How Does the Interest Rate Environment Impact the Financing Component of the Cost of Carry?

A higher interest rate environment directly increases the financing component of the cost of carry. Arbitrageurs typically borrow funds to buy the spot asset in a cash-and-carry trade.

If interest rates rise, the cost of borrowing increases, which in turn raises the theoretical futures price. This narrows the profitable arbitrage window and can potentially shift the market from contango toward backwardation if the rate rise is significant.