In simple terms
A carry trade is a bet on the gap between two interest rates. An investor borrows cheaply in one currency and puts the money to work in another that pays more.
The borrowed currency is called the funding currency. The one bought with it is the target currency. The profit, if it comes, is the difference between the two rates.
How it works
Suppose borrowing costs 1 percent a year in Japan and lending earns 4 percent in the United States. An investor borrows yen, buys dollars, and lends at the higher rate. The San Francisco Fed describes this as borrowing in a low interest rate currency, converting the funds, and lending in the target currency.
Standard theory says this should not work. Under uncovered interest parity, a high interest currency should fall by just enough to cancel the gain. In practice it often does not, an oddity economists call the forward premium puzzle.
Much of the trade runs through currency derivatives rather than simple loans, so its true size is hard to measure. The Bank for International Settlements put outstanding yen swaps and forwards at 14.2 trillion dollars at the end of 2023.
Why it matters
Carry trades move large sums across borders, so they push exchange rates around. A popular funding currency tends to stay weak while the trade is on.
The risk is concentrated in the exit. If the funding currency suddenly rises, borrowers repay at once, and the unwind can shake markets far beyond currencies.
Where you’ll see it
- Market reports on the yen, the Swiss franc and other low rate currencies
- Central bank commentary on financial stability
- Coverage of sudden share falls blamed on a carry trade unwind
- Emerging market currency and bond analysis
Example
The Bank of Japan raised its policy rate to 1.25 percent on September 18, 2026. A narrower gap with rates abroad reduces the reward for funding a carry trade in yen.
Often confused with
A carry trade is not simple currency speculation. The aim is to earn the interest rate difference over time, not to profit from a single move in the exchange rate.
Key facts
- In a carry trade an investor borrows in a low interest rate currency, the funding currency, and lends in a higher yielding one, the target currency.2
- Uncovered interest parity predicts carry trades should earn no profit, but high interest currencies have tended not to depreciate as the theory expects, a pattern called the forward premium puzzle.2
- The yen has been popular as a funding currency because Japanese interest rates were very low for a long period.2
- Outstanding FX swaps, forwards and currency swaps involving the yen reached 14.2 trillion dollars, or 1,994 trillion yen, by the end of 2023.1
- The Bank of Japan raised its uncollateralized overnight call rate to 1.25 percent on September 18, 2026, in a 7 to 2 vote.3
This entry explains a financial term. It is not financial advice.
Related concepts
In the news
Quick checkIn a carry trade, which currency does the investor borrow?Show answer
The funding currency, the one with the lower interest rate.
Sources
- Bank for International Settlements. Sizing up carry trades in BIS statistics, BIS Quarterly Review. 16 September 2024 (accessed 22 September 2026)
- Federal Reserve Bank of San Francisco. Interest Rates, Carry Trades, and Exchange Rate Movements, FRBSF Economic Letter. 17 November 2006 (accessed 22 September 2026)
- Bank of Japan. Change in the Guideline for Money Market Operations. 18 September 2026 (accessed 22 September 2026)
Editorially reviewed by Specialty Digest Editorial TeamLast reviewed September 22, 2026Researched and drafted with AI assistanceReport an issue