What if you could borrow money at a very low interest rate and invest it somewhere that offers a much higher return?

For a global investor, this can create an interesting opportunity. Borrow a low-cost currency, invest in a higher-yielding currency or asset, and potentially earn the difference.

This is the basic idea behind Carry Trade, a strategy that has been used in global financial markets for decades. One of the best-known examples is the Japanese yen carry trade, where investors use the yen as a funding currency and invest in assets that offer higher potential returns.

But why the yen? How does the strategy work? And how can traders gain exposure to it through Forex and CFDs? Let’s break it down.

Why Is the Japanese Yen Used for Carry Trade?

The first part of the story starts with Japan’s interest rates.

For many years, Japan maintained extremely low interest rates compared with other major economies. This made borrowing in Japanese yen relatively cheap and turned JPY into an important funding currency for international investors.

Imagine an investor can borrow ¥1,000,000 at an annual interest rate of 1%. After one year, the investor would need to repay around ¥1,010,000.

Now imagine that the same money is converted into US dollars and invested in an asset offering a 5% return. If the exchange rate remains unchanged, the investment could generate roughly a 4% difference between the return and the funding cost.

The basic idea is therefore:

Borrow at a lower cost → Invest at a higher return → Capture the difference

Of course, real-world Carry Trade is more complicated than this simple example. Investors must consider exchange rates, financing costs, market volatility and changes in interest rates. But this simple relationship explains why low-interest-rate currencies can become attractive funding currencies.

The Yen Carry Trade: How Investors Made Money

The strategy became particularly interesting in 2023 and 2024.

As the US Federal Reserve and other central banks raised interest rates, the gap between Japanese interest rates and rates in other major economies became much wider. At the same time, the yen remained relatively weak against currencies such as the US dollar.

This created an attractive environment for yen-funded carry trades.

A simplified example would look like this:

Borrow JPY → Sell JPY → Buy USD or another higher-yielding currency → Earn the interest-rate difference

If the higher-yielding currency also appreciates against the yen, the investor can potentially benefit from both the yield difference and the currency movement.

For example, an investor holding USD/JPY could potentially benefit if the US dollar remains strong against the yen while the interest-rate difference remains favorable.

For a period of time, this looked like a relatively attractive trade.

But then the market changed.

The August 2024 Carry Trade Unwind

In August 2024, changing expectations around Japanese monetary policy and US interest rates contributed to a sharp strengthening of the yen. Investors who had borrowed yen to hold other assets suddenly faced a different situation.

If you borrow JPY, you eventually need to buy JPY back to close the trade.

When the yen becomes significantly stronger, buying it back becomes more expensive.

As leveraged investors began closing their positions, the process accelerated. This became known as a Carry Trade Unwind.

The episode was an important reminder that Carry Trade is not simply a strategy for collecting interest. A trade that looks profitable because of a large interest-rate gap can still lose money if the exchange rate moves strongly in the opposite direction.

How Can Traders Access Carry Trade Through CFDs?

You don’t need to borrow millions of yen from a Japanese bank to gain exposure to currency markets.

Through Forex and CFD trading, traders can trade currency pairs that are commonly watched when looking for carry opportunities.

Some examples include:

  • USD/JPY
  • AUD/JPY
  • NZD/JPY
  • MXN/JPY

Take USD/JPY as a simple example.

When you buy USD/JPY, you are buying US dollars and selling Japanese yen. In simple terms, you are holding a currency with a relatively higher interest rate while selling a currency with a relatively lower interest rate.

This is broadly similar to the structure of a yen-funded Carry Trade.

Traders also pay attention to Swap, sometimes called overnight financing. Depending on the direction of the position and the broker’s financing conditions, holding a CFD position overnight may result in a credit or a charge.

However, Swap should not be confused with the simple difference between two central bank interest rates. Actual financing costs can be affected by broker conditions, liquidity, market rates and other factors.

For this reason, traders looking at Carry Trade should consider both the potential yield and the total cost of holding a position.

So, What Exactly Is Carry Trade?

At this point, the idea becomes much easier to understand.

Carry Trade is a strategy where an investor uses a relatively low-yielding currency to fund an investment in a relatively higher-yielding currency or asset, aiming to benefit from the difference in returns.

In Forex, this often means:

Sell a lower-yielding currency → Buy a higher-yielding currency

The potential return can come from two sources: the interest-rate differential and the movement of the exchange rate.

This is why Carry Trade is different from simply buying a currency because its interest rate is high. A trader must also consider what happens to the exchange rate.

A high-yielding currency that loses significant value against the funding currency can turn a positive carry into an overall loss.

The Risk: Carry Trade Is Not Free Money

The biggest mistake is to think that a large interest-rate difference means easy or guaranteed profits.

It doesn’t.

The biggest risk is currency movement.

Imagine you earn 5% from holding a higher-yielding currency, but that currency falls 10% against the yen. The interest income would not be enough to cover the currency loss.

Leverage can make the situation even more significant. With a leveraged CFD position, a relatively small movement in the exchange rate can have a much larger impact on your account.

There is also interest-rate risk. Central banks can change monetary policy, reducing the interest-rate advantage that originally attracted investors. Swap rates can also change, while unexpected market events can trigger rapid volatility.

Most importantly, Carry Trade positions can become crowded. When many investors hold similar positions, a sudden change in market conditions can cause them to close their trades at the same time. This can create a Carry Trade Unwind, causing currencies and other assets to move much faster than normal.

The Bottom Line

Carry Trade is built around a simple idea:

Use cheaper funding to invest in something that offers a higher potential return.

The Japanese yen became one of the world’s best-known funding currencies because of its long period of low interest rates. During periods when the interest-rate gap was large and the yen remained weak, yen-funded Carry Trades could generate attractive returns.

But the same trade can work in reverse when market conditions change.

For Forex and CFD traders, understanding Carry Trade means looking beyond the interest rate or Swap alone. The real question is whether the potential return is enough to compensate for currency risk, financing costs, leverage and market volatility.

In other words, Carry Trade is not free money. It is a trade between yield and risk.