Interest Rates and the US Dollar

Interest Rates and the US DollarWhen interest rates are high for a particular currency, it will mean that you will benefit more from saving that currency. If you spend this currency, you will experience an opportunity cost, as if you had continued saving the currency you would have made more interest. So, we can think of interest rates as the cost of spending money.

When they go up, they also go up for newly issued treasuries as well as for bank accounts. This causes consumers to save more than they spend and banks to hold more than they lend. This is because the cost of spending increases as well as the cost of borrowing.

If greater interest rates fail to attract consumers to save more than they spend, banks continue to lend more than they hold and the money supply continues to grow, there will an excess money supply. When there is a money supply surplus, the price of goods and services rise as sellers can ask for more money from buyers. This will in turn cause the demand for these goods and services to fall. These sudden, aggressive price increases can cause people to suddenly feel afraid to spend and it is in this scenario where recessions are more common.

In economics, people and their emotions are generally time-sensitive and although the two are directly linked, governments still do not have control over people are their emotions. Because of this, an economy will never remain at an equilibrium – an economy will always fluctuate, leading to fluctuations in interest rates. Constant fluctuations in interest rates will lead to constant changes in consumer spending and saving. This is the financial cycle and this is why traders and investors can profit/lose on fluctuating values of currencies. The price of currencies change with changes in interest rates, so traders and investors can bet on whether or not a currency will rise or fall in value. Because people don’t have time machines, they must predict or make expectations and in the financial markets, these predictions and expectations are not always accurate. Because of this, you should bear in mind once again that the financial markets are ultimately dependent on mass psychology and collective predictions and expectations.

In conclusion, interest rates are an important part of fundamental analysis and one of the main factors of the Forex market. Currency prices change with interest rates. Traders and investors can bet in advance, for e.g. they will want to take advantage of a predicted and expected change in US interest rates by buying or selling the US dollar prior to the predicted and expected change – so that they sell the US dollar before it decreases in price and vice versa, so that they buy the US dollar before it increases in price. Of course there are other factors that affect the currency market and other parts of fundamental analysis, but interest rates are one of the most important factors: the FX market is directly affected by changes in them.

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