J.P. Morgan: Rate volatility hits carry trades as global market strategy becomes more selective

Why expect a steeper U.S. Treasury curve when the Fed is expected to raise rates?

JPMorgan expects the Fed to raise rates by 25 basis points in December 2026, lifting the federal funds target range to 4.00%–4.25%. It expects two-year and ten-year Treasury yields to reach 4.70% and 5.05%, respectively, by year-end.
The bank believes the ten-year to thirty-year Treasury yield curve remains relatively flat given medium-term monetary policy expectations, and maintains its curve-steepening strategy. The strategy could benefit if the Treasury makes no major adjustments to debt management or if the decline in risk assets broadens.
A reduction in the size of long-term bond auctions by the Treasury is a risk to the opposite view. JPMorgan regards this as a possible policy action, but not its base case.

The bank forecasts a U.S. fiscal 2027 deficit of 1.96 trillion dollars and expects a financing gap to emerge in that fiscal year and widen in fiscal 2028 and beyond.
JPMorgan now expects the Treasury to maintain its current coupon-bearing debt auction sizes until August 2027, compared with its previous forecast of February 2027. Over the following several quarters, increased issuance is expected to focus mainly on maturities of two to ten years.
Growth in foreign investors’ purchases of long-term Treasuries is at its slowest pace since 2021, while bank demand has also slowed as loans grow faster than deposits. The bank therefore believes the Treasury should reduce its reliance on long-term debt issuance.

The global currency carry basket has fallen 2.3%–2.75% over the past two weeks. Brazil’s unexpected election result and the real’s subsequent 8% decline have hit the carry theme. JPMorgan remains positive on high-yielding G10 currencies including the Australian dollar, Norwegian krone and U.S. dollar, but is more selective on emerging-market currencies.
The bank believes the dollar could weaken modestly if Democrats win both houses of Congress; an unexpected Republican retention of the Senate could support it. Regardless of the outcome, however, U.S. equities’ relative advantage is expected to continue and ultimately support the dollar.
That carry view depends on volatility shocks or adverse growth shocks not worsening. The bank also believes investors may reduce exposure as year-end approaches to protect returns.

JPMorgan observes that many economies are still growing, some above their potential rates, while oil consumption is contracting. South Korean oil demand fell 26% year over year in April 2026 and was still down 13% year over year in August; demand in Taiwan fell 20%, 24% and 16% in April, May and August, respectively.
Supply and demand signals for other commodities are also mixed. The bank believes copper fundamentals are broadly supportive, but some market dislocation premium could fade if the United States delays tariff action. The aluminum market remains tight for now but faces an expected supply surplus in the medium term.
Agricultural commodity risk premiums have recently fallen sharply, but the bank expects weather- and nutrient-related yield declines, together with growing biofuel demand, to tighten global agricultural stocks-to-use ratios broadly in 2026/27.

As of the report, the GBI-EM currency spot index was down about 3% from its peak at the end of August, but its year-to-date total return was still up about 3%. JPMorgan believes the recent sell-off mainly reflects position unwinding amid a rate shock and rising implied currency volatility.
The bank’s base case remains a recovery in emerging-market currencies, and the portfolio maintains an overweight currency position, focused on high carry and select opportunities with stronger fundamentals. At the same time, upward revisions to emerging-market growth expectations have stalled, limiting confidence in a broad rebound.
The overall stance on emerging-market local-currency rates remains neutral. Further repricing of central bank policy rates may be limited, but fiscal and supply-demand pressures could still push long-term rates higher relative to short-term rates. The base case for sovereign credit spreads is broadly stable or tighter, provided high oil prices and interest rates do not develop into shocks to growth or financing channels.