Monetary policy transmission to exchange rates: the role of currency carry trades

Key takeaways 

• Carry trade activity can shape the exchange rate response to monetary policy. Significant short positions of carry traders in funding currencies amplify the impact of policy tightening.
• This amplification arises from the unwinding of leveraged carry trade positions accumulated prior to the policy announcement, creating a state-dependent monetary policy transmission to the exchange rate.
• The currency trading strategies of hedge funds and other leveraged investors can play a key role in shaping the exchange rate response to monetary policy and therefore warrant careful monitoring.

The views expressed in this publication are those of the authors and do not necessarily reflect the views of the BIS or its member central banks.