FX Carry
Earn the interest rate differential by going long high-yield and short low-yield currencies, with vol scaling.
Thesis (edge)
Currencies with higher interest rates tend to earn carry over time. By going long high-carry and short low-carry, and scaling by volatility, we capture the risk premium while limiting drawdowns.
Where it works (regimes)
Works in risk-on, low-vol regimes. Fails in sudden risk-off (e.g. 2008, March 2020) when carry trades unwind. Use vol targeting and correlation awareness.
Signals
- Carry = 3m interest rate differential (or forward points).
- Rank G10 (or EM) currencies; long top 3, short bottom 3 (or long/short spread).
- Scale by inverse vol (e.g. target 10% portfolio vol).
Portfolio construction
Equal weight or vol-weighted within long and short baskets. Rebalance monthly. Max single-currency exposure.
Risk model
Tail: coordinated unwind. Stress: correlation to equities in crises. Consider trend filter (reduce exposure when trend opposes carry).
Costs & implementation
Moderate turnover. FX spreads and swap costs. Use institutional execution where possible.
Failure modes
Picking up “value trap” currencies (high carry, about to devalue). Ignoring regime.
Our Notes & Suggestions
Combine with simple trend filter (e.g. only hold carry when trend is favorable). Avoid over-concentration in one region. Backtest with realistic FX costs.
Our Notes & Suggestions
See the "Our Notes" subsection in the body above for practical guidance, gotchas, and best practices. Always validate regime assumptions and transaction cost assumptions before scaling.
Implementation Checklist
- Source 3m forward points or rates
- Rank currencies by carry; filter by vol
- Vol-scale position sizes
- Define max drawdown / deleverage rule