At this point we have reviewed specifi c powerful global fundamental forces that help traders understand what moves markets. In recent years global interest rates were at historic low levels to stimulate growth after the fi nancial collapse in Sept 2008. However, interest rates have begun to increase, and the world is entering a period of tightening of rates. The result is the return (it never really left) of one of the most important forces that move currencies: interest rate differentials. These can be considered the jet stream of the currency market!
Any Binary option trader looking to trade the currency pairs offered by Nadex (USD/JPY, USD/CAD, USD/CHF, EUR/USD, EUR/JPY, GBP/JPY, AUD/UST, GPB/USD) must understand how interest rate differentials and expectations move price action. We could write a book about this subject alone. Namely, interest rates and interest rate differences are prime forces that move the currency pairs . Another way to view the interest rate force is to see it as a global jet stream of the money fl ows.In a very basic way, currencies will strengthen if the interest rates of the economy are expected to increase in value.
They will weaken if the interest rates are expected to decline. Central banks have the role through monetary policy to adjust interest rates to control and minimize infl ation. Higher rates discourage economic activity and are used as a throttle when an economy is perceived to be growing too fast.In currency trading, the value of one currency is always assessed against the value of another currency.
That is why they are called currency pairs. For example, the EUR/USD is a currency pair where the Euro is traded against the U.S. $. For this pair, when the European Central bank increases interest rates, and the U.S. does not, the net effect is bullish for the Euro against the $, because money will tend to be attracted to where it is paid a higher rate.A quick check of the major interest rates associated with the different currencies reveals dramatic differences between some. We can locate the currencies with the lowest interest rates (JPY, CHF, USD), and then locate the currencies with the highest rates (AUD, NZD).
This leads to a strategy called the carry trade. This strategy involves selling low interest rate currencies (or borrowing money to do so) and then buying high interest rate currencies. It is no coincidence that the Aussie is the highest, as it experienced demand for its resources. But going too high is dangerous.If a currency gets very high in value against another currency, it actually slows down the economy of the high priced currency because a higher currency value means exports are less competitive. But it may also trigger a recession.
Ultimately the process is cyclical and self-correcting.ICI is a fund that executes the carry trade strategy. We can see its overall performance has changed when interest rates started declining.If the carry trade comes back as a strategy it would be refl ected in an upward ICI chart. This chart should be monitored if traders are interested in spotting the emergence of better carry trade conditions.