Key Takeaways
Carry trades involve borrowing money in a currency with low interest rates and investing it in a currency or asset with higher returns.
The profit, known as the "carry," comes from the difference between what you pay to borrow and what you earn on your investment.
Currency risk is the biggest danger: if the low-rate currency strengthens, your returns can shrink or reverse when you convert back.
The 2024 and 2025 Bank of Japan rate hikes and subsequent yen carry trade unwinding showed how quickly these strategies can reverse, triggering broader market volatility.
Carry trades are generally more suitable for experienced traders or institutions with strong risk management capabilities.
Introduction
A carry trade is one of the most commonly used strategies in global financial markets. The basic idea is to borrow in a currency with low interest rates, convert that money, and invest it where returns are higher. The difference between the two rates represents your potential gain.
This approach is popular in the forex market but also appears in bonds, equities, and increasingly in crypto. While the concept sounds straightforward, carry trades carry meaningful risks and require a good grasp of global macroeconomics.
What Is a Carry Trade?
A carry trade is a strategy where you borrow in a low-rate currency and invest in a higher-yielding one. The goal is to earn the spread between what you pay and what you receive. The term "carry" refers to the cost or benefit of holding a financial position over time.
While carry trades are most common in currency markets, the same principle applies to any two assets with different yield profiles. You could, for example, borrow at a low rate in one country and buy government bonds in a country with higher yields.
The strategy tends to work well in calm, stable market conditions. It can run into trouble quickly when monetary policy shifts unexpectedly or when global risk appetite drops suddenly.
How Carry Trades Work
Here is a typical example. You borrow Japanese yen at a low interest rate, then convert that yen into US dollars. You use the dollars to buy US government bonds yielding 5%. As long as the yen stays weak and the exchange rate does not move against you, you can potentially earn close to that 5% minus borrowing costs.
In practice, traders often use a lot more borrowed capital than their own. This is what makes carry trades potentially lucrative but also dangerous. A small move in the exchange rate can wipe out the interest income entirely.
The strategy typically involves three steps: borrow in the low-rate currency, convert to the high-rate currency, and invest in a yield-bearing asset. The trade stays open as long as the rate differential is favorable and exchange rates remain stable.
Why Investors Use Carry Trades
Carry trades are attractive because they generate a return without requiring the underlying asset to increase in value. The income comes from the rate differential alone. Institutional investors such as hedge funds often apply leverage to amplify this return, borrowing far more than they hold in capital.
This is why carry trades can be profitable in quiet markets but dangerous in volatile ones. The leverage that boosts gains on the way up also magnifies losses when conditions turn. When many institutions hold similar leveraged positions, an unexpected shift can trigger a cascade of forced selling.
Carry trades also appeal to investors looking for income in low-return environments. When yields in developed markets are very low, borrowing in an even lower-rate currency and investing in slightly higher-yielding assets becomes an attractive option.
Examples of Carry Trades
The most widely cited carry trade is the yen-dollar strategy. For years, traders borrowed Japanese yen at very low rates and invested in US dollar assets offering higher yields. This trade flourished as long as the yen remained weak and US interest rates stayed high relative to Japan.
In July 2024, the Bank of Japan unexpectedly raised interest rates. The yen strengthened sharply, catching many carry trade positions off guard. The resulting unwind led to a rapid sell-off in global equities as traders rushed to repay yen loans, converting assets back into yen at unfavorable rates.
In January 2025, the Bank of Japan raised rates again to 0.5%, their highest level since 2008. In December 2025, the BOJ raised rates further to 0.75%, the highest level since 1995 and a 30-year peak.
The BOJ has signaled that additional hikes are likely, with markets expecting the policy rate to approach 1% by mid-2026. Each increase compresses the spread that yen carry trades depend on, reducing the appeal of borrowing in yen and increasing pressure on outstanding positions.
Estimates from JPMorgan place the total yen carry trade complex at approximately $1 to $2 trillion, with roughly 50 to 60% of the unwind complete as of early 2026. Morgan Stanley estimated that approximately $500 billion in outstanding yen-funded carry positions remained, highlighting the scale of risk still embedded in the system.
Another common approach involves emerging market currencies. Traders borrow in low-rate developed market currencies and invest in higher-yielding currencies from emerging economies. These trades can offer larger spreads but come with additional risks from political instability and sudden capital outflows.
Risks of Carry Trades
The biggest risk is currency risk. If the currency you borrowed strengthens against the one you invested in, your gains can shrink or reverse entirely when you convert back. This is especially dangerous with leverage because losses can exceed the original capital.
Interest rate risk is the other major factor. If the central bank of the currency you borrowed raises rates, your borrowing costs rise. If the bank of the currency you invested in cuts rates, your returns fall. Both scenarios compress the spread you are relying on.
