Published on: 2026-08-14
Updated on: 2026-08-14
Two positions, both funded in dollars, both parked in high-yielding Latin American currencies. One picks the highest rate on the board. A year later it is down, and the lower-yielding one is up. Neither position failed to earn its expected interest advantage. The exchange rate did the rest, giving back more than the carry was worth in one case and leaving it largely intact in the other.
That is why a LATAM carry trade cannot be read off a table of policy rates. Carry is what remains after currency moves, inflation, volatility and the cost of holding the position.
The policy rate is the opening figure, not the return. A large enough currency move turns a double-digit yield into a loss.
Real rates rank an emerging market carry trade more honestly than nominal rates, since inflation consumes part of the advertised advantage.
Each currency compensates carry positions for a different mix of risks: BRL for inflation and fiscal uncertainty, COP for oil and sovereign risk, and MXN with a smaller yield cushion but deeper liquidity.
Volatility sets the speed at which carry disappears, and a few weeks of currency weakness can undo a quarter’s accumulated interest.
One number closes the analysis: the depreciation that would erase the expected carry over the intended holding period.
A carry trade funds a position in a low-yielding currency and holds a higher-yielding one to collect the interest-rate difference. For this comparison, the higher-yielding leg is the Brazilian real, Colombian peso or Mexican peso, while the funding leg is the US dollar.
As of August 2026, that means choosing between a Brazilian policy rate of 14.00%, a Colombian rate of 12.00% and a Mexican rate of 6.50%, against a federal funds target of 3.50% to 3.75%. The nominal gap runs above ten points against Brazil and closer to three against Mexico.
Total carry return ≈ interest-rate differential + FX return - financing and trading costs
Policy rates are reference points rather than realised returns. What is earned depends on the instrument, maturity, forward or swap points, the daily cost of funding the position and whether exposure is taken onshore or through non-deliverable contracts.
Three hypothetical positions held for one year make the point.
| Currency | Interest advantage | Currency move | Approximate result |
|---|---|---|---|
| Currency A | +12% | −15% | −3% |
| Currency B | +8% | −3% | +5% |
| Currency C | +6% | +2% | +8% |
The figures are illustrative rather than historical. Currency A pays the most and finishes last.
Real rates explain part of the distance between headline yield and outcome:
Real interest rate ≈ nominal interest rate - expected inflation
A 10% yield alongside 8% expected inflation offers a thinner cushion than a 7% yield alongside 3% inflation. Brazil shows the shape of the calculation. Banco Central do Brasil cut the Selic to 14.00% on 5 August 2026, the fourth consecutive 25-basis-point reduction from the 15.00% peak, while Focus survey expectations still placed 2026 inflation at 5.0%.
The gap helps explain Brazil’s carry appeal, although the two figures cover different horizons and should not be read as a precise real return.
Six inputs give a fuller picture than the policy rate.
Interest-rate differential. The wider the gap over the funding currency, the larger the cushion.
Real-rate differential. High nominal rates often sit alongside high inflation, which shrinks the underlying advantage.
FX volatility. A position earning 8% a year accumulates roughly 2% over three months. A 5% slide in the currency erases it.
Commodity exposure. Export prices feed trade balances, fiscal revenue and currency demand, and the dominant commodity differs by country.
Fiscal and sovereign risk. Rising credit risk can weaken a currency even while local yields stay high.
Liquidity. Deeper markets are cheaper to enter, hedge and exit, particularly when risk appetite turns.
Brazil offers the largest nominal cushion of the three at 14.00%, while its commodity exposure can reinforce the currency side of the trade when external conditions are favourable.
The offsetting risks are inflation expectations above target and the fiscal path. Concluding its 2026 Article IV consultation on 20 July, the IMF pointed to persistent fiscal pressures and elevated interest costs, and judged that a more ambitious fiscal effort would help place public debt on a firm downward path. Brazilian real yields are high in part because the market prices those pressures.
Colombia held its policy rate at 12.00% on 31 July 2026 in a split vote, with three of seven board members preferring a further increase. Headline inflation stood at 6.14% in June, the reading before the board that day, and eased to 6.03% in July, while analyst expectations for December 2026 rose to 6.6%. The real-rate advantage is narrower than the headline yield implies.
The central bank also noted that peso appreciation had exceeded that of several comparable currencies and had helped ease price pressures. Crude leads Colombian exports, so oil remains the dominant external channel, which is the defining trait of a commodity currency.
The IMF’s most recent Article IV review flagged a widening deficit, rising debt and elevated sovereign spreads.
Mexico’s 6.50% rate, held unanimously on 6 August 2026, is less than half Brazil’s, and the real-rate starting point differs too. Headline inflation ran at 3.12% in July and core at 3.95%, both inside the 2% to 4% target band.
The peso also trades in a market far deeper than most emerging market currencies. In the BIS Triennial Central Bank Survey for April 2025 it ranked fourteenth among the world’s most traded currencies, up from sixteenth in 2022, and third among emerging-market currencies.
A smaller rate advantage can still compete when inflation is contained and the exchange rate avoids the drawdowns that undo higher-yielding positions.
| Factor | BRL | COP | MXN |
|---|---|---|---|
| Policy rate | 14.00% | 12.00% | 6.50% |
| Headline inflation (Jul. 2026) | 4.44% | 6.03% | 3.12% |
| Nominal carry | Very high | High | Moderate |
| Dominant channels | Rates, commodities, fiscal | Rates, oil, fiscal | Rates, US growth, liquidity |
| Main threat to carry | Inflation expectations, fiscal repricing | Oil weakness, sovereign risk | Thinner cushion, external shocks |
No. A higher rate raises potential income, though depreciation can offset or exceed it. The stronger position is the one that keeps more of its advantage after currency moves and costs.
Currency depreciation, because one large move can undo months of accumulated interest. Inflation surprises, fiscal stress, commodity shocks and shifts in global financial conditions are the usual triggers.
There is no permanent answer. The ranking depends on inflation, commodity and fiscal conditions rather than the policy rate alone, so a leader in one year can trail in the next without its rate moving much.
Begin with the nominal and real rate differentials, then weigh FX volatility, the dominant macro driver, sovereign risk and liquidity. Finish by estimating the depreciation that would erase the expected carry over the intended holding period.
A workable review comes down to seven questions:
What rate advantage does the currency offer over the funding leg?
What remains after expected inflation?
How volatile has the exchange rate been?
Which commodity or external factor dominates?
Is sovereign risk improving or deteriorating?
How liquid is the market, and what does the position cost to hold?
How far can the currency fall before the carry is gone?
The last question puts the headline yield in proportion. A position expected to earn 7% is wiped out by a 7% currency loss before financing and transaction costs are counted. Brazil, Colombia and Mexico each reward the trade for different reasons, and each can take it back through a different channel.
