What Factors Influence Market
?Sentiment
Interest rates
Trends in interest rates are one of the most significant factors influencing market
sentiment, as interest rates play a huge role affecting the supply and demand
of currencies
Every currency in the world has interest rates attached to them, and these rates are
decided by central banks. For example, the Fed in the US determines the country’s
interest rates; the Bank of Japan (BOJ) sets Japan’s interest rates; the Reserve Bank
of New Zealand (RBNZ) decides on New Zealand’s interest rates and so on. Some
currencies have higher interest rates than others, and these are usually the
currencies that attract the most attention from savvy international investors who are
always looking across the global landscape in the continual search for a better
interest rate yield on fixed-income investments. This, of course, also depends on the
geopolitical or economic risks of that particular currency. Just like when a bank
lends money to a higher-risk borrower, high-risk currencies require a significantly
higher interest rate for investors to consider keeping money in those currencies
?What causes fluctuations in interest rates
The value of money can and does decrease when there is an upward revision of
prices of most goods and services in a country. Generally, when a country’s
economy expands or when energy costs go up, goods ranging from clothing, food
to computers, and services ranging from public transport to spa treatments get more
expensive, thus eroding the value of money. The nice word for this erosion in value
is, of course,
inflation
Controlling inflation
Central banks are responsible for ensuring price stability in their own country, and
one of the ways they employ to fight inflationary pressures is through the setting of
interest rates. If inflation risks are seen to be edging upward in, say, the US, the Fed
would raise the federal funds rate, which is the rate at which banks charge each
other for overnight loans. When the overnight rate is changed, retail banks will
change their prime lending rates accordingly, hence affecting businesses and
individuals. An increase in interest rates is an attempt to make money more
expensive to borrow so that there will be a gradual decrease in demand for that
currency, thus slowing down an overheated economy. The opposite scenario is true
too: when a country faces deflation, or even decreased inflation, which is often the
result of decreased spending, whether by the government, consumers or investors
it prompts the central bank to lower interest rates so as to stimulate spending
Interest rates and currencies
The most important way in which interest rates can influence currency prices is
through the widespread practice of the
carry trade
A carry trade involves the borrowing and subsequent selling of a certain currency
with a relatively low interest rate, then using the funds to buy a currency which
gives a higher interest rate, in an attempt to gain the difference between these two
rates – which is known as the
interest rate differential. The trader is paid interest
on the currency he or she is long in, and must pay interest on the currency he or she
is shorting. This difference is the cost of carry. Therefore, a currency with a higher
interest rate tends to be highly sought after by investors looking for a higher return
on their investments
Rising interest rates in a country tends to strengthen that country’s currency relative
to other currencies as investors exchange other currencies to buy the currency of
that country when they transfer their assets into the country with the higher interest
rates. The increased demand for that particular currency will thus push up the
currency price against other currencies
For instance, in 2005 there was a strong interest among Japanese investors to invest
in New Zealand dollar-denominated assets due to rising interest rates in New
Zealand. The then near-zero interest rates in Japan forced a lot of Japanese
investors to look outside of their country for better yields on cash deposits or fixedincome
instruments. See
New Zealand Dollar/Japanese Yen (Nov 2004 – Dec 2005
نتابع