Definition
Carry Trade
A carry trade borrows in a low-yielding currency and invests in a higher-yielding one, profiting from the interest rate differential as long as the exchange rate stays stable.
Global investors have historically borrowed cheap yen or dollars and parked the money in higher-yielding emerging assets, including Indian bonds and money markets, to pocket the rate gap. The rupee's relatively high yields make India a frequent carry-trade destination.
The risk is currency: if the rupee suddenly depreciates or the funding currency rallies, the FX loss can wipe out the interest gain. Carry trades unwind violently during risk-off episodes, triggering capital outflows and rupee weakness, which is why sharp yen moves can ripple into Indian markets.
Related terms
- Yen Carry Trade UnwindA yen carry trade unwind is the rapid reversal of positions funded by cheap Japanese yen borrowing, which can spark global selloffs as investors buy back yen and dump risk assets.
- Interest Rate DifferentialThe interest rate differential is the gap between interest rates of two countries, a core driver of currency carry trades, forward premiums and long-run exchange rate trends.
- Covered Interest Rate ParityCovered interest rate parity holds that the forward exchange rate must offset the interest rate gap between two currencies, otherwise risk-free arbitrage would be possible.
- Risk-On / Risk-OffRisk-on and risk-off describe market regimes: in risk-on, investors buy equities and emerging assets, while in risk-off they flee to safe havens like bonds, gold and the dollar.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.