The Dollar's Declining Volatility: A Strategic Reassessment of the US Dollar as a Carry-Trade Funding Currency

The US dollar's declining volatility has quietly transformed its role in global markets, positioning it as a more viable funding currency for carry trades than traditional alternatives like the Japanese yen and Swiss franc. While the yen and franc have historically dominated these strategies due to their low or negative interest rates, shifting macroeconomic dynamics now favor the dollar's stability. This article examines the dollar's evolving appeal, evaluates its competitive advantages, and explores how investors can leverage its low volatility to navigate an era of divergent global interest rates and emerging market opportunities.

The Dollar's Stability Amid Shifting Rates

The US dollar's volatility has trended downward since early 2025, driven by central bank policy predictability and geopolitical risk mitigation. The Federal Reserve's "higher for longer" stance, combined with its gradual approach to rate cuts, has anchored dollar-based assets in a low-volatility corridor.

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This stability contrasts sharply with the yen and franc, which face structural challenges:
- Japanese yen (JPY): The Bank of Japan's (BOJ) reluctance to normalize rates, despite rising inflation, has created a yield gap disadvantage. While the USD offers a 4.5% yield versus the JPY's near-zero rates, the yen's volatility spikes (e.g., 14% swings in 2024) make it riskier for long-term funding.
- Swiss franc (CHF): The Swiss National Bank (SNB) is under pressure to cut rates further to combat deflation, but this risks overshooting and destabilizing the franc. Its 0.25% rate—now above the Fed's 5.25%—has eroded its carry-trade appeal.

Why the Dollar's Low Volatility Matters for Carry Trades

Carry trades thrive on predictable funding costs and yield differentials. The dollar's declining volatility lowers the risk premium investors demand, making it an ideal base currency. Key advantages include:

1. Predictable Policy Environment
   The Fed's transparent communication has reduced surprises, allowing investors to hedge effectively. Compare this to the BOJ and SNB, whose policy shifts (e.g., the SNB's 2025 rate cut rumors) create uncertainty.

2. Global Liquidity Hub
   The USD remains the world's primary reserve currency, offering unmatched liquidity. This liquidity depth dampens volatility during market stress, as seen in Q2 2025 when USD/JPY's daily swings narrowed to 0.5%—half the 2023 average.

3. Emerging Market Exposure
   Investors can pair the dollar with high-yield emerging market currencies (e.g., Brazilian real, Turkish lira) with greater confidence. The dollar's stability acts as a "buffer," allowing carry trades to capitalize on growth without excessive risk.

Risks and Opportunities: A Strategic Playbook

Opportunity 1: Dollar-Funded Carry Trades in EM Debt

Investors can borrow USD at 5% and invest in EM bonds yielding 7–9%, locking in 2–4% annual returns. The dollar's low volatility reduces the risk of adverse exchange rate movements.

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Opportunity 2: Sector-Specific Carry Strategies

Pair USD with commodities (e.g., oil, copper) priced in emerging currencies. For example, funding a copper futures position with USD-denominated debt could amplify returns if commodity prices rise.

Risk Mitigation

• Hedge Volatility Spikes: Use options (e.g., USD call options) to cap downside risk if geopolitical tensions flare.
• Diversify Borrowing Tenors: Short-term USD loans (3–6 months) align with Fed policy cycles, reducing exposure to sudden rate hikes.

Conclusion: The Dollar's New Role in Carry Trading

The US dollar's declining volatility has redefined its utility in carry trades. While the yen and franc remain vulnerable to policy missteps and structural imbalances, the dollar's stability and liquidity make it the safest and most efficient funding currency for investors.

Investment Recommendation:
- Aggressive Investors: Deploy 10–15% of capital in dollar-funded EM carry trades, prioritizing high-yield bonds with BBB+ ratings.
- Conservative Investors: Use USD as a hedging vehicle in multi-currency portfolios, pairing it with low-volatility EM equities (e.g., South Korea's tech sector).

The dollar's era as a carry-trade leader is just beginning. As global rates diverge further, its role as a low-volatility anchor will only grow more critical.

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This analysis underscores the dollar's strategic advantages in a world where volatility is no longer a given—and where opportunity lies in its steady hand.