Carry Trade Cost Comparison Across Countries: Essential Guide for Swap Traders

Carry Trade Fundamentals

Carry trading is an investment strategy that captures interest rate differentials (swap points) by borrowing (selling) low-interest currencies to invest in (buy) high-interest currencies. While one of the most classic and popular methods in FX markets, surprisingly few traders accurately understand its profit structure and risks.

Basic Structure of Carry Trades

Element	Content	Example (MXN/JPY)
Funding Currency	Sell low-interest currency	Japanese Yen (policy rate: 0.1%)
Investment Currency	Buy high-interest currency	Mexican Peso (policy rate: 11.25%)
Interest Differential	Investment rate - Funding rate	11.25% - 0.1% = 11.15%
Daily Swap	Interest differential / 365 x position	~$0.20/day (per 10,000 units)

Uncovered Interest Rate Parity (UIP) Theory

Economic theory suggests interest rate differentials should be offset by exchange rate changes (Uncovered Interest Parity). Meaning, high-interest currencies should depreciate by the interest differential amount.

Theoretically, carry trade expected returns should be zero, but high-interest currencies tend not to depreciate as much as theory suggests. This is called the "forward premium puzzle" and provides the rationale for profit opportunities in carry trading.

Conditions for Successful Carry Trades

• Low volatility environment: Effective when FX fluctuations are small
• Risk-on markets: When investors are taking risk
• Stable interest differentials: When monetary policy is predictable
• Adequate liquidity: When markets are stable and tradeable

Carry Trade Cost Structure

To evaluate true carry trade profitability, consider all costs beyond surface interest differentials.

Explicit Costs

Cost Item	Content	Estimate
Spread	Bid-ask spread (at trade execution)	0.2-3.0 pips (varies by pair)
Swap Spread	Difference between theoretical and actual swap	10-30% deviation typical
Commission	Some brokers charge	$0-several per trade
Account Maintenance	Some offshore brokers charge	$0-several monthly

Implicit Costs

1. Slippage: Difference between order and execution price
2. Rollover costs: Swap adjustments during weekends/events
3. Opportunity cost: Opportunity cost of margin tied up as collateral
4. Taxes: Tax on swap income (varies by jurisdiction)

Specific Cost Calculation Example

For a 100,000 unit MXN/JPY carry trade held for one year:

Item	Calculation	Amount
Annual swap income (pre-tax)	$0.20/day x 365 days x 10	$730
Spread cost	0.3 pips x 100,000 units	-$30
Net income		$700
Required margin (25x)	$5,500 x 100,000 / 25	$2,200
Annual yield (on margin)	$700 / $2,200	~32%

However, this calculation ignores exchange rate fluctuations. In reality, FX gains/losses are the largest variable.

Country-by-Country Comparison

Comparing interest rate levels and carry trade characteristics by country.

High-Yield Country Comparison (As of 2024)

Country/Currency	Policy Rate	Inflation	Real Rate	Liquidity	Overall Rating
Turkey (TRY)	45.0%	65%	-20%	Medium	Dangerous
Mexico (MXN)	11.25%	4.5%	+6.75%	High	Good
South Africa (ZAR)	8.25%	5.5%	+2.75%	High	Good
Brazil (BRL)	10.75%	4.0%	+6.75%	Medium	Good
Hungary (HUF)	7.75%	4.0%	+3.75%	Medium	Fairly Good
Poland (PLN)	5.75%	3.5%	+2.25%	Medium	Fairly Good

Low-Interest Funding Currency Comparison

Country/Currency	Policy Rate	Characteristics	Funding Currency Rating
Japan (JPY)	0.1%	Lowest rate, high liquidity	Optimal
Switzerland (CHF)	1.5%	Safe haven, appreciates in risk-off	Good
Euro (EUR)	4.5%	Rising rates, increasing funding cost	Average
China (CNH)	3.45%	Regulations, trading restrictions	Limited

Selecting Optimal Carry Pairs

Ideal carry pairs meet the following conditions:

• High interest differential: Source of swap points
• Positive real rate differential: Sustainability indicator
• Low volatility: Reduces FX loss risk
• Sufficient liquidity: Ensures spread and execution
• Political stability: Avoids sudden risk events

Importance of Real Yield Analysis

Real yield analysis (nominal rate - inflation) is crucial for judging carry trade sustainability.

Why Real Yields Matter

Even with high nominal rates, if inflation is equal or higher, currency purchasing power declines. This leads to long-term currency depreciation, eroding carry trade returns.

Turkey's nominal rate of 45% is impressive, but considering 65% inflation, real rate is -20%. This means rapid currency value erosion, with FX losses likely far exceeding swap income.

