A currency carry trade is one of the oldest and most persistently profitable strategies in global finance, yet it remains one of the most dangerous when conditions turn. At its core, the trade is disarmingly simple: borrow money in a currency with a low interest rate, convert the proceeds into a currency with a high interest rate, invest those proceeds in interest-bearing assets of the high-yielding currency, and pocket the interest-rate differential (the “carry”) as profit. If exchange rates remain stable or move in your favor, the strategy generates steady, almost bond-like returns with very little day-to-day volatility. When exchange rates move sharply against the position, however, losses can erase years of accumulated carry in a matter of days or even hours.
The appeal is obvious. For more than three decades, investors ranging from Japanese housewives in the 1990s to multi-billion-dollar macro hedge funds today have used carry trades to extract what looks like nearly free money from the global interest-rate structure. Yet every few years the strategy experiences spectacular blow-ups that wipe out unprepared participants and occasionally threaten the stability of entire financial systems. The Mexican peso crisis of 1994, the Asian financial crisis of 1997-98, the Icelandic krona collapse of 2008, the Swiss franc unpeg of 2015, the Turkish lira plunges of 2018 and 2022, and the rapid unwinding of the yen carry trade in August 2024 all share a common thread: massive, leveraged carry positions being forcibly closed at the worst possible moment.
How a Carry Trade Actually Works
Imagine it is early 2023. The Bank of Japan maintains a policy rate of -0.10% and enforces yield-curve control that keeps the 10-year Japanese government bond yield near zero. Meanwhile, the Reserve Bank of Australia has lifted its cash rate to 4.35% to combat inflation. A hedge fund or proprietary trading desk can execute the following trade:
- Borrow 10 billion Japanese yen at roughly 0% overnight interest (or even receive a small amount of interest for holding yen under negative-rate policy).
- Convert the 10 billion yen into Australian dollars at the prevailing spot rate (assume 1 AUD = 95 JPY, yielding approximately 105.26 million AUD).
- Invest the Australian dollars in short-term Australian government bills or high-quality commercial paper yielding 4.2–4.5%.
- Roll the funding and the investment daily or weekly while collecting the positive interest differential.
The annualized carry on an unhedged basis is approximately 4.3–4.5 percentage points. On a notional of 10 billion yen (roughly 67 million USD at the time), the fund earns more than 2.8 million USD per year in nearly risk-free interest income as long as the AUD/JPY exchange rate does not fall by more than about 4.3% per year. Historically, the Australian dollar had tended to appreciate against the yen during risk-on periods, so many players treated the carry as almost pure profit.
Leverage magnifies everything. Global prime brokers are happy to provide 20:1 or higher leverage on major-currency carry trades because daily volatility is low and haircuts are tiny. At 20:1 leverage, the same 67 million USD position controls 1.34 billion USD of notional exposure, turning the 4.3% carry into an 86% annualized return on equity if nothing goes wrong. This is the siren song that has attracted generations of traders.
The Three Sources of Return (and Risk)
Carry trade profitability actually comes from three distinct components, each with its own risk profile:
- Interest-rate differential (the true “carry”): This is known in advance and extremely stable day-to-day.
- Expected currency appreciation/depreciation: High-yielding currencies often depreciate over time (consistent with uncovered interest parity in theory), but in practice they frequently appreciate during prolonged risk-on environments.
- Roll-down or term carry: Many investors buy longer-dated bonds in the high-yield currency and fund short-term, capturing additional positive slope in the yield curve.
In bull markets for risk assets, all three components work in the investor’s favor. Funding currencies (yen, Swiss franc, euro, and formerly the U.S. dollar in 2021–2022) tend to depreciate gradually, while high-yield currencies (Australian dollar, New Zealand dollar, Turkish lira, Mexican peso, South African rand, Brazilian real, etc.) either hold steady or appreciate. The combination can produce double-digit annualized returns for years on end.
