Many believe interest rates affect exchange rates
In reading over much of the commentary and opinion of analysts there seems to be a near universal view that if the Federal Reserve starts to raise interest rates as expected sometime this year then that would be very bullish for the U.S. dollar.
Relationship between interest rates and exchange rates tenuous
I caution traders and market observers not to rush to a conclusion on this. The correlation between interest rates and currency exchange rates is tenuous at best. Modern Monetary Theory (MMT) says that since governments are net payers of interest an increase in the interest rate is akin to a fiscal injection. It equates to more deficit spending or, at the very least, moe spending, and that can be said to make the currency easier to get. (Increases the quantity of currency.)
Rate hikes equate to "money printing"
Think about it for a second. If the U.S. Congress were to announce a major fiscal expansion, say in the hundreds of billions, do you think the dollar would rally? Initially at least you would expect to see a significant amount of dollar selling as economists and investors interpreted this to mean "money printing" and the potential for inflation.
It's odd, then, that traders would interpret a rate increase as bullish for the currency since it also equates to an expansion in government spending. While it may be true that some demand for the currency or, investments denominated in that currency (i.e. fixed income investments) become slightly more attractive, that it offset by the expansion in the money supply.
My Forex Course explains these relationships
In my Forex Course I give historical examples of this. During the mid to late 1970’s the U.S. dollar moved conversely to interest rates. It was only in the early 1980s when the Fed was in its final phase of rate hikes under Paul Volker that the dollar appeared to move in tandem with rates, only to collapse over the remainder of the decade after the G5 nations got together to drive the currency lower.
The lesson to be learned here is that rate hikes or rate cuts are often only loosely tied to exchange rates trends. There are many other factors that go into it.
To learn more about this and how to apply MMT to your own Forex trading, please purchase my 30-hour Forex trading video course below. The price is USD $250
