Interest rate differential

The difference between the rate applying to one currency and the rate applying to another, taken over the same period. On a currency pair it is the rate on the base currency less the rate on the quote currency, and its sign is what decides the direction of the adjustment applied to a position held past the daily cut-off. A position is a claim in one currency funded in the other, so the two legs accrue at their own rates and only the net of them is applied.

The mechanism is the value date. A spot currency deal settles a set number of days after it is struck, and a position kept open is rolled to the next value date rather than settled, with the differential applied as the cost or credit of doing so. Providers derive their published swap figures from market forward points and add a handling charge, so the applied figure and the pure differential are not the same number, and a differential in a holder's favour does not always arrive as a credit once that charge is deducted.

The overstated part is what it predicts. Borrowing a low rate currency to hold a high rate one is the carry trade, and its logic assumes the exchange rate does not move enough to erase the accrual, which is exactly what happens in periods of stress. Uncovered interest parity, the theory that the higher yielding currency should weaken by the differential, fails persistently in the data, and economists have argued about the reason for decades without settling it.