Carry Trade
Quick Answer
A strategy of borrowing in a low-interest-rate currency to invest in a higher-yielding asset.
How Carry Trades Work
Basic Concept: 1. Borrow in low-rate currency (e.g., Japanese yen at 0%) 2. Convert to high-rate currency (e.g., Australian dollar at 4%) 3. Invest in high-yielding assets 4. Pocket the difference minus transaction costs
Example: Borrow ¥1M at 0.1% → Convert to AUD → Earn 4.5% → Return 4.4% spread
Risks and Unwinds
Currency Risk If the funding currency strengthens against your investment, losses can exceed gains.
Carry Trade Unwind When trades are closed en masse (often during market stress), it can cause violent currency moves. The yen strengthens sharply when carry trades unwind.
August 2024 Example: The yen carry trade unwound dramatically when the Bank of Japan raised rates unexpectedly.
Market Implications
Yen as Indicator Yen strength often signals risk-off sentiment and carry trade unwinding.
Emerging Market Impact Carry trades often flow into EM currencies. When they unwind, EM assets suffer.
Central Bank Watching Changes in interest rate differentials between major economies can trigger carry trade flows.