Carry trades are common in the foreign exchange (FX) market. The idea is straightforward: borrow in a currency where interest rates are low, convert the funds into a currency with higher interest rates, and earn the interest rate gap between the two. The goal is to profit from this difference while keeping exchange rate risk under control.
This strategy works best when interest rate levels remain stable and currency prices do not move sharply against the investor. If the higher-rate currency strengthens, the carry trade becomes even more profitable. If it weakens, the exchange rate losses may reduce or completely offset the interest earned.
Carry trades tend to perform well during periods of calm, stable markets when investors are willing to take on more risk. During times of uncertainty or market stress, they can unwind quickly as investors reverse their positions, creating strong price moves in the currencies involved.
Carry trades influence global currency flows, interest rate changes, and market sentiment. They affect FX volatility and can impact the value of major currency pairs.
An attractive carry trade pair has a clear interest rate gap, with a low-yield currency on one side and a higher-yield currency on the other. Investors also look for stability, meaning the higher-interest currency should not be highly volatile. Central bank policies, inflation trends, and economic health all play a role in deciding whether the interest rate spread is reliable over time.
The main risk is exchange rate movement. If the higher-interest currency weakens, the loss from the currency move can be larger than the interest earned. Another risk is sudden policy changes, such as unexpected rate cuts or rate hikes by central banks. Market stress can also force investors to exit positions quickly, causing sharp reversals in currency prices.
Central banks control interest rates, which directly affect the profitability of carry trades. When a central bank raises rates, its currency becomes more attractive for carry trades. When it cuts rates, the appeal decreases. Forward guidance, inflation reports, and policy statements also influence expectations and can shift carry trade demand.
An investor borrows in Japanese yen, where interest rates are low, and exchanges the money into Australian dollars, which offer higher interest rates. The investor earns the rate difference as long as the AUD does not fall sharply against the JPY.
FinFeedAPI’s Currency API provides exchange rates, historical price data, and economic indicators that help track interest rate trends and currency movements. Developers use this data to evaluate carry trade opportunities, risk levels, and long-term performance.
