Carry trade

The carry trade is one of the oldest ideas in currency markets. If one country's interest rates are much higher than another's, an investor can sell the low-yielding currency and buy the high-yielding one, earning the interest rate differential for as long as the position is held.

How it shows up for a CFD trader

Retail traders do not borrow currency directly. Instead the differential appears as the overnight swap. Holding a position long the higher-rate currency may earn a positive swap; holding it the other way usually costs one. Brokers add their own mark-up, so the swap you receive is smaller than the raw differential, and in some cases both directions are negative.

Worked example

Illustratively, currency A's policy rate is 5.00% and currency B's is 0.50%, a 450 basis point difference. On a position worth 100,000 units, a full year of that differential is about 4,500 units of interest before broker mark-ups. But a 5% adverse move in the exchange rate would cost about 5,000 units, more than the whole year's carry.

The risk

Carry trades tend to work in calm markets and can unwind violently when sentiment turns, because many holders rush for the exit at once. Funding currencies such as the Japanese yen have historically rallied sharply during these episodes, for example during the global financial crisis and in the market turbulence of early August 2024. Leverage amplifies those moves.

See swap and overnight financing and central banks and interest rates.