A carry trade is an investment strategy that involves borrowing capital in a low-interest-rate currency or asset and investing it in a higher-yielding currency or asset to profit from the interest rate differential. This strategy is most commonly associated with foreign exchange (forex) markets, where traders borrow in a low-yielding currency—such as the Japanese yen or Swiss franc—and invest in higher-yielding assets denominated in another currency, like the Australian dollar or Mexican peso. The goal is to earn the spread between the two interest rates, provided exchange rates remain stable or move favorably.
trades are not risk-free and are highly sensitive to exchange rate fluctuations. If the value of the high-yielding currency depreciates significantly against the low-yielding currency, the gains from the interest rate differential can be erased or even reversed, leading to losses. This risk was highlighted during the 2024 unwinding of the Japanese yen carry trade, which triggered significant market volatility and demonstrated the interconnectedness of global financial markets. The strategy is also vulnerable to sudden shifts in monetary policy; for example, when the Bank of Japan raised interest rates in 2024, it disrupted long-standing carry trade positions and contributed to rapid currency movements.
The concept of carry extends beyond currencies to other asset classes, including equities, commodities, and bonds, where investors seek returns from holding assets that generate income, such as dividends or coupon payments. In these cases, carry refers to the return generated from holding an asset over time, which can be positive or negative depending on the cost of financing or storage. Research has shown that carry can serve as a predictive tool for returns across various asset classes, suggesting that higher carry assets tend to outperform over time, assuming no major market disruptions.
Despite theoretical models like uncovered interest rate parity suggesting that interest rate differentials should be offset by expected exchange rate movements—making carry trades unprofitable in efficient markets—empirical evidence shows that higher-yielding currencies often appreciate more than predicted, a phenomenon known as the "forward premium puzzle". This anomaly allows carry traders to profit not only from interest rate spreads but also from deviations between actual and expected exchange rate changes.
Historically, the yen carry trade became especially prominent in the 2000s, with estimates suggesting up to $1 trillion was involved by 2007, largely due to Japan’s prolonged period of near-zero interest rates. The strategy played a role in global capital flows, including investments in U.S. subprime mortgages and emerging market assets, but collapsed during the 2008 financial crisis when the yen appreciated sharply, forcing traders to unwind positions and exacerbating the credit crunch. More recently, in early 2026, carry trade investors in Turkey continued to engage in the strategy despite interest rate cuts, using low-cost funding from countries like Japan to invest in high-yielding Turkish lira instruments, providing volatile but powerful support to the Turkish economy.
Carry trades are typically employed by sophisticated institutional investors, hedge funds, and professional traders due to their complexity and risk profile. They often use leverage and forward or futures markets to manage exposure, and timing is critical—traders may enter positions ahead of anticipated interest rate hikes to maximize gains. While the strategy can generate consistent returns in stable environments, it is prone to sudden reversals during periods of market stress, geopolitical uncertainty, or shifts in central bank policy.