A carry trade is an investment strategy in which the investor borrows money at a low interest rate to invest elsewhere in the hopes of achieving a higher return.
For example, if you borrowed money at an interest rate of two percent and put that money to work in an investment yielding 5 percent, you would have a net positive return of three percent.
The Yen Carry Trade is One of the Most Popular Carry Trades
Here’s how it works:
- Large traders such as banks or hedge funds borrow yen at extremely low interest rates.
- The borrowed yen are converted to dollars and invested in U.S. Treasuries with much higher yields than the interest being paid on the borrowed yen.
- As more large institutions and traders buy treasuries, Treasury prices rise.
- Profits may be made as Treasury prices rise or if the dollar appreciates versus the yen.
That’s it in a nutshell. The carry trade can be done, however, on a massive scale utilizing leverage.
So, why should you care? Here’s why:
The carry trade may boost the dollar, U.S. Treasuries, and U.S. stocks while driving declines in commodities.
As the carry trade is unwound, it may potentially have the opposite effect.
Knowing and understanding the potential effects of the carry trade may allow one to take advantage of those effects.
For example, if the carry trade is in full swing, one may consider going long equities or treasuries and avoiding commodities.
On the other hand, if the carry trade is being unwound, one may consider exiting Treasuries or equities while looking to get long commodities.
The yen carry trade can potentially have a significant influence on markets. Paying attention to the carry trade may aid in making investment decisions in the corresponding markets.
