An Unconventional Carry Strategy is a modern evolution of the classic carry trade, designed to profit from interest rate differentials while addressing the limitations and risks of traditional carry approaches. Instead of simply borrowing in low-yielding currencies and investing in high-yielders, unconventional carry strategies incorporate volatility management, dynamic hedging, alternative funding sources, and macro overlays to optimise returns and control downside risks.

This article explores how to build an Unconventional Carry Strategy, the innovative techniques used by professional FX and macro traders, and how it differs from classic carry trading.

Why Move Beyond Traditional Carry?

• High volatility in high-yield currencies can erase carry gains quickly.
• Correlation breakdowns: Safe-haven currencies can strengthen during crises, hurting carry positions.
• Global interest rates have converged post-2008, reducing simple carry trade opportunities.
• Tail risks: Sharp unwinds during liquidity shocks (e.g., GFC 2008, COVID-19 crash) can cause catastrophic losses.

Unconventional strategies aim to capture carry premium while controlling exposure to market stress and dynamic volatility regimes.

Core Components of an Unconventional Carry Strategy

1. Volatility-Adjusted Carry Selection

• Only enter carry trades when realised volatility is low relative to implied volatility.
• Prefer stable high-yield currencies over volatile ones.
• Weight positions by carry-to-volatility ratios rather than just interest differentials.

Example:
If USD/MXN and AUD/NZD offer similar carry, but MXN volatility is twice as high, overweight AUD/NZD instead.

2. Dynamic Hedging Against Tail Risk

• Build hedges using options (e.g., buying cheap out-of-the-money puts on high-yielders).
• Dynamically adjust exposure if risk indicators (VIX, MOVE, credit spreads) spike.
• Use cross-hedges (e.g., long JPY vs basket) during early signs of global stress.

Strategy idea:
Long TRY/JPY carry, but hedge systemic risk by maintaining small long JPY positions against USD.

3. Macro-Conditioned Carry Exposure

• Link carry exposure to macro signals:
  • Positive global growth → Max carry exposure.
  • Rising volatility, falling PMIs → Reduce or hedge carry exposure.
• Use leading indicators like OECD CLI, global PMIs, or EM credit growth.

Tactical approach:
Scale down carry trades if global PMIs fall below 50 or US yield curve inverts.

4. Funding Innovations

• Instead of only borrowing low-yield currencies (e.g., JPY, CHF), use:
  • Negative yielding bonds (e.g., bunds, JGBs) as funding sources.
  • FX swaps or synthetic forwards for leveraged funding at attractive rates.
• Dynamically rotate funding legs based on short-term funding cost shifts.

Example:
Use EUR as a funding currency when ECB rates are negative and swap-implied funding cost is lower than USD.

5. Portfolio Diversification and Cross-Asset Carry

• Blend FX carry with bond carry (long high-yield sovereigns) and equity carry (high-dividend stocks).
• Diversify across regions: LATAM, Asia EM, Eastern Europe.
• Avoid concentration in one type of risk (e.g., commodity currency risk).

Best practice:
Construct a diversified basket of AUD/JPY, MXN/JPY, and BRL/CHF carry trades instead of concentrating only on EM FX.

Example Unconventional Carry Trade Setup

Scenario:

• Global volatility low (VIX below 15).
• Global PMIs above 52.
• US rates stable; EM inflows rising.

Strategy:

• Long AUD/JPY and MXN/JPY equally weighted.
• Hedge via long USD/JPY puts (deep out-of-the-money).
• Allocate smaller position to long Indonesian bonds (IDR exposure) for bond carry.
• Monitor VIX, USD funding spreads, and EM bond ETF flows daily for risk triggers.

Risks and How to Manage Them

Risk	Mitigation
Sharp volatility spikes	Pre-position with tail risk hedges (options)
Funding cost shocks	Use diversified funding currencies
Macro regime shifts	Link carry exposure to macro indicators
Liquidity traps during crisis	Trade liquid currency pairs and bonds; avoid exotic illiquid markets

Advantages of Unconventional Carry Strategies

• Higher risk-adjusted returns than traditional simple carry.
• Better drawdown control during crisis periods.
• Flexible funding and hedging structures allow for adaptive positioning.
• Cross-asset opportunities expand profit sources beyond FX.

Conclusion

Unconventional Carry Strategies represent the future of smart global macro trading. By combining dynamic hedging, volatility-aware positioning, diversified funding, and macro-sensitive allocation frameworks, traders can consistently capture carry premium while mitigating the historically catastrophic risks associated with old-school carry trades.

To learn how to design dynamic carry models, build volatility-conditioned macro frameworks, and master crisis-resilient portfolio construction, enrol in our Trading Courses designed for institutional macro traders, FX specialists, and cross-asset strategists.