The Q4 USD Weakness and Carry Trade Resurgence: A Strategic Analysis

The U.S. dollar's seasonal weakness in the fourth quarter has long been a focal point for global investors, particularly those deploying carry trade strategies. In 2025, this pattern has intensified, with the dollar depreciating roughly 10% against a basket of major currencies year-to-date. This decline has reignited interest in carry trades, where investors borrow in low-yielding currencies like the Japanese yen or Swiss franc and invest in higher-yielding assets, often in emerging markets (EM) or non-U.S. developed economies. The interplay of cyclical and structural factors-ranging from U.S. fiscal uncertainty to Fed easing-has created a unique environment for these strategies, but risks remain.

Historical Seasonality and the Dollar's Q4 Weakness

Historical data reveals a consistent pattern of U.S. dollar (USD) underperformance in Q4. The U.S. Dollar Index (DXY), which measures the dollar's strength against six major currencies, has shown a tendency to weaken during this period, particularly after periods of strong growth or inflationary optimism. For instance, December has historically been a bearish month for USD/JPY, with the pair typically falling by an average of -0.6%. In 2025, this trend has been amplified by structural shifts, including reduced U.S. inflationary pressures and political uncertainty tied to Trump-era trade policies which has driven the dollar's decline.

The dollar's decline is further supported by its role as a funding currency in global carry trades. Despite its 10% pullback in 2025, the dollar remains central to forex transactions, appearing in nearly 90% of all trades. This structural dominance ensures that even during periods of weakness, the dollar continues to serve as a key asset in carry strategies.

Carry Trade Opportunities in a Weaker Dollar Environment

The dollar's weakness has unlocked significant opportunities for carry trades, particularly in EM markets. Currencies like the Egyptian pound, Nigerian naira, and Brazilian real have delivered total returns of around 20% in 2025 when funded out of the dollar. These gains are driven by favorable yield differentials and improved macroeconomic fundamentals in EM countries. For example, Egypt's currency reforms and reduced inflation have made it a compelling carry trade destination, while Brazil's hawkish central bank policies have supported the real's strength according to market analysis.

The appeal of dollar-based carry trades has also been bolstered by reduced volatility. A U.S. government shutdown in late 2025 dampened short-term forex market swings, making carry strategies less risky. Additionally, the Fed's expected rate cuts have reinforced the dollar's role as a high-carry asset, with Bloomberg's Cumulative FX Carry Trade Index hitting its highest level since May 2018.

Risks and Challenges

While the current environment favors carry trades, several risks could disrupt this dynamic. A faster-than-expected pace of Fed rate cuts could erode the dollar's carry advantage. Similarly, political developments in EM markets-such as credit rating downgrades or fiscal imbalances-could trigger volatility. For instance, the Turkish lira, despite its high yield, remains vulnerable to political uncertainties according to market analysis.

Moreover, the dollar's long-term structural challenges, including its diminishing role as a safe-haven asset, suggest that sustained weakness may persist. However, periodic countertrend rallies are likely due to the dollar's reserve-currency status and its embedded role in global markets as noted in market research.

Strategic Implications for Investors

For investors, positioning for USD weakness involves shifting fixed-income allocations toward non-U.S. investment-grade bonds and local currency EM bonds, which have historically shown stronger correlations with dollar depreciation. U.S. exporters also benefit from a weaker dollar, as it enhances the competitiveness of American goods in international markets according to market analysis. Conversely, importers face higher costs, underscoring the need for hedging strategies.

Central banks, meanwhile, continue to maintain confidence in the dollar, with its share of global reserves remaining stable once valuation effects are accounted for. This duality-structural dominance versus cyclical weakness-highlights the dollar's complex role in global finance.

Conclusion

The Q4 2025 weakness in the U.S. dollar has created a fertile ground for carry trade strategies, particularly in EM markets. Historical seasonality, combined with structural shifts like Fed easing and trade policy uncertainty, has amplified the dollar's underperformance. While the dollar's central role in global markets ensures its continued relevance, investors must remain vigilant about risks such as sudden policy changes or EM-specific shocks. For now, the carry trade appears poised to outperform traditional asset classes, offering a compelling case for those willing to navigate the nuances of FX seasonality.