Carry Trade Alert: BNY Warns of Growing Profit-Taking Risk in Second Half

Bank of New York Mellon (BNY) has issued a cautious outlook for carry trade strategies in the second half of 2025, warning that profit-taking risks are building as market conditions shift. The alert comes as traders reassess exposure to high-yielding currencies amid fluctuating interest rate expectations and rising volatility.

What BNY’s Warning Means for Carry Trade Investors

Carry trades, which involve borrowing in low-interest-rate currencies to invest in higher-yielding ones, have been a popular strategy in recent months. However, BNY’s analysis points to several factors that could trigger a wave of profit-taking, including potential shifts in central bank policies and a narrowing of interest rate differentials. The bank’s strategists note that positioning has become crowded, making the strategy vulnerable to sudden reversals.

Key risks highlighted by BNY include the possibility of the Bank of Japan adjusting its yield curve control policy, which could strengthen the yen and unwind popular carry trades funded by the Japanese currency. Additionally, any surprise dovish pivot from the Federal Reserve would compress rate differentials, reducing the appeal of dollar-funded carry positions.

Market Context and Historical Precedents

The warning arrives during a period of relative calm in currency markets, but historical patterns suggest that carry trades often face sharp corrections when volatility spikes. The VIX index, a measure of equity market volatility, has remained subdued, but BNY cautions that this could change quickly as geopolitical uncertainties and data-dependent central banks keep investors on edge.

Analysts point to the 2023 carry trade unwind as a cautionary tale, where sudden yen strength triggered cascading losses. While the current environment differs, the core risk of crowded positioning remains similar.

Implications for Retail and Institutional Traders

For retail forex traders, BNY’s warning suggests a need to tighten risk management, including reducing leverage and setting stop-losses on carry trade positions. Institutional investors may consider hedging through options or reducing exposure to the most crowded trades, particularly those involving the yen and Swiss franc.

The broader takeaway is that the second half of 2025 may not reward passive carry trade strategies as generously as the first half. Active monitoring of central bank communications and volatility indicators will be essential.

Conclusion

BNY’s analysis serves as a timely reminder that carry trades, while historically profitable in stable conditions, carry significant tail risks. As the second half unfolds, traders should prepare for potential profit-taking events that could disrupt currency markets. The warning underscores the importance of diversification and proactive risk management in an environment where central bank policies remain the dominant driver of forex returns.

FAQs

Q1: What is a carry trade in forex?
A carry trade involves borrowing a currency with a low interest rate and using the proceeds to buy a currency with a higher interest rate, profiting from the interest rate differential. It is a popular strategy among forex traders seeking steady returns.

Q2: Why is BNY warning about profit-taking risk now?
BNY sees several converging factors, including crowded positioning, potential central bank policy shifts (especially from the Bank of Japan and Federal Reserve), and a possible rise in volatility that could trigger a rapid unwinding of carry trades.

Q3: How can traders protect themselves from a carry trade reversal?
Traders can reduce leverage, use stop-loss orders, diversify across multiple currency pairs, and monitor central bank announcements closely. Hedging with options or reducing exposure to the most vulnerable trades (e.g., yen-funded carries) is also advisable.