Why Both Currency Investors & FX Traders Should Care about Rates

By Sean Hyman

Last week was “interest rate decision” week all around the world.

The following central banks reported interest rates this week: the Swiss National Bank (SNB), Bank of England (BOE), Reserve Bank of New Zealand (RNZ) and the Bank of Canada (BOC). Phew!

After a week of activity, here’s where the major banks now stand…

  • Switzerland: The SNB held rates at a record low last Thursday. But they changed their message slightly and made traders believe they will start pulling liquidity out of the markets in 2010, by raising rates. For now, they’re still buying euros, and selling francs to hold down the Swiss franc’s strength.

  • U.K.: The BOE also left rates at a record low. Also, the BOE announced they’re going to keep buying gilts (U.K. bonds) through February. In other words, they’re not done with their quantitative easing, and dumping more liquidity into the economy.

  • New Zealand: Again, surprise, surprise: The Reserve Bank of New Zealand left rates unchanged at 0.25%. Here’s the real news: They’ve been saying for a while that they won’t hike rates until the second half of the year. They took back that pledge last week. In other words, they could hike rates sooner.

  • Bank of Canada: Once again, the BOC left rates unchanged as well. The Bank also didn’t give any indication they would hike rates anytime soon.

On top of that, the Reserve Bank of Australia recently hiked rates for the third time earlier this month. Meanwhile, the European Central Bank (ECB) held rates steady once again, but announced they may start draining liquidity soon.

So Why Am I Watching Interest Rates?

First of all, any FX trader worth the cash in their margin accounts watches interest rates.

Indeed, all professional traders listen intently to the rate decisions and any statements the central bankers make about their interest rate policies.

Why? They’re looking for clues about where that country’s currency will go next.

When a currency has a high interest rate, more FX traders want to buy it because they get a higher return on their investment. So traders dump cash into currencies with higher yields. That flood of money boost the currency’s value.

The exact opposite is true for low yielders. When a currency has a low yield, FX traders usually don’t want to own it.

(I say “usually” because there are some extenuating circumstances when traders can pour into low yielders regardless of the return on their investment. Specifically this happens when there is some kind of crisis. For instance, traders poured into the low-yielding dollar as a “safe haven” in mid-2008 to escape the markets.)

But as a general rule, a low yield shoos currency traders away and sinks a low-yielding currency’s value.

How to Use a Central Banker’s Clues to Earn 170% or More

As a currency trader, I can pair up the high and low yielders for higher profits in the currency markets.

For instance I just recommended my Currency Cross Trader buy the high-yielding Aussie dollar and short the New Zealand dollar by going long the AUD/NZD last month.

It took some patience. But a couple weeks later, my subscribers were sitting on a 128% gain, so I asked them to close half their position. A few days later I recommended they close the other half of their position for a nice 170% gain.

In other words, we got two triple-digit winners out of the same currency trade. And it was only based on the interest rate differential between the two currencies.

Even if you don’t have any interest in FX trading, just paying attention to the central bankers can give you a leg-up in your long-term currency investing.

For instance, my colleague Ashish Advani has had his eye on the Australian dollar since June because he was betting the Reserve Bank of Australia would raise rates first.

That’s when he first recommended our long-term Currency Capitalist subscribers go long the Aussie dollar. As of yesterday, that initial long-term bet on the Australian dollar is up over 24%. 

Ashish didn’t recommend his readers go anywhere near the Forex market. That particular play was available through a regular stock broker. And his reasoning was largely based on the prudent Reserve Bank of Australia’s interest rates.

If you’re wondering, I STILL love the Australian dollar for 2010. I still believe the Reserve Bank of Australia will be the first to raise interest rates in 2010.

When they do, it will be their fourth rate hike since October. And the Aussie dollar will soar even higher. In fact, the Aussie dollar could even hit parity with the buck for the first time in decades in 2010.

Bottom line: Stay long the Australian dollar and be sure to keep an eye on interest rates as we head into 2010!

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