Currency investors love a good carry trade. And right now, according to Goldman Sachs, they're getting one of the best setups in more than 20 years.
That's a big deal because carry trades are one of the most popular strategies in the $9.5 trillion-a-day currency market, allowing investors to profit from differences in countries' interest rates. Here's why the opportunity looks especially compelling now – and how to take advantage of it.
What is a carry trade?
The basic idea is simple enough: it involves borrowing in a currency where interest rates are low, investing in one where rates are higher, and pocketing the difference. In the currency, or foreign exchange (FX), market, traders typically sell a low-yielding currency and buy a high-yielding one, earning the interest rate differential each day.
For example, if you borrow Japanese yen at near-zero rates and buy Australian dollars yielding over 4%, you collect that spread daily. Over time, those small daily gains can add up to substantial returns – provided exchange rates don't move against you.
Why now is different
Goldman Sachs notes that wide interest-rate gaps and unusually calm currency markets have created the strongest backdrop for G10 carry trades in over two decades. That mix has helped the strategy return around 8% this year, beating global bonds, gold, and even bitcoin.
The key driver is the divergence in central bank policies. While the Federal Reserve and European Central Bank have raised rates aggressively to fight inflation, the Bank of Japan has kept its policy rate at or near zero. That gap is unusually large by historical standards.
At the same time, currency volatility has fallen sharply. The Deutsche Bank Currency Volatility Index, a common measure, has dropped to levels not seen since before the pandemic. Lower volatility means less risk that exchange rate swings will wipe out the interest income.
Goldman expects the yen to remain a cheap currency to borrow, given Japan's interest rates are still among the world's lowest. The bank also likes long USD/SEK (buying US dollars against Swedish krona), EUR/CHF (euro against Swiss franc), and AUD/NZD (Australian dollar against New Zealand dollar) for investors who want steadier risk-adjusted returns.
The risks that can't be ignored
There's cause for caution, though. Carry trades can unravel quickly if volatility spikes, especially when they're crowded. Add leverage, emerging-market currencies, or a sudden yen rally into the mix, and modest currency moves can wipe out months of income.
The classic risk is a "carry crash" – a sudden shift in market sentiment that causes investors to flee risky currencies and pile into safe havens. That's exactly what happened in 2008 and again during the COVID-19 selloff in March 2020. In both cases, carry trades suffered double-digit losses in a matter of days.
Another risk is central bank policy changes. If the Bank of Japan were to raise rates or signal a shift away from its ultra-loose stance, the yen could strengthen sharply, punishing those who borrowed yen to fund carry trades. That's a scenario some analysts have warned about, though Goldman sees it as unlikely in the near term.
For everyday investors, carry trades are not something to try at home without understanding the risks. Currency markets are highly leveraged, and even small moves can lead to big losses. Most retail investors access carry trade strategies through exchange-traded funds (ETFs) or managed currency funds, which offer some diversification but still carry significant risk.
What it means for investors
The Goldman Sachs analysis is a reminder that in today's high-interest-rate world, there are still opportunities to earn income from currency markets. But it's also a warning that those opportunities come with strings attached.
For investors with a diversified portfolio, carry trades can provide a source of return that is not closely correlated with stocks or bonds. That can be valuable in a year when traditional asset classes have struggled. However, the strategy is best suited for those with a high risk tolerance and a long time horizon.
As always, past performance is no guarantee of future results. The same conditions that make carry trades attractive today – wide rate gaps and low volatility – could reverse quickly. Investors should be prepared for that possibility and avoid overconcentrating in any single strategy.
For more on how interest rate differentials are shaping markets, see our coverage of Handelsbanken's Q2 results and Wells Fargo's net interest income growth. And for a broader look at how banks are navigating the current environment, check out our analysis of bank earnings and the Russell 2000.
