IV Macro Policy & Sovereign Debt
Carry trade
A strategy that borrows in a low-yielding currency and invests the proceeds in higher-yielding assets in another currency to capture the rate differential.
How it works
A carry trade involves two currencies. The funding currency carries the low interest rate, and that is where the investor borrows. The target currency carries the high rate, and the money goes there, usually into short-dated bonds or deposits. The return is the gap between the two rates.
Currency risk is what threatens the return. In theory the rate differential should be offset by the expected depreciation of the high-yielding currency. In practice that parity rarely holds, and the trade can pay for long stretches. But if the target currency drops sharply, months of accumulated carry can be wiped out in a few days.
The danger grows when leveraged positions crowd onto the same side. A shock that lifts volatility triggers margin calls, investors exit at once and the funding currency appreciates fast. According to the BIS, yen carry trades stood at roughly 40 trillion yen (250 billion dollars) before the unwind of August 2024.
Measurement is hard: positions are scattered across off-balance-sheet derivatives, and the BIS stresses that such trades are difficult to track with available data. Size estimates are therefore given as ranges.
Why it matters here
High-yielding emerging-market currencies are the targets of carry trades. That money keeps the exchange rate calm, but in a sudden geopolitical shock, such as an oil spike or a sanctions headline, it leaves all at once. A calm currency may therefore signal not a durable equilibrium but an exit that has simply not been triggered yet. On the funding side, rising yen or dollar rates also break the arithmetic of the trade and can set off an unwind.