Recap on Central Banking

Let’s go through the concepts we discussed in this chapter as they relate to central banking and forex:

• Central banks set interest rates, which affects economic growth and inflation.
• Interest rates are returns you earn by lending your money to a bank. Real interest rates are the rates of return minus inflation. Nominal interest rates are simply the rate without an inflation adjustment.
• Currency values can rise or fall based on central bankers’ opinion, as well as their policy decisions. Higher rates slow inflation and attract new investment, which increases currency values relative to other currencies. Lower rates may spark inflation, and may give incentive to investors to move their money elsewhere.
• Inflation is the amount of value that a certain currency loses over time due to the creation of new money and rising prices.
• The interest rate differential is the difference in interest rates in one currency against another. If the Euro were to pay 3% interest, and the US dollar were to pay 1%, then the interest rate differential is said to be 2%.
• Central banks increase the amount of money available for loans to lower rates. To raise rates, the amount of money available for loans is reduced.

Actionable trades from Central Banks

In this section, we emphasized central bank decision and opinion as a method to make long term profits in the foreign exchange market. While a rate cut or hike may generate a large movement in the price of a currency shortly after the news hits the market, the momentum may continue for days, weeks, or months. That is to say that a rate hike may push up a currency value, but it doesn’t necessarily mean that the rate hike isn’t as important 60 days after the hike as it is 5 minutes after the announcement.

In the following sections we’ll target:

• Economic Growth
• International Trade
• Capital Flows Between Nations
• Political Stability and Outlook

In each section, and under each topic, we’ll place focus on how we interpret each concept, and how each affects currency prices.