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Funding currency

The low-yielding currency a trader borrows or sells short to finance a position in a higher-yielding one.

The yen and the Swiss franc have been the archetypes, with the euro joining them during its negative rate years. Being a funding currency has consequences: it tends to be weak while the carry is on, then strengthen sharply when risk is cut, because closing positions means buying it back.

This is why the yen often rallies on bad news that has nothing to do with Japan. It is a position effect, not a judgement about the Japanese economy. See safe-haven-currency for the overlapping but distinct idea.

Example: with Japanese rates at 0.3% and Mexican rates at 10.5%, a yen-funded peso position earns about 10.2% a year. If the yen gains 12% in a month, that year of carry is gone and the position is down roughly 2%.

Related: carry-trade, carry-unwind, yen-cross

See it drawn

Original diagrams for the ideas on this page. Illustrative, not real market data.

Contango and backwardationTwo futures curves against contract expiry: one rising above spot, one falling below it.The same commodity, priced for delivery at different dates.78.0076.0074.0072.0070.00Futures pricespot+1m+2m+3m+4m+5m+6mMonths until the contract expiresspot price74.00CONTANGOlater contracts cost more than spotBACKWARDATIONlater contracts cost less than spot
Contango and backwardation. A futures curve shows what buyers will pay for delivery in one month, two months and so on. When later contracts cost more than the spot price the curve is in contango; when they cost less it is in backwardation.

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