Carry trading involves borrowing a low yielding currency and buying a high yielding one in order to profit from the interest rate differential. You may have noticed when trading CFDs on forex that you get charged overnight swap fees at the rollover time (which is at the end of the trading day). Those swap fees are calculated on the interest rates involving the two currencies in the pair you are trading plus other commissions and costs of the broker.
For example, if you short USD/MXN you are credited interest and therefore you profit not only from the trade going in your favour but also from pocketing the interest from the broker every day. This is an example of a positive carry trade. On the other hand, if you were to go long USD/MXN and hold it more than one day, then you would be debited an interest from the broker, and this would be called a negative carry trade.
Back in 2020 with all the stimulus from governments and central banks that made the market expect an economic recovery and a following growth, the carry trades involving EM (emerging markets) currencies were absolutely the best ones in the FX space. Below you can see a daily chart of USD/MXN that spiked hard during February/March 2020 and then started a year long decline.
One of the most famous funding currencies has been the JPY and the carry trades involving it amounted to an estimated 1 trillion dollars back in 2007 before getting unwound as the Global Financial Crisis (GFC) hit.
Carry trades are generally taken when there’s a risk propensity in the markets. In fact, when there’s a risk on sentiment you will generally see the funding currencies involving carry trades perform badly as they are sold against high yielding currencies. On the other hand, if there’s risk off sentiment you will witness what is called “unwind” and the funding currencies are bought back gaining in value.
This article was written by Giuseppe Dellamotta.