Forexadvanced

Carry trade explained

Earning the rate differential — and the FX risk you take.

TL;DR

A carry trade borrows in a low-yielding currency and invests in a high-yielding one, pocketing the rate differential. Steady return — until the funding currency rallies sharply and unwinds the trade in days.

How it works

If JPY rates are 0.5% and MXN rates are 11%, borrow yen, convert to peso, deposit, earn ~10.5% on the spread. Profitable as long as MXN doesn't depreciate more than 10.5% vs JPY.

Classic pairs

Carry works best with structurally low-yielding funding currencies and stable high-yield targets.

→Funding: JPY, CHF, historically EUR
→Target: MXN, BRL, ZAR, TRY
→Within G10: short JPY, long USD or AUD

When carry blows up

Carry is 'picking up pennies in front of a steamroller'. Works for years, then unwinds in days during risk-off. The funding currency rallies as positions cover, amplifying losses.

Worked example

USD/JPY carry trade

Borrow ¥10M at 0.5%. Convert to USD at 150. Buy 2Y Treasury at 4.8%.

1Borrow cost¥10M × 0.5% = ¥50,000/yr
2Convert¥10M / 150 = $66,667
3Treasury yield$3,200/yr = ¥480,000
4Net carry¥430,000/yr (~4.3%)
5RiskUSD/JPY → 135 (-10%) wipes years of carry

Takeaway

Carry is steady income with occasional catastrophic drawdowns. Sizing matters more than picking the right pair.

Common mistakes

What to avoid

!Treating carry yields as 'free money'
!Forgetting broker rollover (swap) shaves the theoretical carry
!Maxing leverage — a 5% move with 10x leverage = 50% drawdown
!Ignoring intervention risk — Japan has intervened in JPY several times

Self-check

Test yourself

Q1What's the core mechanic of a carry trade?+

Borrow in low-yield, invest in high-yield, earn the spread.

Q2Why do carry trades 'work for years and blow up in days'?+

Risk-off events trigger mass unwinds that rally the funding currency and crash the target simultaneously.

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