The cost of carry is one of the most reliable structural forces in FX. It’s simply the interest rate differential between the two currencies in a pair. While sentiment drives day-to-day moves, the cost of carry determines whether holding a position pays you or costs you over time.
What Cost of Carry Actually Means
For any currency pair:
Cost of Carry = Base currency rate - Quote currency rate
- Positive carry: you earn interest by holding the long position.
- Negative carry: you pay interest to hold it.
This differential matters because it affects forward pricing, trader positioning, and long-run capital flows.
Policy Rate Backdrop
Over the past two years, central banks have diverged significantly:
- RBA (AUD): lifted rates, then eased slightly.
- Fed (USD): hiked aggressively and held at elevated levels.
- ECB (EUR): tightened, then began cutting.
This divergence sets up three very different carry environments.
AUD/USD - A Negative Carry Environment
Carry = RBA rate - Fed rate
When the Fed sits well above the RBA, AUD/USD long positions pay the differential. This creates a steady drag:
- Forward points generally favour USD.
- Long AUD/USD positions become expensive to run.
- AUD needs strong fundamentals (e.g., commodities, China, risk sentiment) to offset that structural headwind.
EUR/USD - Consistently Negative Carry
Carry = ECB rate - Fed rate
EUR/USD has spent most of the period with deep negative carry. That has two effects:
- Long EUR/USD positions are costly.
- EUR tends to underperform during calm or risk-neutral periods.
Negative carry doesn't dictate the spot trend on its own, but it does shape the underlying pressure against the Euro over time.
AUD/EUR - A Positive Carry Example
Carry = RBA rate - ECB rate
Here the story flips: the RBA has held rates well above the ECB, producing a strong positive carry in AUD/EUR.
- That usually provides:
- A supportive floor under AUD/EUR.
- A favourable environment for carry-trade flows into AUD.
- Higher forward pricing for AUD versus EUR.
Why This Matters for FX Pricing
Cost of carry feeds directly into Interest Rate Parity, meaning rate differentials influence forward prices and medium-term capital flows.
- Positive carry pairs (like AUD/EUR) attract inflows and tend to be more resilient in quiet markets.
- Negative carry pairs (AUD/USD, EUR/USD) require strong macro catalysts to move higher because traders are paying to hold them.
Conclusion
Carry isn't the only driver of exchange rates, but it's a persistent force running in the background. Look at the charts and you’ll see the impact clearly; where rate differentials widen, forward pricing shifts and price action often follows.
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