Classic Historical Cycles
The yen carry trade has been the mother of all carry regimes because Japan has kept interest rates near or below zero for most of the period since 1995. Between 2000 and mid-2007, borrowing yen to buy almost anything—Australian dollars, Icelandic krona, Hungarian forint, Brazilian real, or even U.S. subprime mortgage securities—generated extraordinary returns. Global macro funds such as Moore Capital, Tudor, and BlueCrest built legendary track records on the back of these trades.
Then came the global financial crisis. As risk aversion spiked in 2007–2008, investors rushed to repay yen loans and unwind leveraged positions. The AUD/JPY cross fell from above 107 in July 2007 to below 55 by early 2009—an almost 50% decline. A trader who had been earning 5–6% carry per year suddenly lost 50% or more in a few months. Many funds imposed gates or simply blew up.
The same pattern repeated with Swiss franc carry trades in 2010–2014. The Swiss National Bank capped the franc at 1.20 versus the euro, turning the franc into the world’s premier funding currency. Eastern European mortgages denominated in Swiss francs became popular in Poland, Hungary, and Austria. When the SNB abruptly removed the cap on January 15, 2015, the franc appreciated 30% in minutes. Retail FX brokers lost more than they had in client deposits, several hedge funds were wiped out, and the phrase “black swan” trended again.
More recently, the summer of 2024 provided another textbook unwind. The Bank of Japan finally began normalizing policy in March 2024 and surprised markets with a 25 basis-point hike on July 31, 2024. At the same time, U.S. recession fears triggered a sharp drop in Treasury yields, narrowing the once-massive U.S.-Japan interest differential. The yen, which had weakened beyond 160 to the dollar, suddenly strengthened to below 140 in a matter of weeks. Estimates suggest that the notional size of yen-funded carry trades peaked at close to 20 trillion yen (approximately 130 billion USD) across G10 and emerging-market exposures. The speed of the unwind forced the Japanese stock market into a one-day 12% plunge on August 5, 2024—the largest single-day drop since 1987.
Why Do Carry Trades Persist Despite Recurrent Crashes?
Behavioral finance offers part of the answer. Carry trades exhibit positively skewed day-to-day returns (small steady gains) combined with infrequent but severe negative tail events—a profile that humans systematically underestimate. This is the same reason people buy lottery tickets or disaster insurance at bad odds: the small steady wins feel real, while the rare catastrophe feels abstract until it arrives.
Institutional inertia and benchmarking also play a role. Many global macro and absolute-return funds are judged against cash or LIBOR-plus benchmarks. In a world where high-quality bonds yield little or nothing, earning 400–600 basis points of carry with single-digit volatility looks irresistible on a risk-adjusted basis—until the risk actually materializes.
Central banks themselves inadvertently encourage carry trades during prolonged periods of unconventional monetary policy. When major central banks pin short-term rates at zero and cap longer-term yields, they create an artificial scarcity of high-yielding safe assets, pushing investors further out the risk spectrum.
Risk Management (or the Lack Thereof)
Professional carry traders use a variety of tools to mitigate risk, though none are foolproof:Stop-losses: These are notoriously difficult to execute in fast-moving markets. During the Swiss franc unpeg, many stops were simply skipped as liquidity vanished.
- Options and structured products: Buying cheap out-of-the-money puts on the high-yield currency can cap downside, but the cost eats deeply into carry and the protection often expires worthless for years—until the one time it is desperately needed.
- Dynamic position sizing: Reducing leverage as the currency moves against the position and increasing it when it moves in favor (trend-following overlay) can smooth returns but also caps upside.
- Diversification across multiple carry trades: Spreading exposure across AUD/JPY, NZD/JPY, USD/MXN, USD/TRY, USD/ZAR, etc., reduces idiosyncratic risk but does nothing against broad-based risk-off events that hit every high-yielder simultaneously.
In practice, the most common risk-management technique is hope—hope that the trade will not blow up on one’s specific watch and that someone else will be left holding the bag when the music stops.
