Global institutional investors, such as hedge funds and banks, are constantly on the lookout for the highest rate of return on their funds, and have no qualms about shifting their money around, in the global sense. This act of shifting huge amounts of money into high-yielding assets lays the foundation of the carry trade, since a carry trade is all about borrowing money at low interest rates and then using the funds to purchase higher yielding financial instruments from elsewhere, which can include bonds or even cash itself.
For quite some time, institutional or individual investors have been able to enjoy and exploit the large interest rate spread between US and Japan. Investors were drawn to borrowing the Japanese yen at near zero percent interest rate and using the money to buy US treasury bonds which gave them a much higher rate of return. The conversion of Japanese yen into US dollars for the purchase of the US bonds has resulted into a form of carry trade even though the asset may not be in cash because these assets are nonetheless denominated in the high-interest-rate currency. So it does not matter if investors are moving their money into bonds, currencies or other instruments, because it is ultimately cash that is changing hands.
This conversion from one currency to another is significant if it is done on a large scale as an increased demand for that high-interest-rate currency will cause that currency to appreciate against the low-yielding currency. Usually, birds of the same feather will flock together, with money attracting more money to the same place as other investors follow suit. Forex traders, sensing this snowballing effect, will then execute carry trades in the currency market, with the hope that there will be a continued demand for the high-yielding currency as they can then profit from the interest spread as well as from capital appreciation.
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