FOREX THEORY
Why Interest Rates Matter for Forex Traders (Part 5)
Interest Rate Differentials
Pick a pair, any pair.
Many forex traders use a technique of comparing one
currency’s interest rate to another currency’s interest rate as the starting
point for deciding whether a currency may weaken or strengthen.
The difference between the two interest rates, known as the
“interest rate differential,” is the key value to keep an eye on. This spread
can help you identify shifts in currencies that might not be obvious.
An interest rate differential that increases helps to
reinforce the higher-yielding currency, while a narrowing differential is
positive for the lower-yielding currency.
Instances where the interest rates of the two countries move
in opposite directions often produce some of the market’s largest swing.
An interest rate increase in one currency combined with the
interest rate decrease of the other currency is a perfect equation for sharp
swings!
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