The Lira Carry Trade: A Minefield in Emerging Markets

The carry trade—a strategy where investors borrow in low-yield currencies to invest in higher-yielding ones—has long been a cornerstone of emerging market investing. But in 2025, the Turkish lira, once a poster child for this strategy, has become a cautionary tale. Goldman Sachs' stark warnings about its vulnerabilities underscore a critical truth: the lira's high yields mask systemic risks that could upend portfolios and amplify broader emerging market instability.

Why the Lira Was a Favorite—And Why It's Now a Liability
The lira's appeal stems from its potential for high returns. With Turkey's central bank (CBRT) maintaining sky-high policy rates (peaking at 50% in 2023), the real yield advantage over currencies like the USD or EUR has historically attracted carry traders. But as Goldman Sachs emphasizes, this strategy is now perilously exposed to inflation persistence, policy reversals, and geopolitical volatility.

The Four Pillars of Risk: Why the Lira Carry Trade is Unstable

1. Inflation's Double-Edged Sword

While the CBRT's aggressive rate hikes have slowed inflation—from a peak of 61.78% in 2023 to projections of 29.1% by 2025—the path is fraught. Persistent core inflation, driven by service-sector prices, could force further hikes, stifling growth. Even if disinflation succeeds, real rates may remain volatile, undermining carry trade returns.

2. Policy Uncertainty Under Erdoğan

President Erdoğan's history of unorthodox economic theories—such as opposing high interest rates—looms large. While the CBRT has shifted to orthodox policies since his 2023 re-election, any political shift could reverse course. A sudden rate cut, for instance, would collapse real yields, triggering a carry-trade unwind.

3. Structural Weaknesses

Turkey's current account deficit (9.5% of GDP in 2023) and heavy reliance on foreign currency deposits (52% of total bank deposits) amplify vulnerability. A sudden stop in foreign capital—a hallmark of emerging market crises—could spark a currency collapse, as seen in 2023 when the lira fell 30% in a month.

4. Geopolitical Turbulence

Turkey's regional conflicts, from Syria to Ukraine, and its strained ties with Western allies create diplomatic risks. Any escalation could disrupt trade, energy flows, or tourism, worsening the lira's outlook.

Goldman Sachs' Bottom Line: A High-Reward, High-Risk Gamble

Goldman Sachs' analysis paints a stark picture: the lira's carry trade is viable only if inflation declines sustainably, policy consistency holds, and geopolitical calm prevails. The stakes are immense.

• Bullish Scenario (2025+): If real rates turn positive and inflation stabilizes, the lira could regain its appeal.
• Bearish Scenario (2025+): Persistent inflation or policy missteps could send USD/TRY to 43.0 (S&P) or even 95.0 (outlier models), erasing carry trade gains.

Broader Implications for Emerging Markets

The lira's struggles are a microcosm of broader risks in emerging markets:
- Yield Competition: Rising global rates (e.g., US Fed hikes) reduce the relative appeal of lira yields.
- Contagion Risks: A lira crisis could spook investors in other volatile markets (e.g., Argentina, Nigeria), triggering a broader sell-off.

Investors: Proceed with Extreme Caution

The lira carry trade is no longer a “set-and-forget” bet. Here's how to navigate it:

1. Hedge Against Volatility: Use FX forwards or options to protect against lira depreciation.
2. Short-Term Exposure: Opt for shorter tenors (e.g., 3–6 months) to avoid prolonged exposure to policy risks.
3. Diversify: Pair lira exposure with safer emerging markets (e.g., Poland, Czech Republic) to mitigate fallout.

Conclusion: The Lira's High Yields Come with a Price Tag

Goldman Sachs' warnings are a wake-up call: the lira's potential rewards are matched by systemic risks. Investors must ask themselves: Is the yield worth the chance of a 30%–40% currency devaluation?

For now, the answer is clear: proceed with caution, and prioritize risk management over quick gains. The lira's volatility isn't just a Turkish story—it's a reminder that in today's markets, every carry trade is a gamble with a loaded gun.