What is the Carry Trade?
A trade where you borrow and pay interest in order to buy something else that has higher interest. For example, with a positively sloped term structure (short rates lower than long rates), one might borrow at low short term rates and finance the purchase of long-term bonds. The carry return is the coupon on the bonds minus the interest costs of the short-term borrowing. Of course, if long-term interest rates unexpectedly rose (and long-term bond prices fell as a result), the carry trade could become unprofitable. Indeed, if this occurred, there could be a number of investors trying to unwind the carry trade, which would involve selling the long-term bonds. It is possible that this could exacerbate the increase in long-term interest rates, i.e. push the rates even higher. Carrying over the opportunity to make money by borrowing money at say 1% and then, for example, reinvesting those borrowed proceeds at 2%.
