with equity markets, and thus its potential use as a hedge or source of extra volatility.
Below we show a 2x2 matrix plotting each currency’s historical carry versus the historical correlation with the S&P 500.
Figure 1: Currency Carry vs. Correlation to S&P 500 (1995-2025)
Source: Capital IQ, Verdad analysis
This chart helps us understand how to think about different currencies.
The Japanese yen (JPY) is the best defensive currency, providing the most negative correlation to equity markets. But this comes at the cost of paying about 2% per year in carry relative to USD.
The Mexican peso (MXN) is a classic carry-trade currency, offering a potentially juicy 5% carry. But its high correlation to the S&P 500 can subject it to high volatility.
The Swiss franc (CHF) looks like today’s best funding currency. Investors can borrow to invest in higher-yielding currencies like USD, and that trade is not meaningfully corelated with the S&P 500.
Meanwhile, the Canadian (CAD) and Australian (AUD) dollars have been positively correlated with equities, but without any interest rate premium, making them potentially useful as equity hedges.
Trying to earn carry and generate return from a currency portfolio doesn’t seem particularly attractive, given the correlation that high-carry currencies have to global equity markets. But when we consider the potential for currencies to mitigate equity volatility, we think they can play an important role in a portfolio context.