What is a Negative Carry Pair?
Used in foreign exchange (forex), a negative carry pair refers to a situation in which the investor buys the currency of a country with low interest rates and shorts the currency of a country with high interest rates. It is the opposite of a positive carry pair trading strategy.
How Does a Negative Carry Pair Work?
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 Does a Negative Carry Pair Matter?
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.