Borrow in low-yielding currencies or assets and invest in high-yielding ones to capture the interest rate differential. A cross-asset strategy spanning FX, fixed income, and commodities.
History
The carry trade is one of the oldest trading strategies, with roots in the 19th century gold standard era. In modern markets, the Japanese yen carry trade became infamous in the 2000s as investors borrowed cheaply in yen (near-zero rates) and invested in high-yielding currencies like the Australian dollar. Koijen, Moskowitz, Pedersen, and Vrugt (2018) documented carry as a pervasive factor across asset classes. The strategy suffered catastrophic losses in October 1998 (yen carry unwind during LTCM crisis) and again in August 2024 when the Bank of Japan rate hike triggered a massive yen carry trade unwind, causing global market turmoil.
How It Works
In FX: borrow in low-interest-rate currencies (JPY, CHF, EUR) and invest in high-rate currencies (AUD, BRL, TRY, MXN)
In fixed income: buy higher-yielding bonds funded by short-term borrowing (riding the yield curve)
In commodities: go long backwardated markets (positive roll yield) and short contangoed markets (negative roll yield)
In equities: the dividend yield can serve as an equity carry signal (long high-dividend, short low-dividend stocks)
Size positions inversely proportional to volatility to equalize risk contribution from each carry trade
Monitor for carry trade crowding and unwind risk using positioning data and flow indicators
Example Trades
Japan rates at 0.1%, Australia rates at 4.35%; 425bp carry differential
entry Borrow JPY, buy AUD/JPY at 97.50 with 5x leverage
exit Hold for 3 months, collecting carry; exit if AUD/JPY drops 3%
result +1.06% carry per quarter (4.25% annualized) plus any AUD appreciation
WTI crude oil in backwardation: front month at $78, 6-month futures at $75
entry Long front-month futures, rolling monthly
exit Collect positive roll yield each month as futures converge to spot
result +0.5% per month from roll yield, ~6% annualized
Related Charts
Who Runs This
When It Works vs. Fails
works
Stable macro environments with predictable central bank policy. Wide interest rate differentials. Low global volatility (carry loves calm).
fails
Risk-off episodes, central bank surprises, currency crises. Any event that triggers a 'flight to safety' unwinds carry trades violently (JPY strengthens, high-yield EM currencies crash).
Risks
01 Crash risk: carry trades have negative skewness. Gains accumulate slowly but unwinds are sudden and violent
02 The October 1998 JPY carry unwind (LTCM crisis) caused 20%+ losses in days for many carry traders
03 August 2024: BOJ rate hike triggered a massive yen carry unwind, causing a global equity selloff
04 Central bank policy changes can instantly eliminate or reverse carry differentials
05 Emerging market carry trades expose investors to sovereign risk, capital controls, and currency crises
Research
Koijen, Moskowitz, Pedersen, Vrugt, 2018
The Returns to Currency Speculation
Burnside, Eichenbaum, Kleshchelski, Rebelo, 2011
The Yen Carry Trade Unwind of August 2024
Ichiue, Shimizu, 2024