Emerging-Market Carry: Even Higher Reward, Even Higher Risk
While G10 carry trades grab headlines, the really eye-watering yields are found in emerging markets. In 2023–2024, Turkish lira short-term rates exceeded 50%, Brazilian rates were above 11%, and Mexican TIIE rates hovered near 11.5%. Borrowing in yen or dollars to buy these currencies could generate carry of 15–50% per year. The catch, of course, is that the Turkish lira lost more than 30% against the dollar in 2023 alone, and similar depreciations have occurred repeatedly in Argentina, Lebanon, Venezuela, and elsewhere.
Sophisticated investors try to separate “good carry” from “bad carry.” Good carry comes from countries running orthodox monetary policy to fight temporary inflation shocks (e.g., Brazil 2021–2023, Mexico 2022–2024). Bad carry comes from countries with chronic fiscal dominance, capital controls, and a history of default or forced conversion (Turkey, Argentina). Distinguishing between the two in real time is more art than science.
The Macroeconomic Feedback Loop
Large carry trades are not merely passive bets on interest differentials; they become self-reinforcing macro phenomena. When investors borrow yen and buy Australian dollars, they weaken the yen and strengthen the AUD. The weakening yen prompts Japanese exporters to repatriate less money, further loosening domestic financial conditions and justifying the Bank of Japan’s continued easy policy. Meanwhile, the stronger commodity currency supports higher raw-material prices and stronger terms of trade for the target country, validating the initial investment flow.
When the loop eventually reverses, the feedback runs equally powerfully in the opposite direction. Forced unwinding strengthens the funding currency, tightens financial conditions in the funding country, and triggers deflationary pressure there while crashing asset prices in the previously favored high-yield destination.
Regulatory and Policy Responses
Post-crisis regulation has made banks more reluctant to warehouse huge carry-trade positions on their own balance sheets, but it has not eliminated the trade. Instead, the activity has migrated to hedge funds, family offices, proprietary trading firms, and retail FX platforms. Japanese retail investors—“Mrs. Watanabe”—remain legendary for piling into high-yield currencies through online margin accounts.
Central banks have occasionally intervened directly. The Bank of Japan has sold dollars and bought yen on multiple occasions to slow rapid appreciation during carry-trade unwinds. The Swiss National Bank accumulated more than 100% of GDP in foreign-currency reserves defending first the 1.20 euro cap and later an informal 1.05 level. Such interventions merely delay the inevitable adjustment and often increase the ultimate volatility when the dam finally breaks.
The Future of Carry Trades
As of late 2025, the global interest-rate landscape has changed dramatically from the zero-rate world that prevailed from 2009 to 2021. The Federal Reserve, ECB, and Bank of England have all cut rates significantly from their 2022–2023 peaks, while Japan is only gradually normalizing. The classic yen-funded carry trade has lost much of its luster, with JPY interest rates now positive and the former 500+ basis-point differentials against the dollar largely gone.
Yet the search for yield never ends. New funding currencies emerge (the Chinese yuan when the PBOC eases), and new high-yield destinations appear (India, Indonesia, and parts of the Gulf Cooperation Council). Crypto “carry trades” have also developed, borrowing stablecoins at 3–5% to buy higher-yielding proof-of-stake tokens or perpetual futures basis.
The fundamental dynamics remain unchanged: in a world of fiat currencies managed by independent central banks, interest-rate differentials will always exist, and speculators will always attempt to arbitrage them. The rewards can be spectacular, but the risks are existential. Every veteran macro trader has a personal graveyard of blown-up carry-trade positions. The strategy is often described as “picking up nickels in front of a steamroller.” Sometimes the nickels add up to millions, and sometimes the steamroller arrives without warning.
In the end, successful carry trading is less about predicting the next crash and more about surviving it when it inevitably comes—maintaining enough liquidity, keeping leverage modest, and having the emotional discipline to take profits and reduce risk long before the crowd rushes for the exits. Those who master that discipline can compound attractive returns over decades. Those who treat carry as free money rarely last long enough to tell the tale.
The currency carry trade, therefore, remains the ultimate embodiment of the old market adage: high reward, higher risk. It is a strategy that has enriched generations of traders and ruined just as many. In the global financial casino, it is the table with the most seductive odds—and the one most likely to wipe you out if you stay too long.