JPMorgan reports a slowdown in the strategy of backing currencies with stronger fiscal positions. This tactic, once among the most profitable foreign-exchange themes of the year, has seen a decline in momentum recently.
Currencies such as the Swiss franc, Norwegian krone, Swedish krona, and Australian dollar have outperformed weaker currencies like sterling and yen earlier this year. However, over the last month, this “fiscal factor” has seen reduced performance.
Fiscal Factors Underperform
Despite the supportive fiscal fundamentals and steepening of long-end developed-market bond yields, these currencies have underperformed. JPMorgan attributes this to adverse movements in front-end yield differentials impacting gains.
We have noticed that a very reliable foreign exchange strategy from earlier this year is beginning to fail. For most of 2025, it was profitable to buy currencies from countries with strong finances, like the Swiss franc and Australian dollar, while selling those with weaker books, like the British pound and Japanese yen. However, this trade has been losing money over the past month.
The problem lies with short-term interest rate expectations, which are now overpowering the longer-term fiscal story. For example, the yield advantage on 2-year Australian government bonds over Japanese bonds has recently narrowed by about 35 basis points, making the Australian dollar less attractive in the short term. This move has come as recent inflation data from Australia in August 2025 cooled slightly, while the Bank of Japan has been less aggressive in its bond-buying program.
Similarly, we’ve seen short-term UK bond yields hold firm as July’s wage growth data, released last month, remained elevated at 5.9%, suggesting the Bank of England must stay vigilant. This has provided short-term support for the pound against fiscally sounder currencies like the Swiss franc, directly opposing the prevailing theme from earlier in the year. The market is now focused more on immediate central bank actions than on long-term government debt profiles.
Rise in Implied Volatility
For derivative traders, this shift suggests that betting on straightforward currency direction is now riskier. The breakdown of such a popular theme has caused implied volatility in pairs like GBP/CHF to rise, with 3-month options volatility climbing from around 6% to over 7.5% in recent weeks. This indicates that buying options to protect against sudden, sharp price swings or to profit from increased choppiness could be a prudent strategy.
Instead of simple spot trades, this environment favors strategies that benefit from uncertainty, like straddles or strangles in key currency pairs. We remember from the sharp reversals in late 2022 that when a market-wide theme breaks down, the transition period is often messy and volatile. This is not the time for complacency, as the forces driving currency markets are clearly in flux.
