The Fed offers the interest cut and a dovish statement on future rates, the USD will drop significantly. If the drop was higher than usual, like 0.50% instead of 0.25%, the market turmoil would sink the US dollar. On the other hand, if rates were kept as they are, investors would quickly buy back the USD and push it back up. So, you may use your a trusted forex broker to be a part of this process.
Interest rates therefore offer the possibility of speculating on the rise or fall of a currency, but also of investing on the basis of fundamental analysis and expected changes. Their importance is that they create opportunities but also risks due to increased market volatility.
What Is Interest Rate and How Is It Calculated?
For news trading strategies, everything around the interest rate matters the most.
So the purpose of interpreting all economic releases for forex traders (e.g. GDP, CPI, and unemployment) between two central bank meetings is to get an idea of what central banks will do next with the level of interest rate.
It is, most of the time, a decision of the central bank based on the examination of a number of relevant economic indicators in both short term and long term, such as
- Household spending
- Unemployment and sometimes
- The real estate market or the level of business investment.
By putting all these indicators together, a good Trader can therefore perfectly get an idea of the imminence of a decision, and, if they are smart enough, of its magnitude.
It's practically mechanical in analysis of trading in 2022: if conditions improve, rates don't move, or else they increase, to prevent a resumption of inflation. If they deteriorate, rates can be lowered to try to restart the machine. Many professional traders choose Exness Mt4 platform to trade.
Nominal Interest Rate vs Real Interest Rates
The interest rate or cost of money remunerates the loaned capital. In other words, it is a percentage of the amount lent, paid back to the lender by the borrower. There are two categories of interest rates, real interest rates and nominal interest rates.
The nominal interest rate is the interest rate decided by the borrower and the investor during the initial loan. It is therefore paid by the borrower to the lender.
For example, an investor lends $1,000 in crowdlending (the debt form of crowdfunding) at a nominal interest rate of 6% with a maturity of one year. After one year, the investor will have recovered the money lent in addition to the interest received, so they will have 1000*(1+0.06)=$1060.
The real interest rate is a nominal interest rate that takes into account inflation, i.e. the increase in prices. To calculate it, the inflation rate is deducted from the nominal rate.
Specifications of Interest Rates for Each Country
If it is a rate hike, the currency should normally appreciate, as traders will be looking for more. If it is a decline, we must expect massive selling, or rather arbitration in favor of more generous currencies. In this case you have to be able to react at lightning speed.
|Australia||Reserve Bank of Australia (RBA)|
|Canada||Bank of Canada (BOC)|
|European Union||European Central Bank (ECB)|
|Japan||Bank of Japan (BOJ)|
|New Zealand||Reserve Bank of New Zealand (RBNZ)|
|Switzerland||Swiss National Bank (SNB)|
|United Kingdom||Bank of England (BOE)|
|United States||Federal Reserve System (Fed)|
For example, in July 2008, the Central Bank of New Zealand decided to raise its current interest rate from 8.25% (one of the highest in the world) to 8% against all odds.
The reaction was quick, the New Zealand currency lost more than 100 Pips against the dollar in less than one session, causing big losses for those (and there were many) who had not seen it coming.
Role of Announcements from Central Banks
Central banks, major players in the currency market, intervene to prevent excessive and rapid movements in the price of their currencies. They thus ensure that their currencies are not undervalued or overvalued over too long a period.
Among the main modes of intervention of central banks are: the issuance and withdrawal of liquidity in national currency or the massive exchange of currencies in a relatively short period of time.
While all central banks play an essential role, some have a greater impact on the currency market, depending on the economy and the currency they represent.
All share a common objective: to guarantee price stability within a country or a monetary union. To achieve their ends, their modes of intervention vary.
Closely following the announcements and interventions of the central banks makes it possible to better understand the evolution of the foreign exchange market.
Keep the Pace on a Level with Interest Rates
The more the trader invests in a pair with a high potential for gain, the more likely it is that the interest rate will play an important role in setting it up. And the greater his risk.
The risk, in this case, will be a variation of the parity, which could eliminate any gain on the rate.
Buying currencies offering a high interest rate can be tempting (especially when you finance this purchase with a currency with a low interest rate) but is not always a wise decision: if this kind of arrangement, a little too predictable, worked every time, it would be known!
It is all the easier since central banks tend to announce what they are going to do by regularly giving their point of view on the evolution of the economy.
We remember the warning given by the governor of the American Federal Reserve against the irrational exuberance of the markets in the early 2000s, and the abyssal plunge in world stock markets a few weeks after his announcement.
Market sentiment—around these rate changes—is accessible through the forecasts of the main analysis offices. The follow-up of a particularly relevant office or an average of the forecasts of the main offices (provided that the differences are not too wide) is often enough to get an idea of the magnitude of the decisions to come.