If you have spent any time following foreign exchange markets, you have probably come across the term “carry trade.” It is one of the oldest and most widely used strategies in currency trading, and the Australian dollar has long sat at the centre of it. Understanding why can shed light on some of the bigger forces driving the AUD on any given day.

What Is the Carry Trade?

At its simplest, a carry trade involves borrowing money in a currency with low interest rates and investing it in a currency with higher rates. The trader pockets the difference — the “carry” — provided exchange rates do not move against them too sharply.

For example, imagine borrowing Japanese yen at an interest rate near zero and converting it into Australian dollars earning four or five per cent. If the AUD/JPY exchange rate stays flat, you earn that interest rate differential for free. In practice, of course, exchange rates rarely stay flat.

Why the AUD?

Australia has historically maintained higher interest rates than most developed economies. Through much of the 2000s and 2010s, the Reserve Bank of Australia’s cash rate sat well above those of the US Federal Reserve, the European Central Bank, and especially the Bank of Japan. Even when the RBA cut rates during the pandemic, Australia’s relative rate advantage returned faster than many expected.

Several factors explain this persistent rate premium. Australia’s economy is tightly linked to commodity exports — iron ore, coal, natural gas, and agricultural products. When commodity prices rise, export revenues pour into the country, boosting growth and putting upward pressure on inflation. The RBA responds by keeping rates higher than its counterparts in countries with less commodity exposure.

There is also the structural factor of Australia’s current account. For decades, Australia ran persistent current account deficits, meaning the country needed to attract foreign capital. Higher interest rates served as an incentive for overseas investors to park their money here. That dynamic has shifted somewhat in recent years as the trade balance has improved, but the rate premium persists.

The Risks Are Real

Carry trades work beautifully — until they do not. The strategy is sometimes described as “picking up pennies in front of a steamroller.” Returns trickle in steadily during calm markets, but when risk sentiment turns, carry trade currencies can fall violently.

The AUD is particularly sensitive to global risk appetite. During the 2008 financial crisis, the Australian dollar plunged from above 0.98 USD to below 0.61 USD in a matter of months as carry trades were unwound en masse. Traders who had borrowed yen to buy AUD were suddenly scrambling to close positions, amplifying the sell-off.

This pattern repeats in miniature during every bout of market stress. When equity markets tumble or geopolitical tensions spike, the AUD tends to weaken as carry trades are reversed. It is one reason why the Australian dollar is sometimes called a “risk-on” currency.

What This Means for Everyday Australians

You do not need to be running a carry trade to feel its effects. When global investors pile into AUD carry trades, demand for the dollar rises, pushing the exchange rate higher. That is good news if you are planning an overseas holiday or buying imported goods. When those trades unwind, the dollar falls, making imports more expensive and overseas travel pricier.

For businesses, carry trade flows add a layer of volatility that can make hedging decisions more complicated. An exporter might see the AUD strengthen beyond what economic fundamentals suggest, squeezing margins. An importer might enjoy a temporarily strong dollar, only to see it reverse sharply.

The Algorithmic Dimension

It is worth noting that much of the carry trade today is executed by quantitative funds and algorithmic systems that can move billions in milliseconds. Firms like the Team400 team are among those building sophisticated analytical tools that help institutional players and advisers interpret these fast-moving flows. The days of carry trades being placed by a trader on a phone are long gone — today it is a data-driven, machine-speed business.

Looking Ahead

As of early 2025, the carry trade remains relevant. The RBA has kept rates higher for longer than many expected, and the interest rate differential between Australia and Japan — still the most popular funding currency — remains wide. But with global central banks navigating uncertain inflation paths, the calculus could shift quickly.

For anyone watching the Australian dollar, understanding the carry trade is essential. It is not the only factor driving the currency, but it is one of the most persistent and powerful. When you see the AUD move sharply on a day without any obvious Australian news, there is a decent chance the carry trade is involved.

James Hargreaves is a Sydney-based financial journalist covering currency markets and macroeconomic trends.