Many investors have never heard of the term carry trading. However, when this forex investment strategy affects the stock market, it’s suddenly in everyone’s Google search bar. What is carry trading exactly?
It involves borrowing in a currency that has a low interest rate and investing those funds in an asset or currency with a higher interest rate.
Carry Trading and the Japanese Yen
The Japanese Yen (JPY) has maintained very low interest rates, hovering around 0% for years. Many borrowed it almost interest-free and converted it into a currency with a higher interest rate, such as the Australian Dollar (AUD) or the New Zealand Dollar (NZD). The interest rate on the Yen was even negative for many years to boost the economy, but that didn’t go as expected for many reasons.
In August 2024, the interest rate to borrow the Yen was raised from 0% and 0.10% to 0.25% (the highest level in 15 years!), and the markets went wild. Japan’s main stock market index, the NIKKEI, lost over 12% in a single trading session.
At one point, it was down nearly 25% in a single month. In the US, many believed Black Monday would repeat itself at the opening bell on Monday, August 5th, due to this interest change. Thankfully, the day was bloody, but most stocks recovered later in the week.
Carry Trading Example
Before we explore carry trading any further, let’s look at an example to understand this strategy better.
- A trader borrows 1,000,000 JPY at an interest rate of 0.1%.
- The trader converts the 1,000,000 JPY into NZD, which has an interest rate of 6%.
- The funds are invested in NZD in a high-yielding asset or deposit.
- In 12 months, the trader earns 6% on the NZD investment while paying only 0.1% on the JPY loan.
Profit: The trader earns the interest rate differential of 5.9% minus any transaction costs or fees. That’s a very reasonable profit for the amount of effort invested. Unfortunately, it doesn’t always work out this way for everyone.
That’s not all. Carry trading is also very popular, thanks to leverage. It can amplify the return (and risks). If the trader has a 10:1 leverage, the amount borrowed and the potential return are multiplied by 10.
Historical Examples of Carry Trades
There exist several examples of carry trading with various currencies. Below is one example of the Turkish Lira and two examples of the Japanese Yen.
The Japanese Yen Carry Trade (2000s)
During the 2000s, Japan maintained ultra-low interest rates, while many other countries had higher rates. Traders borrowed in Yen and invested in higher-yielding currencies like the AUD (interest rate surpassed 7% in 2008), NZD (interest rate reached 8.25% in 2007), or emerging market currencies.
The Yen carry trade was so popular that it became a significant driver of global financial markets.
As investors fled to safer assets, the Yen appreciated sharply while other currencies depreciated. It caused massive losses for those holding Yen carry trades.
The Turkish Lira Carry Trade (2010s)
In the early 2010s, Turkey offered very high interest rates compared to developed economies. The Turkish Lira became a popular target for carry traders.
Unfortunately, political instability, economic mismanagement, and external pressures led to a decline in the late 2010s. Traders engaged in carry trades involving the Lira faced severe losses as the currency’s value plummeted.
Since 2010, the Lira has lost almost 95% of its value against the USD and the Euro.
Japanese Yen Part 2 (2024 and Beyond)
Japanese investors who are significant holders of foreign assets may start repatriating their investments to Japan due to the higher domestic yields.
A stronger Yen makes Japanese exports more expensive, which could impact companies and markets reliant on Japanese goods. The end of Japan’s low interest rates could reduce the attractiveness of yen-funded carry trades.
This is all hypothetical. The effects can be softer or more damaging.
Modern-Day Carry Trading
Carry trading remains a decent strategy, but traders must be more cautious due to market volatility and geopolitical issues.
Since 2008, many central banks have adopted policies like QE, leading to historically low interest rates in many countries.
Final Thoughts on Carry Trading
Carry trading is a forex strategy aiming to borrow a currency with a low interest rate and exchange it for a higher-yielding currency. Countries like Brazil, South Africa, and Argentina offer attractive interest rates on their currencies, but their geopolitical conditions aren’t very enticing.
According to some analysts, carry trading has recently decreased by nearly 75% due to increased market volatility and decreasing interest rates (or increasing in Japan’s case).
Frequently Asked Questions
Traders borrow money from a country with low interest rates and invest it in countries with higher interest rates.
A small movement in exchange rates can cause big losses (or profits), especially when leverage is involved.
As of early 2026, the interest rate is near 0.5%.
