Forex Trading Fundamental Analysis Masterclass – Part 5

The Globe of Economic Complexity Provided by the Center for International Development at Harvard University

The Globe of Economic Complexity
Provided by the Center for International Development at Harvard University

Forex Trading Fundamental Analysis Masterclass – Part 5.

In this chapter of the Forex Trading Fundamental Analysis Masterclass we will be focusing in Interest Rates and their impact in expectations.

To start some wise words from wise investors:

The approach and strategies are very similar in that you gather all the information you can and then keep adding to that base of information as things develop. You do whatever the probabilities indicated based on the knowledge that you have at that time, but you are always willing to modify your behaviour or your approach as you get new information. In bridge, you behave in a way that gets the best from your partner. And in business, you behave in the way that gets the best from your managers and your employees. “Buffett on Bridge” at Buffetcup.com (2013)

 

“Money values do not simply mirror the state of affairs in the real world; valuation is a positive act that makes an impact on the course of events. Monetary and real phenomena are connected in a reflexive fashion; that is, they influence each other mutually. The reflexive relationship manifests itself most clearly in the use and abuse of credit.” George Soros

 

In the previous installment, we looked at interest rates, and how they can affect the way that the market feels about a currency in terms of the attractiveness of investments in that country. However, if it was as easy as looking at the interest rate, everyone would be looking just at that and trading currencies profitably based upon it. The fact is that, in every case, the market already did this a long time ago, which brings other, more nebulous factors into play – such as the market’s expectations of future changes.

The questions to start are: can interest rates expectations alone explain the changes in currencies and the yield differentials among bonds of different maturities? To what extend do attitudes toward risk and transactions costs influence the behavior of bond investors? Is it possible for the Central banks / Federal Reserves to “twist” the interest-rate structure in accordance with its policy objectives?

Interest rate expectations

Markets change on a constant basis in anticipation of different events and situations, but while interest rates also change, they don’t do so nearly as often. That’s why most traders don’t obsess over the current interest rates, because in most cases they have already been priced into the current valuation of a currency.

Far more important, from forex trading point of view, is where the market EXPECTS interest rates to go. It’s also crucial to know that interest rates tend to shift in line with the end of monetary cycles, and the monetary policy changes that go with these market events. If rates have been on a downwards trajectory for a long time, it’s inevitable that the trend will eventually reverse – rates will have to increase at some point.

What professional Forex traders attempt to do is to figure out when this will happen, and the amount that they will change by. And for clues, they will inevitably look to the market – a change in expectations is a signal that a shift in speculation will start, and this movement will gain more momentum as the change in interest rate approaches.

Although interest rates move in tandem with the gradual changes in monetary policy, the sentiment of the market can change altogether more abruptly on the basis of a single report. This, in turn, can cause interest rates to change more drastically, or even in a different direction to that which was anticipated initially.

Other articles in this series:

Forex Trading Fundamental Analysis Masterclass Part 1
Forex Trading Fundamental Analysis Masterclass Part 2
Forex Trading Fundamental Analysis Masterclass Part 3
Forex Trading Fundamental Analysis Masterclass Part 4
Forex Trading Fundamental Analysis Masterclass Part 5
Forex Trading Fundamental Analysis Masterclass Part 6
Forex Trading Fundamental Analysis Masterclass Part 7
Forex Trading Fundamental Analysis Masterclass Part 8
Forex Trading Fundamental Analysis Masterclass Part 9
Forex Trading Fundamental Analysis Masterclass Part 10
Forex Trading Fundamental Analysis Masterclass Part 11
Forex Trading Fundamental Analysis Masterclass Part 12
Forex Trading Fundamental Analysis Masterclass Part 13
Forex Trading Fundamental Analysis Masterclass Part 14
Forex Trading Fundamental Analysis Masterclass Part 15