What Is a Funding Currency?
What is a funding currency? It is the currency traders borrow, or sell, to pay for positions in higher-yielding assets: the cheap leg of a carry trade. The classic funding currencies are the Japanese yen and the Swiss franc, whose interest rates spent years at the bottom of the developed world.
How the carry works
A carry trade pays the funding currency’s low rate, earns the target currency’s higher one and keeps the difference for as long as the position is open. The mechanics, with a worked example, are in Carry Trade Guide: How It Works and Why It Unwinds. The gaps that make carry pay are on Interest rate differential by currency pair and, after inflation, on Real interest rates by currency; what the gap is, and how to work it out, is in What Is an Interest Rate Differential?
Calm markets: a steady drift lower
In calm markets, each new carry position sells the funding currency. That steady flow keeps it soft whatever its domestic news. The position is comfortable while volatility stays low: the carry builds up day by day and the funding currency drifts lower.
Stress: the buy-back
Stress reverses this at once. Closing a carry trade means buying the funding currency back, and a shock can close a great many carry trades within days. A currency that drifted lower for months can then rise sharply against almost everything, just as other markets fall. This buy-back is part of why the yen behaves as a safe haven currency.
August 2024 is a recent case. On 31 July the Bank of Japan raised its policy rate to around 0.25% (Bank of Japan statement). In the turmoil of early August, the BIS found that FX carry trades were hit hard by the deleveraging, and put their size going in at a rough ¥40 trillion, about $250 billion (BIS Bulletin 90). The shock could not be forecast. How crowded the trade had become could be seen beforehand in the positioning data (What Is COT? The Commitments of Traders Report).
The yen and the franc
- The yen is the funding currency most traders think of first. Its rate gap with the US, the Bank of Japan and intervention are in Japanese Yen Fundamentals (JPY); how short leveraged funds are is on the Japanese yen COT report.
- The franc took the role while Swiss rates were below zero: the SNB cut its rate to −0.75% in January 2015 (SNB press release). Its story is in Swiss Franc Fundamentals (CHF), its positioning on the Swiss franc COT report.
Both COT pages read the CFTC’s weekly Traders in Financial Futures report (CFTC). Any currency with persistently low rates and deep markets can play the role; the euro did while the ECB’s rates were below zero (Euro Fundamentals (EUR)), and its positioning is on the Euro COT report.
Common mistakes
The first is reading a funding currency’s weakness as a verdict on its economy. When carry trades dominate, the weakness is flow, not fundamentals, and it can reverse without any domestic news at all.
The second is holding a short in a funding currency without watching volatility and positioning. The risk is not the slow daily drift but the sudden unwind. Watch the funding currency’s central bank above all: a rate rise narrows the gap, makes carry less attractive and can push positions to close, as the yen showed in 2024.