Liquidity risk is also significant. During the 2008 financial crisis, a sharp spike in volatility forced many carry traders to unwind simultaneously. The resulting demand for low-rate currencies like the yen caused it to surge, creating steep losses for anyone holding yen-funded positions.
Carry trades can also suffer from a sudden unwind. Because many institutional players hold similar positions, any trigger can cause a synchronized rush for the exit, amplifying the damage. The 2024 yen carry trade unwind was a recent example of this dynamic.
The Impact of Market Conditions
Carry trades perform best in low-volatility, risk-on environments. When investors feel confident, they are willing to hold complex, leveraged positions for the sake of a steady yield. Stable exchange rates and predictable central bank behavior support these conditions.
When uncertainty rises, carry trades tend to suffer quickly. Investors unwind positions and move back to safe-haven assets, which often means buying back the low-rate currencies used for borrowing. This creates a self-reinforcing feedback loop: as carry trades unwind, the borrowed currency strengthens further, pushing more traders to exit.
Global events such as geopolitical crises, unexpected central bank decisions, or sudden shifts in inflation data can all be triggers. The leverage embedded in most carry trade strategies means that even a moderate exchange rate move can cause outsized losses.
Carry Trades and Crypto Markets
The carry trade concept has also appeared in crypto markets. In crypto futures markets, traders may borrow stablecoins at relatively low rates and deploy them into yield-generating strategies that offer higher returns. The logic is similar: earn the difference between borrowing costs and investment yields.
Funding rates in perpetual futures markets are another example. When the market leans heavily in one direction, funding rates can become very positive or very negative. Traders sometimes take carry-like positions by holding the opposite side of the trade to collect these periodic payments.
Like traditional carry trades, crypto carry strategies can unwind sharply when conditions change. High leverage and 24/7 markets mean that reversals can happen faster and with less warning than in traditional finance.
FAQ
What is the "carry" in a carry trade?
The carry is the net income earned from holding a position. In a currency carry trade, it is the difference between the interest rate you pay on borrowed funds and the interest rate you earn on your investment. A positive carry means you earn more than you pay; a negative carry means you lose more than you earn.
Why is the Japanese yen commonly used in carry trades?
Japan has maintained very low interest rates for decades, making the yen a cheap currency to borrow. Traders take yen loans at low rates and convert the proceeds into higher-yielding assets in other currencies.
However, with the BOJ raising rates to 0.75% by December 2025, the spread has narrowed meaningfully. The trade works as long as the yen does not strengthen significantly, but the gap between Japanese and foreign rates is no longer as wide as it once was.
How did the 2024 Bank of Japan rate hike affect carry trades?
In July 2024, the Bank of Japan raised its benchmark interest rate unexpectedly. This caused the yen to strengthen rapidly. Traders holding yen-funded carry positions faced rising borrowing costs and adverse exchange rate moves simultaneously.
Many were forced to sell their investments quickly to repay yen loans, contributing to a global market sell-off. Further hikes in January 2025 (to 0.5%) and December 2025 (to 0.75%) continued to compress carry trade spreads.
Are carry trades suitable for individual traders?
Carry trades involve leverage, currency risk, and a strong understanding of global macroeconomics. They are generally better suited to experienced institutional investors who can monitor positions continuously and manage risk carefully. Individual traders attempting carry trades with high leverage face the risk of significant losses if conditions change suddenly.
Can carry trades work in crypto?
Yes, the carry trade concept applies in crypto markets. Traders can earn the spread between borrowing costs and investment yields using stablecoins and yield-bearing protocols. Funding rates in perpetual futures markets also create carry-like opportunities. These strategies carry similar risks to traditional carry trades, often with added volatility.
Closing Thoughts
Carry trades are a well-established strategy built on a simple idea: borrow cheap, invest where yields are higher, and earn the difference. In practice, they require careful risk management, an understanding of global interest rate dynamics, and the ability to respond quickly when conditions change.
The 2024 and 2025 Bank of Japan rate hikes, culminating in a 0.75% policy rate by December 2025, are a reminder that carry trades can reverse sharply. The leverage involved amplifies both gains and losses. For most individual traders, the risks likely outweigh the potential returns. For those who do engage with carry trade strategies, understanding what drives the trade and when to exit is just as important as finding the initial opportunity.
Further Reading
Disclaimer: This content is presented to you on an "as is" basis for general information and educational purposes only, without representation or warranty of any kind. It should not be construed as financial, legal, or other professional advice, nor is it intended to recommend the purchase of any specific product or service. You should seek your own advice from appropriate professional advisors. Where the content is contributed by a third-party contributor, please note that those views expressed belong to the third-party contributor, and do not necessarily reflect those of Binance Academy. Digital asset prices can be volatile. The value of your investment may go down or up and you may not get back the amount invested. You are solely responsible for your investment decisions and Binance Academy is not liable for any losses you may incur. For more information, see our Terms of Use, Risk Warning, and Binance Academy Terms.