The biggest influence that drives the foreign-exchange market is interest rate changes made by any of the eight global central banks. These changes are an indirect response to other economic indicators made throughout the month, and they possess the power to move the market immediately and with full force. Because surprise rate changes often make the biggest impact on traders, understanding how to predict and react to these volatile moves can lead to quicker responses and higher profit levels.

Read Get To Know The Major Central Banks for background on these financial institutions. Interest Rate Basics Interest rates are crucial to day traders on the forex market for a fairly simple reason: Read A Primer On The Forex Market for background information. Of course, the risk in this strategy is currency fluctuation, which can dramatically offset any interest-bearing rewards.

It is worth stating that while you may always want to buy currencies with higher interest funding them with those of lower interest , it is not always a wise decision. If trading on the forex market were this easy, it would be highly lucrative for anyone armed with this knowledge.

Read more about this type of strategy in Currency Carry Trades Deliver. That isn't to say that interest rates are too confusing for the average day trader ; just that they should be viewed with a wary eye, like any of the regular news releases. Read Trading On News Releases to learn more. How Rates Are Calculated Each bank's board of directors controls the monetary policy of its country and the short-term rate of interest at which banks can borrow from one another.

The central banks will hike rates in order to curb inflation, and cut rates to encourage lending and inject money into the economy. Typically, you can have a strong inkling of what the bank will decide by examining the most relevant economic indicators, namely:. Read more about the CPI and other signposts of economic health in our Economic Indicators tutorial. Predicting Central Bank Rates Armed with data from these indicators, a trader can practically put together an estimate for the Fed's rate change.

Typically, as these indicators improve, the economy is going well and rates will either need to be raised or, if the improvement is small, stay the same. On the same note, significant drops in these indicators can mean a rate cut in order to encourage borrowing.

Read more about the factors that influence interest rate changes in Forces Behind Interest Rates. Major Announcements Major announcements from central bank heads tend to play a vital role in interest rate moves, but are often overlooked in response to economic indicators. That doesn't mean they are to be ignored.

Any time a board of directors from any of the eight central banks is scheduled to talk publicly, it will usually give an insight into how the bank views inflation.

For example, on July 16, , Federal Reserve Chairman Ben Bernanke gave his semiannual monetary policy testimony before the House Committee. At a normal session, Bernanke reads a prepared statement about the U.

Forex Compound Interest Effects

At this session, he did the same. Read more about the head of the Fed in Ben Bernanke: Bernanke, in his statement and answers, was adamant that the U. The 10am session was widely followed by traders, and because it was positive, it was anticipated that the Federal Reserve would raise interest rates, which brought a short-term rally by the dollar in preparation for the next rate decision.

Forecast Analysis The second useful way to predict interest rate decisions is through analyzing predictions. Because interest rates moves are usually well anticipated, brokerages, banks and professional traders will already have a consensus estimate as to what the rate is.

Currency Interest Rates | OANDA

Traders should take four or five of these forecasts which should be very close numerically and average them in order to gain a more accurate prediction.

What to Do When a Surprise Rate Occurs No matter how good your research is or how many numbers you have crunched before a rate decision is made, central banks can throw a curve ball and knock all predictions out of the park with a surprise rate hike or cut. When this happens, you should know which direction the market will move. If there is a rate hike, the currency will appreciate, which means that traders will be buying it.

If there is a cut, traders will probably be selling it and buying currencies with higher interest rates. Once you have determined this:. In July , the Bank of New Zealand had an interest rate of 8. The rate had been steady over the previous four months, as the NZD was a hot commodity for traders to purchase due to higher rates of return. While the quarter-percentage drop seems small, forex traders took it as a sign of the bank's fear of inflation and immediately withdrew funds, or sold the currency and bought others - even if those others had lower interest rates.

Learn how commodities influence the New Zealand dollar in Commodity Prices And Currency Movements. As a side note, it is import to read through the actual central bank press release after determining whether there has been a surprise rate change to gain understanding of how the bank views future rate decisions.

The data in the release will often induce a new trend in the currency after the short-term effects have taken place. The Bottom Line Following the news and analyzing the actions of central banks should be a high priority to forex traders because as they determine their region's monetary policy, currency exchange rates tend to move. As currency exchange rates move, traders have the ability to maximize profits - not just through interest accrual from carry trades , but also from actual fluctuations in the market.

Thorough research analysis can help a trader avoid surprise rate moves and react to them properly when they inevitably happen. For related reading, see Formulating Monetary Policy. Dictionary Term Of The Day. A measure of what it costs an investment company to operate a mutual fund.

Latest Videos PeerStreet Offers New Way to Bet on Housing New to Buying Bitcoin? This Mistake Could Cost You Guides Stock Basics Economics Basics Options Basics Exam Prep Series 7 Exam CFA Level 1 Series 65 Exam. Sophisticated content for financial advisors around investment strategies, industry trends, and advisor education. Why Interest Rates Matter For Forex Traders By David Hunt Share.

Typically, you can have a strong inkling of what the bank will decide by examining the most relevant economic indicators, namely: The Consumer Price Index CPI Consumer spending Employment levels Subprime market Housing market Read more about the CPI and other signposts of economic health in our Economic Indicators tutorial.

Outside of economic indicators, it is possible to predict a rate decision by: Watching for major announcements Analyzing forecasts Major Announcements Major announcements from central bank heads tend to play a vital role in interest rate moves, but are often overlooked in response to economic indicators. Once you have determined this: The market tends to move at lightning speeds when a surprise hits, because all traders vie to buy or sell depending on hike or cut ahead of the crowd, which can lead to a significant profit if done correctly.

Be aware of a volatile trend reversal.

A trader's perception tends to rule the market at the first release of data, but then logic comes into play and the trend will most likely continue on in the way it was going. The following example illustrates the above three steps in action. The Consumer Price Index is a broad measure of inflation, and inflation can have a dramatic impact on a currency's value against rival currencies.

The policies of these banks affect the currency market like nothing else.

See what makes them tick. Learn about the forex market and some beginner trading strategies to get started. Interest rates can have a complicated ripple effect through financial markets.

Here's what you need to know. Central banks use these strategies to calm inflation, but they can also provide longer-term clues for forex traders. Here we examine some telling patterns in the relation between countries' interest rates and their currency pairs.

Currencies can provide diversification for a portfolio that's in a rut. Find out which ones you need to know. We go over some of the things you need to understand before you can trade currencies. Interest rates can have both positive and negative effects on U. Knowing the factors and indicators to watch will help you keep pace in the competitive and fast-moving world of forex.

Discover the impact of interest rates on the profitability of the banking sector. When rates rise, profits increase for the In general, as interest rates are lowered, more people are able to borrow more money, causing the economy to grow and inflation Learn about the most important interest rates in the economy; the Federal funds rate and discount rate are set by the Federal Inflation is closely related to interest rates, which can influence exchange rates.

Countries attempt to balance interest An expense ratio is determined through an annual A hybrid of debt and equity financing that is typically used to finance the expansion of existing companies.

A period of time in which all factors of production and costs are variable. In the long run, firms are able to adjust all A legal agreement created by the courts between two parties who did not have a previous obligation to each other.

Interest Rates and the FX Market

A macroeconomic theory to explain the cause-and-effect relationship between rising wages and rising prices, or inflation. A statistical technique used to measure and quantify the level of financial risk within a firm or investment portfolio over No thanks, I prefer not making money. Content Library Articles Terms Videos Guides Slideshows FAQs Calculators Chart Advisor Stock Analysis Stock Simulator FXtrader Exam Prep Quizzer Net Worth Calculator.

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