Carry Trade - Borrowing Low, Lending High

By EC Assets Research Team, Multi-Asset Strategy · Published 19 May 2026 · Updated 16 October 2026

Carry Trade: A carry trade borrows in a low-yielding instrument and invests in a higher-yielding one. The strategy captures the yield differential as positive carry. Carry is a recognised factor premium across currencies, fixed income, and commodities.

What a Carry Trade Is

A carry trade funds itself in a low-yielding asset and invests in a higher-yielding one, earning the difference, the carry, for as long as prices stay put. In currencies, that means borrowing in a currency with low interest rates, such as the Japanese yen or historically the Swiss franc, and holding one with higher rates, such as the Australian dollar or emerging-market currencies.

The idea extends across markets. In government bonds, carry is the yield plus roll-down earned by holding longer maturities funded at short rates, which depends on the slope of the yield curve. In commodities, it is the roll yield of futures curves in backwardation. In credit, it is the spread over funding. The return always has two parts: the carry, earned steadily, and the price change, which can wipe it out.

How It Works

Uncovered interest parity says that a currency with higher interest rates should, on average, depreciate by the rate difference, leaving no excess return:

$$E[\text{carry return}] \approx (i_{\text{high}} - i_{\text{low}}) + E[\Delta s] \approx 0 \quad \text{under UIP}$$

Covered interest parity, which ties forward exchange rates to the same rate gap, does hold closely, so in practice the trade is often done by buying the high-yield currency forward at a discount; the forward discount is the carry, and the bet is that the spot rate will not fall to the forward price.

Empirically, uncovered parity fails. Fama (1984) found that high-yield currencies tend not to depreciate as predicted and often appreciate, the forward premium puzzle. Lustig, Roussanov and Verdelhan (2011) show that currency carry returns load on a common global risk factor, and Koijen, Moskowitz, Pedersen and Vrugt (2018) find that carry predicts returns in currencies, bonds, commodities and equity indices alike, which is why carry is treated as a style in factor investing.

The premium has a price. Brunnermeier, Nagel and Pedersen (2008) show that carry returns are negatively skewed: high-yield currencies tend to crash when global risk appetite falls and funding liquidity dries up, often together with equities. In the language of skewness and kurtosis, carry pays in many small steps and loses in a few large ones.

Worked Example

A trader borrows yen and holds Australian dollars. In mid-2024 the Reserve Bank of Australia's cash rate was 4.35 percent and the Bank of Japan's policy rate about 0.10 percent, a carry of about 4.25 points a year.

AUD/JPY then fell from 109.11 on 10 July 2024 to 94.27 on 6 August 2024, a decline of 13.6 percent in under four weeks, after the Bank of Japan raised rates on 31 July. That move equals about 3.2 years of carry. At five times leverage, the annual carry of about 21.25 percent would have been overwhelmed by a loss of about 68 percent of equity.

The 2008 unwind was larger. AUD/JPY fell from 107.49 on 31 October 2007 to 56.39 on 27 October 2008, a fall of 47.5 percent. With the Australian cash rate at 7.25 percent and the Japanese rate at 0.5 percent for much of 2008, the carry was about 6.75 points a year, so the fall erased about 7.0 years of it. Over a similar period the yen rose 41.7 percent against the US dollar, from 123.74 yen per dollar in June 2007 to 87.32 in December 2008.

Exchange rates are daily closes from Yahoo Finance; policy rates are those of the Reserve Bank of Australia and the Bank of Japan at the time.

When It Applies (and Limitations)

Crash risk is the cost. The premium is compensation for losing in bad times. Average returns hide the drawdowns, and short track records can miss them entirely.

Crowding amplifies unwinds. When many investors hold the same carry positions with leverage, an exit by some forces losses on others, as in August 2024.

Policy can end the trade. Carry depends on rate differentials. A change in policy at either end, as with the Bank of Japan's hikes in 2024, can shrink the carry and trigger an unwind at the same time.

Carry is not the whole return. Expected price changes, valuation and momentum matter as well; high carry with a strongly overvalued currency is a weaker signal than high carry alone.

Why It Matters for Institutional Investors

A diversified premium. Carry across many currencies and asset classes has historically earned positive returns, and diversification across markets reduces, without removing, the impact of any single unwind.

Hidden carry exposure. Many portfolios carry without labelling it: unhedged high-yield foreign bonds, emerging-market debt and long-duration bonds funded at short rates all contain carry and share its crash risk.

Sizing for the unwind. Position size should be set by the losses of 2008 or 2024, not by normal volatility, and leverage should be modest enough to survive them.

Currency hedging decisions. A US investor hedging yen assets back into dollars sells yen forward at a premium and earns the rate gap; a Japanese investor hedging dollar assets back into yen sells dollars forward at a discount and pays it. Hedging policy is therefore partly a carry decision and should be judged as one.

Regime awareness. Carry tends to suffer when volatility spikes and policy shifts; reading macro regimes and pairing carry with crisis-diversifying strategies helps manage it.

References

1. Koijen, R. S. J., Moskowitz, T. J., Pedersen, L. H., & Vrugt, E. B. (2018). Carry. Journal of Financial Economics, 127(2), 197-225.
2. Fama, E. F. (1984). Forward and Spot Exchange Rates. Journal of Monetary Economics, 14(3), 319-338.
3. Lustig, H., Roussanov, N., & Verdelhan, A. (2011). Common Risk Factors in Currency Markets. Review of Financial Studies, 24(11), 3731-3777.
4. Brunnermeier, M. K., Nagel, S., & Pedersen, L. H. (2008). Carry Trades and Currency Crashes. NBER Macroeconomics Annual, 23, 313-348.