Real Rate Differential Calculation

Pair	Investment Country Real Rate	Funding Country Real Rate	Real Rate Differential
MXN/JPY	+6.75%	-2.0%	+8.75%
ZAR/JPY	+2.75%	-2.0%	+4.75%
TRY/JPY	-20.0%	-2.0%	-18.0%
BRL/JPY	+6.75%	-2.0%	+8.75%

Currency Selection Based on Real Yields

1. Positive real rate differential: Consider as carry trade candidate
2. Near-zero real rate differential: Decide on factors other than interest
3. Negative real rate differential: Generally avoid

Monitoring Inflation Trends

To continue real yield analysis, regularly check:

• Monthly CPI releases
• Central bank inflation outlooks
• Break-even inflation rates (market expectations)
• Core inflation trends

Broker Swap Point Comparison

Swap points vary significantly by FX broker even for the same currency pair. For carry traders, broker selection directly impacts returns.

Swap Point Determinants

• Interbank rates: Benchmark rates
• Broker margin: Revenue deducted by broker
• Cover counterparties: Conditions of broker's financial institution partners
• Business strategy: Incentives for customer acquisition

Major Broker Swap Comparison (MXN/USD, per 10,000 units/day)

Broker	Long Swap	Short Swap	Spread	Overall Rating
Broker A	$0.28	-$0.31	2 pips	Excellent
Broker B	$0.26	-$0.29	3 pips	Good
Broker C	$0.24	-$0.30	2 pips	Good
Broker D	$0.22	-$0.28	4 pips	Average
Broker E	$0.18	-$0.35	5 pips	Review Needed

Note: Swap points fluctuate daily; check each broker's site for latest information.

Broker Selection Checklist

1. Swap point level: Compare same currency pairs
2. Swap stability: No sudden changes
3. Combined spread evaluation: Consider entry costs too
4. Platform usability: Monitoring for long-term holding
5. Financial stability: Segregated accounts, financial condition

Multiple Account Strategy

When optimal brokers differ by currency pair, maximize returns by using multiple accounts:

• MXN pairs - Broker A (best swap)
• ZAR pairs - Broker B (best swap)
• TRY pairs - Broker C (tightest spread)

Carry Trade Risk Management

Carry trades have an asymmetric return profile: "steady gains in normal times, rapid losses in crisis." Proper risk management is essential.

Key Carry Trade Risks

1. Exchange Rate Risk

Swap points annualize to 5-15%, but exchange rates can move 20-30% in short periods. FX losses can significantly exceed swap income.

2. Carry Trade Unwinding

During risk-off, many investors simultaneously close carry positions. This accelerates high-yield currency declines, amplifying losses.

3. Interest Rate Risk

Central bank policy changes may narrow or reverse interest rate differentials.

4. Liquidity Risk

During crises, emerging currency liquidity significantly decreases, potentially preventing closure at desired prices.

Specific Risk Management Techniques

Technique	Content	Effect
Leverage limits	Keep effective leverage at 3x or below	Avoid forced liquidation during crashes
Diversification	Spread across multiple high-yield currencies	Reduce country-specific risk
Stop-loss	Pre-set loss limits	Cap maximum losses
Regular profit-taking	Regularly realize unrealized gains	Lock in profits
VIX monitoring	Stay alert when fear index rises	Early warning system

Position Size Determination

Recommended position sizing formula for carry trades:

1. Set maximum acceptable loss (e.g., 10% of capital)
2. Check historical maximum drawdown (e.g., 30%)
3. Maximum position = Max acceptable loss / Max drawdown
4. Example: 10% / 30% = 33% of capital in positions

There's a saying: "Carry trades climb stairs and fall down elevators." Be prepared for rapid declines during risk-off, always maintaining conservative position sizes for long-term success.

Optimal Carry Trade Strategy

Based on the above analysis, presenting optimal carry trade strategies.

Strategy 1: Conservative Carry Strategy

Element	Setting
Target currencies	MXN, ZAR (positive real rates)
Leverage	2-3x
Diversification	Equal weight across 2-3 pairs
Stop-loss	15% below entry
Holding period	6 months - 1 year
Target return	15-25% annually (excluding FX)

Strategy 2: Tactical Carry Strategy

1. Environment assessment: Check VIX, risk sentiment
2. Risk-on: Expand carry positions (3-5x leverage)
3. Cautious: Halve positions
4. Risk-off: Close positions or hedge in opposite direction

Strategy 3: Basket Carry Strategy

Combine multiple high-yield currencies to diversify regional/currency risk:

• Asia: IDR (Indonesian Rupiah), INR (Indian Rupee)
• Latin America: MXN (Mexican Peso), BRL (Brazilian Real)
• Africa: ZAR (South African Rand)
• Eastern Europe: HUF (Hungarian Forint), PLN (Polish Zloty)

Optimal Entry Timing

• Technical: Buy near support lines
• Sentiment: Bounce after excessive pessimism
• Macro: At rate hike cycle start, or during high-rate stability
• Seasonality: Year-start (January effect), September after summer lull

Exit Strategy

1. Profit-taking: Target return reached, or significant FX appreciation
2. Stop-loss: Stop-loss triggered
3. Environment change: Rate differential narrows, political risk materializes
4. Regular rebalancing: Review portfolio quarterly

---

Carry trading, when properly managed, can be a stable income source, but underestimating risk leads to significant losses. Focus on real yields not just nominal rates, implement diversification across multiple currencies and conservative leverage management for long-term success. Swap investing is not a "get rich quick" method but a strategy to "slowly and steadily grow wealth."