Weekly Trading Lesson: The Relationship Between Interest Rates and Currencies

In the FXCM Power Courses we teach new traders about how interest rates can be the biggest factor in the value of a currency pair. Higher interest rates usually lead to a higher currency value while lower interest rates usually lead to a lower currency value.

The chart below is a daily chart of the EUR/USD. In addition, we have plotted the highs and lows of the 10-year US Treasury Note to see if there is indeed any relationship between the US interest rate environment and the value of the USD when compared to the EUR.

The 10-year note is typically the benchmark comparison mostly because all major industrialized nations issue a 10-year government note/bond. Since this is the EUR/USD, a rising market would indicate USD weakness, while a falling market would indicate USD strength. We can see where the highs and lows of the 10-year yield do indeed coincide with the highs and lows of the EUR/USD. The currency pair typically falls as the yield moves higher and the pair rises as the yield move lower. The only time this did not happen was as the 10-year yield was moving up from 4.47 to 4.75 in March and April of this year, when interest rates in Europe were also rising. We can also see though how the strong sell off in the bond market (higher yields) from May into June resulted in the EUR/USD falling and once again confirming the relationship. The best way to follow the yield of the 10-year US Treasury Note is to use the symbol $TNX on most stock charting packages. For those who are interested, the symbol $TYX offers the yield on the 30-year US Treasury Bond. Both offer a good idea of the US Treasury market and can give a clue into the prevailing strength or weakness of the USD.