What is a carry trade?

Imagine you’re a kid, and you borrow $5 from your mom to loan it to your brother and charge him $2 interest. That’s similar to a carry trade. When short-term rates are lower than longer-term rates, a bond trader can borrow at the lower short-term rate and invest the proceeds at the higher long-term rate. Similarly, a currency trader can borrow currency in a country with low interest rates and invest the money in another country, where rates are higher and attractive investment returns are expected.

In the last two examples, the traders are investing with borrowed money, a practice known as leveraging. Leveraging amplifies both returns and losses, increasing the volatility of your investment results.  

Example: “Carry trades were blamed in part for a steep decline in global markets in August 2024. The Bank of Japan raised interest rates, triggering heavy selling by traders who had borrowed low-cost Japanese yen to buy U.S. stocks. The increase in borrowing costs, combined with concerns about the outlook for the US economy, drove many to sell their stocks and pay off their loans.”

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About MoneySense Editors

MoneySense editors and journalists work closely with leading personal finance experts in Canada. Since 1999, our award-winning magazine has helped Canadians navigate money matters.

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