I wanted to ask why when a country let’s say for example AUD releases it’s interest at -10 and the cons and previous say -10 and 1 or 2 weeks ago the usd said it’s interest rates are are at 75 bais points.if I am wrong correct me isn’t it that the country with the highest interest rate stronger than the weaker one with is the lowest interest rates
that’s how i understand it too at least based on this lesson
An interest rate differential that increases helps to reinforce the higher-yielding currency, while a narrowing differential is positive for the lower-yielding currency.
Instances where the interest rates of the two countries move in opposite directions often produce some of the market’s largest swings.
An interest rate increase in one currency combined with the interest rate decrease of the other currency is the perfect equation for sharp swings!
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In general when a Central Bank raises it’s interest rates it’s basically telling the market that it’s going to give higher yields on it’s government securities (bonds). Since these assets are considered to the most risk free investments in the market there’s a lot of demand for it, especially from large institutions in foreign countries with lower interest rates (like Japan).
If you were a Pension fund manager in Japan, where interest rates are -0.10, you’d be very interested in learning that the US raised in interest rates by 75bp. Instead of parking your money at home and seeing it depreciate, you’ll want to buy US government securities because of it’s higher risk free return. Since those bonds are in USD you’ll be selling your JPY and buying USD. If enough institutions do this you can see how it’ll drive up the USD.
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@Kid_707 - I was wrong about bonds being more attractive. It’s US equities that are supposed to benefit from an increase in the interest rate.
When the FED raises interest rates to curb inflation that signifies raising interest rates of short-term fixed assets (2-YR bonds). When bond yields go up bond prices go down: The charts below show the yield for the 2-Y Bond and the price for US 2-Y Futures. They tend to go in opposite directions.
That’s makes short-term bonds less attractive and, in theory, is supposed to stimulate investment in the stock market.
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Thank you for your effort it greatly appreciated
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When it comes to interest rate differential, if you go long in favor of a currency with higher interest rates you may benefit from carry trade.
Example.
AUDUSD
Current rates RBA 4,35% compared to Fed 5.33%
Going long USD due to US having higher interest rate would mean going short AUDUSD
This may help yield carry trade credits.
But to be sure always check with your broker.
Next.
When a central bank has its meeting to decide on adjusting rates, prior to the announcement of what the central bank is doing you can find information on the market consensus regarding any adjustments. If the end result differs from market expectations you can expect the market to move accordingly.
Example
Fed meeting scheduled and market consensus is for no change in rates.
If however the fed reduces rates by 25 points you would expect USD weakness immediately after the release of the report. Hence USD weakness would mean you may benefit from a trade taking a long position EURUSD
Finally the more practical day to day interest rate differential strategy would be to monitor the spread between the 10 year German Bund and the 10 year USD Note. You can create a TradingView chart to monitor the spread between the two. This spread chart should very closely correspond with the EURUSD.