Usage of interest rates in trading

The interest rates of the Central banks of the largest world states are the basis of contemporary Forex trading. The majority of price fluctuations that occur during trading depend on the dynamic changes of this indicator. The formation of interest rates is influenced by both global political and macroeconomic factors, as well as domestic events. And each trader should be able to predict market behavior and sentiment based on changes in interest rates. Of course, if he does not plan to trade at a loss.

Interest Rates: Basics

The majority of traders who actively use information about changes in interest rates in their trading forecasts choose intraday (short-term) trading options. In this case, the profit will be directly related to the growth of the interest rate - the higher it is, the more percent of the profit will be obtained as a result of investing.

Of course, in addition to changing rates, it is worth considering other factors of influence. For example, exchange rate fluctuations that can completely change the picture of intraday trading.

Buying currencies with high interest rates at the expense of currency funds with lower rates is an attractive option, sometimes highly profitable, but you can’t expect guaranteed profits from it - forecasts are too weak based on only one specific indicator.

The dynamics of changes in interest rates is also effective as an analytical tool for long-term forecasting. It’s true that it is worth considering additionally such auxiliary factors as the release of economic and political news. But, in general, monitoring changes in interest rates is a very effective way of analysis, which allows you to get a fairly objective idea of future changes in the market situation in the short and medium term.

Interest rate dynamics analysis

The policy of any central bank involves the artificial regulation of the financial and economic situation in the domestic market. Accordingly, the focus is on changes in short-term interest rates that determine the conditions for interbank lending. Interest rate increase is a measure designed to reduce the current inflation rate. Lower rates lead to an increase in demand for loans and a general increase in investment in the economy.

What changes may signal the upcoming revision of rates:

  1. increase / decrease in inflation in the consumer sector;
  2. increase / decrease in indicators of the level of expenditures within the consumer market;
  3. increase / decrease in the level of employment;
  4. dynamic fluctuations in the indicators of the subprime credit market;
  5. changes in price indicators in the real estate market.

Interest Rates: Forecasting

When making forecasts on the dynamics of changes in interest rates, it is important to correlate the obtained analytical data with the forecasts of the Fed. Otherwise, everything is quite obvious: with the growth of economic indicators, interest rates can either stabilize or grow. With a decrease in the level of economic development, the state usually reduces interest rates, activating the credit market, attracting new customers to it.

In addition, there are two objective factors that can signal about a possible change in interest rates:

  1. statistics and forecasts of analytical agencies;
  2. statements by officials with significant status for the economy.

Among official statements, speeches by the heads of central banks are of paramount importance in the case of forecasting changes in interest rates. It is they who are able to clarify the general mood of the market and demonstrate the presence of short-term trends in the dynamics of the development of price indicators in the near future.

Do not underestimate the forecasts of analysts. It is they who, as a rule, have a sufficient level of knowledge and resources to most objectively assess the future dynamics of interest rates. Of course, do not blindly rely on the opinion of one single professional. Use several sources at once to obtain more accurate information and average the data obtained, systematizing it to achieve the desired calculation result.

What interest rates should be considered when forecasting?

  1. The rate on federal funds (Federal Funds Rate) - is relevant for banks which activities are regulated by the Fed. It’s valid for the short-term overnight lending market. Interest rate changes in this case are regulated by the US Open Market Committee. Committee meetings are traditionally held 8 times during the year. The traditional day of the meeting is Tuesday (the first and fourth are held in a two-day mode, with a decision on the change in rates on the second day - Wednesday). The final data on the upcoming change in interest rates are announced on the day the meeting closes at 18:15 GMT.
  2. Refinancing Tender - European refinancing rate set by the ECB. Changes in rates for such tenders are held every two weeks, on Thursdays. Changes in the frequency can be observed only in connection with the loss of a traditional meeting on holidays or during the summer holidays for members of the European Central Bank.
  3. Bank Rate - the rate of the Bank of England, valid for the lending market according to the repo scheme (repeated resale of assets to previous owners after the agreed deadlines). A decision is made on changes in interest rates on a monthly basis, as part of a meeting of the Financial Policy Committee. Traditionally, a committee meeting is scheduled for the first week of the month (Wednesday / Thursday or Tuesday / Wednesday), the results are announced on the second day, at noon, London time.
  4. Overnight Rate Target - a rate of the Bank of Canada that determines the desired level of the short-term depositary market. The decision on the change in rates is made by the Council managing the National Bank. Data becomes publicly available on the day of the meeting.
  5. Three-month loans (3 Month Libor), the corridor of rates established by the National Bank of Switzerland. A change in the rate may occur on a daily basis. However, they will all occur within a given range. Changes in the range of the rates are made quarterly, traditionally on the third Thursday of March, June, September and December.
  6. Official Cash Rate - the basic interest rate used by the Reserve Bank of New Zealand. The rate review is carried out 8 times a year, with the announcement of the results on the same day.
  7. Repo Rate - the basic interest rate of the National Bank of Sweden (operating as part of weekly borrowing), is set six times a year at meetings of the Bank Council.
  8. Cash Rate - the base interest rate of the Reserve Bank of Australia. Decisions on changes in rates are made at monthly (except January) meetings held on the first Tuesday of the month. Data on decisions made is available on the day of the meeting.
  9. Overnight Call Rage Target - overnight borrowing rate applied by the National Bank of Japan. Rate changes are set monthly, as part of traditional meetings.
Author: Kate Solano,
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