while currencies valuation depends on several factors, it is one of the most important factors in the interest rate of a country. In fact, consider other valuation factors as equals and place all your focus on interest rates. In this article, the ITBFX brokerage tells you what interest rate is and how it affects the currency value of a country.
Interest rate: What are we looking for?
If the geopolitical and economic situation across the world stabilizes, the Forex market will naturally support a currency, which will witness an increase in interest rates and can hope for higher rates in the future. However, interest rates are not the sole driver of a currency. Other factors such as war, geopolitical interfaces, inflation, correlation with other markets and many other items also play their role.
When interest rates are higher, it attracts a lot of foreign capital. This happens because ” money is going in the way that is best welcomed”. For example, if you run a large Hedge Fund, you are looking for more efficiency for your customers. If Country A pays five percent for bonds and Country B pays for two percent, then Country A is where you should invest. In order to buy those bonds, or invest in that financial instrument, you will need to do your shopping with the host country’s currency.
An experimental case related to the Forex market
Let’s assume you run a Hedge Fund outside the UK. You ‘re told to invest money somewhere and naturally invest a substantial amount of money, where you can see that it’s growing pretty. Normally, if the economy works well, central banks increase the interest rate. There is a scheduling problem here; but sometimes you may come to the stock market and you will need to buy the currency of the destination. The reason for raising interest rates is usually that central banks are concerned about the economic slowdown, but at the same time it is in this condition that the stock markets go higher. Looking at the economic situation all over the world, you decide to invest your customer’s money in Germany where the companies experience high growth. In order to buy shares in DAX, you should purchase the euro at the beginning.
In this scenario, it is clear that you have to buy the EUR/GBP in the Forex market. If the EU economy is strong, you are not only looking for buying shares in the region, but also willing to buy bonds. Again, you have to buy them in Euros. In this scenario, this is the natural flow of money seeking higher returns. You may face the conditions in which the UK has an interest rate of 1.00 %, while the European Union (EU), for instance, offers an interest rate at 2.25 %.
A few months later
A few months later, the world has changed drastically. We are on a steep incline of the global recession and you have to do something for your money. At the time of the financial crisis, the economic conditions were similar, and people thought that investment in the Forex market was far from common sense. With the U.S. housing bubble explosion, the first thing happened was that currency took power. The U.S. dollar began to gain strength after the initial shock. The reason for this is that there are very few places in the world that can attract the kind of transaction that is made in the American treasury.
In this scenario, we had an asset exit from some countries in the world to raise the dollar value. It was out of mind because the interest rate was rapidly decreasing, but if we want to deal with the problem frankly, people are looking to secure their own money. It didn’t matter if the money came from New Zealand when the United States was decreasing rate, its interest rate was equivalent to 6 %. At that time, profit was not the problem, but the issue was to protect the portfolio.
As soon as the situation calmed down, the money managers started buying currencies, such as New Zealand dollars, the Australian dollar and even emerging currencies such as Turkish Lira and South Africa Rand. Emerging currencies were particularly attractive because the rates in these countries were five or six times higher than those in the developed countries, although they were low in the history of these countries.
Conclusion
The interest rate is the first factor driving the value of currency, but much of it comes from what traders think about in a certain political – economic situation. It is a law that the traders would buy with higher efficiencies, including the pair of currencies that have higher returns when they feel the time is right. When they feel that they should not do that, other currencies with lower interest rates, such as the Japanese yen and the Swiss franc, take the place of other currencies. Try to first consider the specific risk management of the current Forex market conditions, then you can consider the interest rate.
We hope you have made the most use from this ITBFX brokerage article. This article is based on questions we have received so far from respected readers. By asking your questions and issues, you can help us expand this article and pay attention to this important issue and according to the needs of your audience. Thank you for having been with us until the end of the article, and we will invite you to consult the Forex advanced training section for further acquaintance with the Forex market.
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