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Forex 101: How Interest Rates Affect Forex

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If you are a newcomer in the world of forex trading, forex rates may appear mysterious to you. You might even say that it’s totally random, and they are always on the move. The latter assumption is true, but the former is not. There are many factors that affect forex movements, thus affecting forex trading. Know more about various factors at HQBroker Review and Online Trading Review.

One of these factors is the interest rates. The question is: How do interest rates affect Forex?

It’s perfectly logical to say that interest rates are always an underlying factor that directly influences foreign exchanges.

How It Works

To cut it short, interest rates are what pushes global investors pour money into countries, and they aiming to get a piece of the return. When interest rates go up, that country’s currency’s interest also goes up.

When a country raises interest rates over a long period, you can expect a broad trend against other currencies. Money will accumulate into these currencies. Oftentimes, indications show themselves, suggesting that the party will end soon.

The Downside

You must remember that this also has its downside: risk sensitivity. And it’s very risk sensitive, for that matter.

Every time a global catastrophe or anything that could affect the global economy happens, it can wreak havoc to an interest rate. Even if this very rarely happens, it surely leaves economies and investors shaken and trembling. It’s a total disaster to be unprepared when this comes.

For instance, in 2008, the world witnessed a crisis that affected almost every country. The global economy moved with uncertainty. High-interest currency pairs jumped up and down and moved over 1000 pips a day. Attempts to recover were almost futile since many expected that similar smaller disasters would happen.

How to Use This to Your Advantage

Look at the bigger picture.

Interest rates don’t move often. But that doesn’t mean that expectations on the direction of the rate movements also don’t move. Speculators as well as investors change their predictions and expectations quickly. You may notice that such changes may happen weekly.

Try looking up the US 2-Year Treasury. That’s a perfect place to observe and analyze the changing interest rate expectations.

You also have to assess a particular country’s economic performance, because that’s another factor that affects foreign exchange. If they decide to raise interest rates, figure out why. If they decide to lower them, also find out why.

Additionally, it’s important to remember that all of these are related. Find out the cause of the rates’ movement—it may be caused by another currency, or by both currencies in your currency pair.

Consider Other Factors

Interest rates are not the only factor to consider. If you’re planning to gain much, you also have to study other factors, such as inflation rates, a country’s current account/balance of payments, government debt, political stability and performance, and the speculation on that currency. In short, arm yourself with knowledge.

Once you understand how these factors affect forex rates and one another, you’re sure to have better judgment over your trades. In any case, it’s always better to make the understanding of interest rates your starting point.