The most important driver for the currency market is the change in interest rates by any of the eight major central banks around the world. The dynamics of the interest rate is a reflection of a number of economic indicators , which are published in the country within a month. Therefore, decisions of central banks can lead to a very strong and sharp fluctuations in exchange rates. Traders because it vulnerable to attack from unexpected changes in interest rates, their forecasting and right actions will help accelerate response trader and increase profits.
Interest rates : Basic principles
Intraday traders , it is important to have information on the value of the interest rate for one simple reason : the higher the rate of return , the higher the percentage is calculated on the currency invested , respectively , the greater the profit.
Of course , the increased risk when using this trading strategy is associated with exchange rate fluctuations , due to which the investor may lose interest income. It should be noted that the acquisition of a currency with a higher interest rate may look tempting ( if you use this for a currency with a low interest rate ). However , such a solution is not always reasonable. If the profit on forex was given so easily , it would be too profitable occupation for anyone who owns such knowledge .
Do not assume that the scheme of the higher and lower interest rates too complicated for ordinary intraday trader. You only have to follow their changes , as well as for other regular economic publications.
How to calculate the possible interest rate
The Board of Directors of any central bank determines the monetary policy of the country and sets short-term interest rate at which interbank loans issued . To curb inflation the central financial controller will increase the interest rate. Her fall, in turn, helps to stimulate lending and promotes ” infusion ” of cash in the economy.
Usually get a clear idea about the intentions of the central bank can by analyzing the following economic indicators :
– Growth rate of consumer price inflation ( index CPI)
– The level of consumer spending
– Employment rate
– Market subprime
– The real estate market
How to predict interest rate
Having the data , any trader can match them with the assessment of the Fed. Usually, if the economic indicators are growing, ie the economy is gaining momentum , the interest rates will be raised either , or remain the same (if positive changes in the economy are insignificant ). Severe deterioration of indicators , in turn , would mean a possible lowering of interest rates in order to stimulate lending.
In addition to economic indicators , ” suggest ” changes in interest rates can external factors such as:
1. Significant statements by officials
2 . Analyst Forecasts
Significant statements by officials
Keynote speeches central bankers are essential to changing interest rates . However, they are often underestimated by the economic indicators. Nevertheless , this does not mean that the content of speeches dignitaries neglect . Any of the official reports of the central bank can ” tell ” as financial regulator assesses inflation.
For example , July 16 , 2008, Fed Chairman Ben Bernanke once again testified before the Joint Economic Committee of Congress. As usual during these speeches , Bernanke read previously prepared speech about the value of the U.S. currency , and then responded to questions from Committee members .
During his speech, the Fed chief expressed confidence that the U.S. dollar is “in great shape .” Moreover , the government intends to maintain its stability , despite the fact that concerns about a possible recession have an impact on other markets.
Traders closely followed the speeches . Since its contents appeared optimistic with respect to USD, it was expected that the Federal Reserve will increase interest rates . This, in turn, caused a short-term rise in the dollar.
Figure 1: EUR / USD rate falls in response to the speech of the Fed
Within an hour, the pair EUR / USD lost 44 points , which is favorable for the U.S. dollar. This would allow the traders who followed the performance , earn 440 dollars.
Analyst Forecasts
Another useful way to anticipate changes in interest rates is to keep track of analysts’ forecasts. Since the movement of interest rates usually very expectedly , the brokers , banks and professional traders will have a preliminary assessment of the possible size of the bet .
For a more accurate prediction of the outcome must take 4 or 5 of these “opinions” ( they should be very close in terms of numbers ) and average them.
What if the interest rate change was a surprise?
No matter how mean and how much was forecast calculations had to make the decision on the eve of the central bank, sometimes it turns out to be a complete surprise and breaks all the calculations to the nines .
In such cases it is important to determine in which direction the market moves . If the interest rate is increased , the rate of the national currency will go up , that is, traders will buy it . Decrease in interest rates means that short positions in the currency will be more likely. Traders may prefer to sell a given currency and buy another with a higher interest rate . Once unable to determine the direction of the market , you must :
– Act fast ! Once might surprise movement in the market begins a furious pace , because every trader wants to sell or buy a currency (depending on the increase or decrease in rates ) among the first. Only in this case, you can count on big profits.
– Be aware of the possible reversal of the trend in high volatility.
Usually right after the news market is ruled by the perception of the trader, then “turned on” logic . In most cases, the greenback continues in the original direction.
For illustration, consider the following example . In July 2008, the Reserve Bank of New Zealand held the highest compared to other central banks , the interest rate ( 8.25 %). Within 4 months the day before the next meeting of bet size remained unchanged. ” New Zealander ” was popular among traders because of the higher rate of return.
However, according to the results of the July meeting , contrary to analysts’ forecasts , it was decided to reduce the repo rate to 8%. And although the change of 25 basis points seems very low , investors viewed the move as a signal that the central bank fears inflation. Traders rushed to sell NZD and started buying other currencies , even if the interest rates on them are lower.
Figure 2: The pair NZD / USD went down due to lower interest rates
As a result , for 5-10 minutes quotes NZD / USD fell from 0.7497 to 0.7414 mark . Overall drop was 83 points. Those traders who are able to sell at least one item on the NZD, in minutes earned about 833 dollars.
Nevertheless , after a rapid decline followed the same rapid growth – a pair NZD / USD began to move under the previous uptrend. The reason lies in the fact that despite the decrease in the interest rate , the total rate of 8% was higher than that of most other currencies .
In addition, after an unexpected change in interest rates is important to familiarize yourself with the accompanying statement , as well as the minutes of the central bank in order to understand the vision of the bank for further monetary policy. It is the content of such publications often sets a new trend after the market fade “first wave .”
Conclusion
Trader should give priority to analyzing the actions of central banks , as their decisions to change monetary policy affect exchange rates. Possession of the necessary information will maximize profit and receive not only on the transaction ” carry trade “, but also because of currency fluctuations . Moreover , a careful analysis will help avoid unexpected changes in interest rates or the time to respond to them.