When winning with carry trade turns into a loss: what really happens

Executive Summary

The carry trade is that strategy that seemed like a win-win: you borrow cheap money from one place, invest it at high interest in another, and pocket the difference. Simple? Theoretically yes. In practice? When the market breathes wrong, everything crashes. The Bank of Japan's movement in 2024 was a red warning for the world: positions that seemed safe turned into financial bombs.

The mathematics behind carry trade

Think of it this way: you get a loan in yen at 0% interest. Seems like a joke, right? This really happened in Japan for decades. Then, you convert that yen into dollars and invest in American bonds that pay 5.5%. There you go: you already have a net gain of 5.5% (minus the fees, of course).

It is exactly this profitability differential that moves billions around the world. Hedge funds, financial institutions, and sophisticated investors thrive on this interest rate arbitrage. Some even multiply all of this by 10, 20, or 50 times using leverage. The greater the risk you take, the higher the potential return – but also the greater the fall when the tide turns.

The two biggest scares in recent history

The 2008 fiasco

The 2008 financial crisis was the first major horror movie of the carry trade. Investors who were calmly borrowing yen woke up to chaos: markets collapsing, credit freezing, interest rates skyrocketing. Many lost fortunes trying to unwind positions that no longer had any market value. It was a warning that no one really heard.

The fall of 2024

Wait a minute, 2024 is too recent to be history? That's right. In July 2024, the Bank of Japan surprised the world by raising interest rates. A seemingly small decision? No. The yen skyrocketed in value. And when that happens, those with leveraged carry trades begin to panic. The rush to unwind these positions was so violent that it shook not only the foreign exchange market but sent shockwaves through risk assets globally. Stocks fell, cryptocurrencies fell, everything related to risk had a terrible day. All because investors needed to sell as many assets as possible to get yen and pay off their loans.

Why is this so risky?

The carry trade has two main enemies: exchange rates and central bank decisions.

Exchange rate risk is the invisible killer. If you borrow money in yen and invest in dollars, you are betting that the yen won't appreciate much. But what happens when the Japanese central bank changes its mind? The yen can rise by 10%, 20%, or more in days. Suddenly, your 5% profit turns into a 15% loss. Converting back becomes too expensive.

Interest rates are the other problem. If the central bank you borrowed from raises interest rates, your costs skyrocket. If the bank where you invested lowers interest rates, your earnings vanish. It is an environment where the decisions of half a dozen people in central bank offices can vaporize billions.

When does the carry trade work?

Works better in calm markets, when investors are optimistic and willing to take risks. During these times, currencies do not fluctuate much, rates are predictable, and you reap the gains month after month, year after year.

But calm markets never last forever. An election, a central bank's statement, a geopolitical crisis – anything can turn a quiet day into chaos. And when that happens, especially in a highly leveraged environment, investors go into a frenzy. They start liquidating positions, selling everything they can sell, just to get cash and get out of trouble.

Who should be in this game?

The answer is simple: experienced investors and large institutions. Why? Because they have the structure to monitor risks, tools to do proper hedging (protection), and enough capital to absorb losses without going bankrupt.

If you are a common investor, know little about global markets, and do not understand how central bank decisions work, carry trade may seem like a money-making machine, but it is more like a financial landmine waiting to explode in your portfolio.

The takeaway

The meaning of carry trade goes far beyond simply “borrowing cheap and lending expensive.” It is a dangerous dance with the forces of the global market, where consistent gains can turn into monumental losses in a matter of hours. 2024 proved that even strategies that have worked for decades can collapse when the landscape changes. Respect the risks, understand the game, or stay out.