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Carry Trades

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Carry Trades

A carry trade is one of the simplest yet most powerful strategies in forex: you borrow money in a currency with low interest rates and invest it in a currency with high interest rates, profiting from the interest rate differential. The most famous carry trade of the past two decades was borrowing in Japanese yen (near 0% rates) and buying higher-yielding currencies like the Australian dollar or the Brazilian real. Carry traders made money twice: on the interest rate differential that accrued daily and, often, on the appreciation of the high-yielding currency as global growth continued.

But carry trades are not free money. When sentiment shifts and risk-off events occur, the trades unwind violently. Currencies that rallied for years on carry flows can reverse sharply as traders rush for the exits simultaneously. This chapter teaches you how carry trades work, why they can be profitable over long periods, and why they occasionally blow up in spectacular fashion. By the end of this chapter, you will understand the mechanics of funding currencies, you will know what triggers a carry trade unwind, and you will have frameworks to exploit carry trades when they are safe and to avoid them when they are dangerous.

Why This Matters​

Carry trades can generate substantial returns with relatively low volatility during bull markets, but they concentrate risk in a way that is not obvious until a shock occurs. In August 2015, when China devalued the yuan, carry trades unwound and the yen rallied sharply—losses mounted into the billions. Again, in 2023, as the Fed and other central banks hiked rates, the yen carry unwound further. For a trader, understanding carry means understanding when to bet on it and when to step aside. For an investor managing a long-dated currency exposure, understanding carry helps you anticipate when your currency hedge might stop working and why.

What You Will Learn​

This chapter covers the complete mechanics of the carry trade. You will learn how daily interest accrual (swap fees) works and how it creates a profit stream for carry traders. You will understand what makes a currency suitable as a funding currency (low rates, stable policy, abundant supply) and what makes a currency attractive for the other side of the trade (high rates, growth expectations, commodity exposure). The chapter then examines the most famous carry trade in modern history: borrowing yen to buy commodity currencies and high-yielding emerging-market currencies. You will see how carry trades are crowded, how the crowding creates hidden risks, and what catalysts trigger unwinds. Finally, you will learn to assess carry trade health: what signals tell you a carry is thriving versus tottering on the edge, and how to position yourself either to profit from carry or to avoid its unwind.

How to Read This Chapter​

Start with the swap and interest accrual section to understand the daily profit stream. Then move through the funding currency section, which teaches you which currencies attract carry flows. The historical carry trades section provides concrete examples: read it to see how massive profits can build and then evaporate. The unwind section is critical; it teaches you the warning signs of carry reversals and the catalysts that trigger them. Once you understand both the appeal and the dangers, move into the positioning section, which teaches you to manage carry trade risk. If you are a long-term investor, focus on the unwind and catalysts sections to understand when your long carry position might become dangerous; if you are an active trader, study all sections carefully to identify opportunities to profit from carry flows.

The articles below will teach you to harness the power of interest rate differentials while respecting the risks that come with crowded positions.

Articles in this chapter​