The Carry Trade: The Strategy That Shook the Markets in 2024

How a Cheap Loan Turns into a Financial Trap

The financial bicycle, more commonly known in professional circles as “Carry Trade,” is much more than a simple investment strategy. It is a mechanism that exploits differences in the cost of money between different currencies to generate profits. However, what seems simple in theory becomes something very different when markets behave unpredictably.

The fundamental concept is straightforward: borrow money at very low rates in one currency, convert it into another currency where returns are higher, and invest in assets that pay higher interest. The theoretical profit is the difference between what you pay for the loan and what you earn from the investment. But here’s the key point: this operation only prospers as long as exchange rates remain stable and interest rates do not experience unexpected changes.

The Real Operation: Step by Step

In practice, the process is more complex than it sounds. An institutional investor, for example, might borrow in Japanese yen at an interest rate close to 0% (a situation that persisted for years in Japan). Then, convert those yen into US dollars and invest in US Treasury bonds offering yields of 5.5% or higher.

The calculation seems attractive: you receive a 5.5% annual gain with almost no cost of debt. Less operational fees, it remains a profitable business. Millions of dollars flowed into this type of transaction for years, creating a huge but fragile market.

What many investors seem to forget is that this margin between rates does not fall from the sky. It exists for a reason: to compensate exactly for this exchange rate risk that we are ignoring.

Leverage: When Ambition Surpasses Prudence

Where the risk truly amplifies is when investors use leverage. That is, they borrow not only what they need but multiple times that amount. If an investment fund has $100 million in capital, it could borrow an additional $500 million to amplify its potential gains.

During calm markets, this works wonderfully. Gains multiply. But when volatility hits, losses also multiply proportionally, and then some. An unfavorable 5% movement in the exchange rate can turn profits into catastrophic losses.

2024: When Theory Turns into Chaos

In July 2024, the Bank of Japan surprised markets with an increase in its interest rates. It was an unexpected turn after years of ultra-expansive monetary policy. What happened next was a domino effect that no one fully anticipated.

The yen strengthened dramatically against the dollar. For those investors who had borrowed yen, this meant they now needed more dollars to repay the loan. Gains evaporated instantly. Many funds panicked and liquidated, selling higher-risk positions globally to raise cash and cover their losses in yen.

The impact was almost immediate: currency markets convulsed, high-risk stocks suffered massive sell-offs, and soaring volatility affected portfolios worldwide. It was not just a problem of financial bicycles; it was a global financial stability event.

Inherent Risks: Beyond the Numbers

Currency risk is the most obvious. If the currency you borrowed strengthens unexpectedly, your gains disappear and losses appear. It’s pure mathematics.

But there are more dimensions to risk. Central banks can change policies without warning. A decision that seemed distant becomes a reality overnight. Interest rates in the currency where you invested can be reduced, compressing your yields. Macroeconomic conditions can deteriorate, reducing risk appetite in the market.

When multiple risks activate simultaneously—especially in highly leveraged markets—the situation becomes uncontrollable very quickly. The 2008 crisis provided lessons on exactly this: investors relying too much on historical trends were trapped when everything changed.

The Market Environment Is Everything

These operations work optimally when there is market complacency. In periods of calm and optimism, investors take risks more freely, currency prices fluctuate within predictable ranges, and the financial system distributes risk more orderly.

But when uncertainty arrives—whether due to monetary policy decisions, economic crises, or simply changes in sentiment—the behavior changes radically. Leveraged investors who once seemed safe suddenly find themselves forced to unwind positions. The speed of these exits can shake entire markets.

What happened in July 2024 was a reminder: the global market has a short memory of risks. While conditions are favorable, money accumulates in financial bicycle strategies. When they change, everyone tries to exit simultaneously.

Conclusions for Investors

The financial bicycle is not inherently a bad strategy. For experienced investors and institutions with access to quality macroeconomic information and real risk management capacity, it can provide consistent returns.

However, it requires much more than understanding interest rates. You need to constantly monitor central bank decisions, evaluate geopolitical changes affecting currencies, and have sophisticated risk management systems. More importantly: you must be brutally honest about how much leverage you can truly afford in an adverse scenario.

For most retail investors, these operations are probably too complex. For large institutions, they are powerful tools but demand absolute respect for the underlying risks. What we learned in 2024 is that ignoring these risks, no matter how small they seem during calm markets, is a strategy that eventually pays its price.