Carry Trade Guide: How It Works and Why It Unwinds

What should a carry trade guide tell you first? How the trade earns: you hold a currency that pays a high interest rate against one that pays a low rate, and you collect the difference for every night the position stays open.

That income is small and it arrives slowly. The exchange rate can take a year of it back in a week.

The two legs

The currency you sell is the funding currency. It is cheap to borrow because its central bank keeps rates low. For years the Japanese yen was the obvious choice: the Bank of Japan only left negative rates behind in March 2024, for a range of 0 to 0.1% (Bank of Japan statement). Why the yen and a few others play this role is in What is a funding currency?

The currency you buy is the target currency, the one with the higher rate. The gap between the two short-term rates is the interest rate differential, and that gap is your carry. You can see it for every major pair on Interest rate differential by currency pair.

Watch where the gap is heading, not just how wide it is today. If the market starts to expect the high-rate central bank to cut, the pair can fall long before any rate changes, and your swap stays the same while the price takes it back.

How the interest reaches your account

You never see a loan. Your broker handles the financing and books it as swap, also called rollover, on every position still open at 5 p.m. New York time (FXCM on rollover).

Bought the currency with the higher rate? You usually receive swap. Bought the lower one? You pay it. The broker and the banks behind it each keep a spread on the interest, so you receive less than the full differential. On a pair where the two rates are close, both directions can cost you.

On Wednesdays you will see roughly three times the usual amount. The market books the weekend’s interest that day (FXCM on when rollover is booked), so a Wednesday credit is not a sign the trade suddenly got better.

Strictly speaking, any position that earns positive swap is carry. A carry trade is one you hold mainly for that interest, rather than one where the swap is a side effect of a view on direction.

What the numbers look like

These rates are invented to keep the sums easy. They are not any pair’s rates today.

Say the target currency pays 4.5% and the funding currency 0.5%, a gap of 4 points. On a position of 100,000 that is about 4,000 a year, or 11 a day. Take off a broker spread of 1 point and you keep about 3,000 a year: roughly 8 a day, and about 25 on a Wednesday.

Now the pair falls 5% in one nervous week. That is a loss of about 5,000, more than a year and a half of swap. If you opened the position on 10,000 of margin, 10:1 leverage, half of your margin is gone.

This is the trade newcomers misjudge. Eight a day feels like free money, and for months it can be. The risk sits in the rare week when the price moves further than months of swap can cover.

The worst falls, counted in years of carry

History puts real numbers on that trade-off. AUD/JPY and NZD/JPY are the classic yen carry trades. Since January 2000 the gap between the Australian and the Japanese policy rate has averaged about 3.5 points a year, and the New Zealand gap about 3.8. AUD/JPY itself rose about 64 percent over those years. With the gap added every day, at central bank rates and before any broker’s spread, 100 grew to about 420. That is the slow side.

Now the falls. From July 2007 to October 2008 AUD/JPY lost 47 percent. The gap at the top was 5.75 points, so the fall took about eight years of carry. NZD/JPY lost 54 percent from July 2007 to February 2009, about seven years of a 7.5-point gap. AUD/JPY’s price did not get back above its 2007 high until June 2024. Even with the interest counted at those central bank rates, a holder who bought at the top waited until February 2012.

The unwind that began in July 2024 is the recent case. By April 2025 AUD/JPY was 20 percent lower, close to five years of a 4.3-point gap, and the price was back above its July 2024 high in February 2026.

These figures use the BIS’s daily central bank policy rates (BIS) and the Fed’s H.10 rates for the Australian dollar, the New Zealand dollar and the yen, crossed through the US dollar. A fall runs from a closing high to the lowest close before the price gets back above it, and a year of carry is the gap on the day of the high. The background to each side is in Australian Dollar Fundamentals (AUD) and New Zealand Dollar Fundamentals (NZD).

Why carry unwinds fast

Carry does best in calm markets, when exchange rates barely move and the interest builds up. It suffers when volatility jumps.

Funding currencies are often safe havens as well, the currencies investors buy when they are scared. Target currencies pay more partly because they are riskier, and they tend to fall hardest when the mood turns. So in a panic both legs of your trade move against you together.

Carry is also leveraged and crowded. When the price drops, some holders have to cut. They buy back the funding currency and sell the target, which pushes the price further and forces the next group out.

August 2024 shows how little it takes. On 31 July the Bank of Japan moved its rate to around 0.25% (Bank of Japan statement). Against a 4-point gap like the one in the example above, that is a quarter of a point at most. On paper the trade still paid. Then a weak US data release came out in early August.

The BIS found that the unwinding of leveraged positions amplified the reaction to that release, and that FX carry trades were hit hard. It put their size going in at a rough ¥40 trillion, about $250 billion, and said gaps in the data make that figure, if anything, too low. Markets then steadied quickly (BIS Bulletin 90). That was little help to anyone already forced out near the bottom.

Watching the size of the crowd

Crowding is what turns a bad week into a violent one, so it pays to know how big the crowd is. Speculative positioning in currency futures shows part of it, though not every speculative position is a carry trade. How the largest traders are positioned in the yen is on the Japanese yen COT report.

That count is a measure of how much could unwind once the mood turns. Size the trade for the week the pair drops 5%, not for the 8 a day.