The carry trade is one of the oldest and most influential strategies in currency markets. It moves billions of dollars, affects exchange rates globally, and can create dramatic reversals when it unwinds. In 2026, with interest rates varied across the world, carry trades are very much alive and popular among institutional investors.
The Core Concept: Borrow money in a low-interest-rate currency, convert it to a high-interest-rate currency, and invest it. You earn the interest rate difference, called the "carry." It works beautifully until exchange rates move against you.
How the Carry Trade Works
Example: The Classic Yen Carry Trade
Japanese rates: 0.5%
Mexican rates: 10%
Starting capital: $1,000,000
- Borrow 150 million Yen (≈ $1M at 150 JPY/USD) at 0.5% interest
- Convert to Mexican Pesos (≈ 17 million MXN)
- Invest in Mexican government bonds at 10%
- After one year, earn 1.7 million MXN in interest
- Pay 750,000 Yen (≈ $5,000) in borrowing costs
- Net profit: ~$95,000 (9.5% return on $1M)
This assumes exchange rates stay stable. In reality, they don't.
Why It Works (When It Works)
Economic theory says carry trades shouldn't work. High-interest-rate currencies "should" depreciate to offset the interest advantage (uncovered interest parity). But in practice:
- Exchange rates don't move enough to offset carry most of the time
- High-interest currencies often appreciate, adding to returns
- The "peso problem" — disasters are rare, so steady gains accumulate
- The carry trade itself pushes up high-yield currencies (self-reinforcing)
Studies show carry trades generate positive returns over long periods, though with fat-tailed risk — occasional large losses that can wipe out years of gains.
Popular Carry Trade Pairs in 2026
Funding Currencies (Low Rates — You Borrow These)
- Japanese Yen (JPY): The classic funding currency, still with relatively low rates despite BOJ normalization
- Swiss Franc (CHF): Low rates, but SNB intervention risk
- Euro (EUR): Lower rates than many EM currencies, used for European-based trades
Target Currencies (High Rates — You Buy These)
- Mexican Peso (MXN): High rates, relatively liquid, popular carry target
- Brazilian Real (BRL): Very high rates, but higher volatility
- Turkish Lira (TRY): Extreme rates but extreme risk — not for the faint-hearted
- South African Rand (ZAR): High yields, moderate liquidity
- Indian Rupee (INR): Solid rates, growing popularity as India's market opens
The Risks: Why Carry Trades Blow Up
The Classic Pattern: Carry trades are like "picking up pennies in front of a steamroller." Small, steady profits until a sudden massive loss. The 2008 crisis saw Yen appreciate 25% in months, destroying years of carry trade profits.
Currency Risk
The biggest risk. If the funding currency strengthens (or target currency weakens) by more than your interest income, you lose money. A 10% appreciation in Yen wipes out nearly a year of gains on most JPY carry trades.
Unwind Risk
Carry trades are crowded — lots of money doing the same thing. When fear spikes, everyone rushes to close positions simultaneously:
- Traders sell high-yield currencies (they crash)
- Traders buy funding currencies (they spike)
- This triggers more stop-losses
- The unwind accelerates
This is why safe haven currencies like JPY often spike during crises — carry trade unwinds.
Leverage Risk
Carry trades often use leverage (borrowing more than your capital) to amplify small interest rate differences. 10:1 leverage on a 5% carry gives 50% annual return — until a 10% currency move causes a 100% loss.
Liquidity Risk
Some high-yield currencies are less liquid. During stress, you might not be able to exit at any reasonable price.
Why 2026 Favors Carry Trades
Several factors make carry trades attractive right now:
- Wide rate differentials: Japan still has low rates; many EM countries have high rates
- Contained volatility: No major crisis (so far) means steady carry accumulation
- Fed/ECB at neutral: Reduced uncertainty about major central bank moves
- EM stability: Many emerging markets have better fundamentals than in past cycles
But beware: Carry trade popularity itself is a warning sign. Crowded trades create fragility. The more money piles into carry, the more violent the eventual unwind.
Carry Trade Impact on Exchange Rates
Carry trades affect currencies you might exchange for non-speculative reasons:
- High-yield currencies stay strong: Carry inflows support Mexican Peso, Brazilian Real, etc.
- Funding currencies stay weak: Yen weakness partly reflects carry trade funding
- Crisis reversals: When carry unwinds, Yen spikes and EM currencies crash
If you're exchanging JPY, MXN, or other carry-relevant currencies, you're indirectly affected by these flows even if you're just converting money for a trip or remittance.
Can You Do a Carry Trade?
Technically, yes. Retail forex brokers let you put on positions that earn (or pay) interest daily based on the rate differential. This is called "swap" or "rollover."
Should you? For most people, no:
- Carry returns are small without leverage, which amplifies risk
- You're competing with institutional traders with better information and execution
- Unwinds can be sudden — you might be asleep when they happen
- Most retail traders lose money on forex overall
If you want carry exposure, consider emerging market bond funds — professional management, diversification, and no leverage.
Frequently Asked Questions
What is a carry trade in simple terms?
A carry trade is borrowing money in a currency with low interest rates and investing it in a currency with high interest rates. You profit from the interest rate difference (the "carry") as long as exchange rates don't move against you. Example: Borrow Japanese Yen at 0.5%, invest in Mexican Pesos earning 10%, pocket the 9.5% difference.
Why is the carry trade popular in 2026?
Interest rate differences have widened significantly. Japan still has relatively low rates while many emerging markets offer high yields. With volatility somewhat contained and the Fed/ECB reaching neutral rates, conditions favor carry trades. However, this popularity itself creates risk — crowded trades can unwind violently.
What are the risks of carry trades?
The main risk is currency depreciation wiping out your interest gains. If you borrow Yen and the Yen suddenly strengthens 10%, you've lost more than a year's interest income. Carry trades also face liquidity risk — in crises, everyone rushes to unwind simultaneously, amplifying losses. Leverage magnifies both gains and losses.
Can regular people do carry trades?
Technically yes, through forex brokers. Practically, it's risky for non-professionals. Carry trades require leverage to be meaningful, can reverse suddenly during crises, and require constant monitoring. Most retail traders lose money on carry strategies. Professional fund managers have better tools, access, and risk management.
The Bottom Line
The carry trade is a fundamental force in currency markets. It creates persistent patterns (Yen weakness, EM currency strength during calm periods) and dramatic reversals (Yen spikes during crises). Understanding carry trade dynamics helps explain currency movements that might otherwise seem random.
For most people, the practical takeaway is this: currencies with high interest rates can weaken violently during crises, while funding currencies like JPY tend to spike. Factor this into your planning if you're exposed to carry-relevant currencies.