International Interest Rates
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International interest rates and the direction of monetary policy are the most important factors in determining trends in the Forex market. One can infer market direction from monetary policies (through movements in equity and bond markets), various economic reports and central bank reports. In order to understand the behavior of Forex markets, merely knowing the trends in international interest rates is not sufficient. One should understand the future direction of monetary policies to understand currency markets.[br]
International Interest Rates – Forex Markets
When you compare the international interest rates of Australia, US, Japan, UK, Eurozone and Switzerland, the carry trade was strongest during 2002-2007. (Carry trade refers to selling low yielding currencies to purchase high yielding currencies). During this period Japan’s interest rate remained lower than 1% while the central banks of US, UK, Eurozone and Switzerland started raising interest rates.[br]
Most of these countries were very aggressive to let their currencies to post significant gains over the Yen. Given Japan’s status as being the second largest economy in the world with more than $4 trillion of GDP, the Yen witnessed sharp declines of carry trades during accumulation. When carry trades unwind, the Yen witnesses rapid gains. The point in effect being that the Japanese are desperately looking to invest in foreign currencies abroad — particularly in the US dollar — with the hope to get better returns. Recently, they have been investing their huge resources in the US government bonds, as these bonds offer a stable income with a guarantee from the US government.
If one looks at the international interest rates of Australia, US, Japan, UK, Eurozone and Switzerland for 2005-2009, the US Fed was the first to cut interest rates due to a falling US dollar. Australia, UK, New Zealand and Canada followed the US and cut interest rates. Markets are also of the opinion that the slowdown in Japan and Eurozone countries is at an early stage, and the US will be the first to recover. One can identify this phenomenon from the sharp rally in US dollar during August 2009. The bottom line is that the US dollar is expected to post strong gains during 2010.
