A carry trade exploits the gap between interest rates in two countries. You borrow money in a low-rate currency, convert it to a high-rate currency, and earn the difference while you hold the position. The profit comes not from price movement but from the daily interest accrual, called the rollover or swap. It is a bet that the exchange rate stays stable or moves in your favor while you collect that yield.
- Funding currency
- The low-interest-rate currency you borrow, typically a major like JPY or CHF.
- Investment currency
- The high-interest-rate currency you buy, often an emerging market or commodity currency.
- Interest rate differential
- The gap between the two central bank rates, paid to you daily as long as you hold the trade.
- Rollover risk
- The danger that the exchange rate moves sharply against you, wiping out months of interest gains in hours.
Wide rate differential and stable pair: carry accrues steadily with low drawdown risk.
Narrowing rate differential or currency weakness: carry yield no longer compensates for FX risk.
Carry trades are seductive because the daily interest feels like free money, but they concentrate risk. When volatility spikes or central banks shift policy, the funding currency can rally sharply, forcing a mass unwind that crushes the trade in days. The desk has seen traders pocket six months of carry in gains only to lose it all in a single risk-off session.
We monitor carry flows as a leading indicator of where capital is rotating and when complacency might be building.