Negative Carry Pair
What it is:
How it works/Example:
For example, if short-term interest rates in Country A are 2% per year and long-term interest rates in Country B are 5% per year, an investor could create a negative carry pair by buying Country A's currency and shorting Country B's currency. The end result is that the investor's cash obligations on the short position (pay out 5%) exceed the investor's cash inflows from the long position (earn 2%), creating a negative carry of 3% per year.
Why it matters:
When a country offers relatively high interest rates, it attracts more capital. This increase in demand in turn increases the value of the country's currency. Though the typical trading strategy is to buy the currency that has the higher interest rate and short the currency that has the lower interest rate, when a trader does the opposite (a negative carry pair), he or she is signaling that the country with the lower interest rate may soon experience significant economic strengthening -- to the point that the benefits outweigh the cost of enduring a negative carry pair. Thus, volatility in interest rates is a key component of making a negative carry pair pay off.