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The carry trade: borrowing in low-rate currencies to buy high yields
· Concept
Fact, law or dataA rule, statute, definition or measured number.
Borrowing in a currency with low interest rates and investing in one with higher rates, pocketing the gap.
See it on the Money & Finance map →How it works
Borrow yen at under 1%, convert to dollars, buy Treasuries or Mexican bonds yielding 4–10%, and keep the difference. It works as long as the exchange rate holds steady. If the funding currency jumps 10%, a year of interest gains can vanish in days, and leveraged traders rush to repay, buying back the currency and pushing it higher still. Returns are steady for years, then crash. Funding currencies have included the yen, the Swiss franc and, at times, the dollar.
Why it matters
Large carry positions tie markets together: a central-bank move in Tokyo can force selling of stocks and bonds in New York, as on August 5, 2024.
Think of it like
Like financing a 7% cap-rate building with a 1% loan in a foreign currency: positive leverage until that currency suddenly rises.
Facts, rules and data
Decades of academic research (Fama 1984; Brunnermeier, Nagel and Pedersen 2008), CFTC futures positioning data and BIS reports on the 1998, 2008 and 2024 unwinds.
Debates and risks
No one knows how large the trade is; estimates range from a few hundred billion to several trillion dollars, depending on what counts.
Inside this (1)
Connections (3)
▸The carry trade: borrowing in low-rate currencies to buy high yields is classically funded in The Japanese yen: safe haven and cheap funding currencyFact, law or data
The connection
For most of 1999–2024 the Bank of Japan held rates near or below zero, so yen were among the cheapest money in the world to borrow. Investors borrowed yen, sold them for dollars, pesos or Australian dollars, and bought higher-yielding assets. That selling kept the yen weak, which made the trade more profitable, until it reversed.
When and why
Tokyo and global markets since the late 1990s; players include hedge funds, banks and Japanese retail traders nicknamed 'Mrs. Watanabe'.
How we know
CFTC data on speculative yen positions, BIS cross-border yen lending data and Bank of Japan rate history.
Debates and risks
The trade's true size is unknown, and Japan's rising rates since 2024 may shrink it for good.
▸The carry trade: borrowing in low-rate currencies to buy high yields profits from gaps in Interest: the rent paid for using moneyFact, law or data
The connection
Profit equals the interest earned minus the interest paid, minus any currency loss. Borrow at 0.5%, earn 10%, and keep 9.5% if the exchange rate holds. Textbook theory, uncovered interest parity, says the high-yield currency should fall enough to erase the gap; in practice it often doesn't for years, then drops abruptly.
When and why
Documented by Eugene Fama in 1984 and studied across most major currencies since.
How we know
Decades of research, including Brunnermeier, Nagel and Pedersen (2008) on carry trades and currency crashes.
Debates and risks
Whether carry profits are fair pay for crash risk or a genuine market anomaly is still debated.
▸The carry trade: borrowing in low-rate currencies to buy high yields is a staple strategy of Hedge fundsFact, law or data
The connection
Macro hedge funds run carry trades with leverage through currency forwards and futures, turning small rate gaps into large returns. Leverage also makes exits violent: in October 1998, after Russia's default and LTCM's near-collapse, the yen jumped more than 10% against the dollar in two days as funds rushed to repay.
When and why
Trading desks in London, New York and Tokyo since the 1990s; big unwinds again in 2008 and August 2024.
How we know
CFTC Commitments of Traders positioning data and BIS reports on the 1998 and 2024 unwinds.
Debates and risks
How much carry is now run by hedge funds versus Japanese institutions and retail traders is unclear.