Interest Rates in Vision: their Development and Impact on the Forex Market

The interest rates in the U.S. are undoubtedly at a historical low point. Plus they have already remained at these dismal levels for a lengthy 6+ years. But the U.S. is certainly not the exception of the world. A global trend for lower and lower rates is noticeable and the end is not yet in sight as central banks push the rates beyond the historical lows.

The question arises: what is going on? This post analyzes the history of interest rates, the future developments and trends, and how this could impact the future Forex market.

26- 2- 2015 fed rates


The above image shows that the US rates are the lowest levels since the 1950’s, but how do they compare with other major currency pairs?

Only two major currencies have rates above the 1% level at this moment and those are New Zealand and Australia. The US, the Euro zone, Japan, Switzerland, Canada and Great Britain all have rates below 1%. In fact in a historical decision Switzerland even decided to set its rate at a negative level of -0.75%. Here is a summary comparing March 2014 with February 2015:

  • Four currencies have lower rates now than they did just one year ago, even though the financial crises took place 7 years ago.
    • The Euro zone moved from 0.25% to 0.05%;
    • Switzerland moved from 0.1% to -0.75%;
    • Canada moved from 1.0% to 0.75%;
    • Australia moved from 2.5% to 2.25%.
  • Three currencies (USD, GBP, JPY) kept their historical low rates stable. The US, Great Britain and Japan have maintained ultra low rates ever since the start of the financial crises.
  • Only 1 currency was the exception: the NZD raised its rates from 3.25% to 3.5%.

During the 1st week of March new interest rate decisions are expected for the CAD, AUD, GBP and EUR. Although no changes are expected on the EUR and GBP, the CAD and AUD are expected to drop their rate by a quarter.

27- 2- 2015 global rates


The above image clearly shows that the many of the major currencies are keeping their rates at extremely low levels but how do they historically compare with each other? This question is too broad for this post, but as an alternative we have compared the last 15 years of the EUR and USD.

As we know from the table above, at the moment the Euro’s interest rate (0.05%) is very similar to that of the United States (0.25%): near zero. But small and interesting differences emerge when comparing the USD and EUR rates since the year 2000.

27- 2- 2015 eurusd rates part 1

  • The divergence between the two currencies reached 2.0 – 2.5% at times;
  • The Euro and USD rates crossed 4 times in the last 15 years:
    • The USD dipped below the EUR in April 2001 to combat the effects of the dotcom recession.
    • The USD moved above the EUR in December 2004 when the US was rebounding stronger than the Euro zone.
    • The USD then dipped back below the EUR in January 2008 as the US responded to the financial crises of ’08.
    • Recently in June 2014 the EUR went below the USD as the ECB cut rates below the US mark of 0.25%.

The US seems to be leading the rate movements whereas the EUR is in a leading role and adjusting to the action from the US sometime down the road. The later response from the EUR is also visible with the implementation of the Quantitative Easing (QE) program: the USD stopped the expansion of its third program in the 4th Quarter 2014, whereas the Eurozone will start to expand its QE in March 2015.

27- 2- 2015 eurusd rates part 2


So far it is obvious that the global trend in interest rates is down (from the 1st part of the post) and that USD sets the global pace in rates (in comparison with EUR, although more data needs to be reviewed). The main questions then become: what are the chances of rate hikes in the US, how will they impact the rates of other currencies, and how will this impact the Forex?

Thursday’s post explained why rate hikes in the US seem capped this year. I myself expect rates to rise in 2016, whereas many others point to the 4th quarter of 2015. In any case, one year from now there is a decent chance (pending on many factors this year too), that the rate will have increased to 0.5%.

With such a weak perspective of rate hikes in the US, the global trend of stable low interest rates with the occasional change lower will probably continue.

  • The EUR, JPY and CHF will probably stay at their record lows;
  • The AUD might even lower further and the NZD could follow the AUD’s lead;
  • The GBP together with the USD is the only currency that has a chance of a slight rate hike.

All in all rate hikes are highly dependent on economic data, global growth and also geopolitical developments. They would only seem viable for the USD and GBP for the moment and if rates do increase, they are seriously limited in their range compared to historical levels. Almost equally likely is the fact that USD and GBP rates remain flat together with the rest of the majors.

So how could the Forex market move with the future rates in mind?

27- 2- 2015 rates next year


The Forex market is partly moved by the differential between the interest rates of various currencies but investors have slim pickings with many of the rates at historical lows. When all rates are very low, then the demand for any 1 of the currency’s rate will probably not be overly powerful and other factors could be more important in judging currency demand. In fact, investors might realize that with rates so low, the difference between holding a currency and gold (no rate) becomes less distinguishable. With that said, here is an overview of expectations:

  • With the US economic data outperforming most of its major counter parties in the last year, the USD has made substantial gains. The USD will probably to continue to gain against most other pairs, especially if the data confirms the uptrend and a rate hike indeed seems likely.
  • The GBP seems to have a similar upbeat mode. The economic data has been positive and a potential rate hike will help the GBP as well.
  • The demand for the EUR and JPY could be seriously negatively affected by their Quantitative Easing programs. The EUR and JPY will probably continue to weaken.
  • The Swiss decision to hold rates far below the 0% level will also help curb demand for its currency.
  • The commodity downside pressure has weakened the AUD, CAD, and NZD. However, with an increase in the demand for Gold and slight increase of oil prices 1 to 2 years from now, these currencies can regain demand in the intermediate future.

What do YOU think will happen with the interest rates one year from now?

Thanks for sharing and wish you Happy Hunting!

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