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Forex Basics |
Fundamental Factors |
Technical Tools |
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Market Reactions to Central Banks - FOMC Example
We will attempt to show how important interest rates are to currency movements by examining price action on the Forex market during a recent central bank tightening campaign. The following example focuses on the EUR/USD pair.
Let’s investigate the implication of the United States Federal Reserve’s interest rate decisions to the value of the US Dollar.
Dollar Gaining
The Euro started 2005 at a high exchange rate, 1.3500 Dollars per Euro. US interest rates had been hovering at very low rate of 1% prior to this time and the Euro was appreciating. In 2005, on the other hand, there was steady Euro depreciation. The US central bank, the Federal Reserve, continued a campaign, started in July 2005 to gradually raise interest rates from 1%. At every subsequent meeting of the Federal Open Market Committee (FOMC), federal officials increased the base interest rate by .25%. Financial markets reacted to this gradual hiking campaign by favoring and strength ending the Dollar. When 2006 started, the EUR/USD pair traded around 1.2000, a change of 13 cents or 1300 pips. The central bank's actions were a major cause for the Dollar appreciating in 2005. |
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EUR/USD - December 2004 - December 2006
When the value of the Dollar is rising the chart will be moving downwards. This means that the Dollar is appreciating, or in other words it takes less Dollars to buy the same amount of Euros. When the Euro is doing better price is moving upwards on the chart.
Trend Reverses
In December ‘05, at the 1.2000 level, the Euro finds support and begins to gain (second rectangle). At this time investors are speculating that the Fed tightening campaign is likely coming to an end. Similar speculation, and Euro appreciation, happened between July and August ‘05 (first rectangle). In February the Fed’s base rate was raised to 4.50%. Speculation that the Federal Reserve would finally pause after 15 straight rate hikes continued throughout March and the first half of April, creating an upward trend favoring the Euro.
EUR/USD - March 2005 - April 2006
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Risk Warning
Before deciding to participate in the Forex market, you should carefully consider your investment objectives, level of experience and risk appetite. Most importantly, do not invest money you cannot afford to lose.
There is considerable exposure to risk in any off-exchange foreign exchange transaction, including, but not limited to, leverage, creditworthiness, limited regulatory protection and market volatility that may substantially affect the price, or liquidity of a currency or currency pair.
More over, the leveraged nature of forex trading means that any market movement will have an equally proportional effect on your deposited funds. This may work against you as well as for you. The possibility exists that you could sustain a total loss of initial margin funds and be required to deposit additional funds to maintain your position. If you fail to meet any margin requirement, your position may be liquidated and you will be responsible for any resulting losses. To manage exposure, employ risk-reducing strategies such as 'stop-loss' or 'limit' orders.
Trading foreign exchange on margin carries a high level of risk, and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to invest in foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with foreign exchange trading, and seek advice from an independent financial advisor if you have any doubts. |
Forex.com/UK acts as the clearing agent and counterparty to customers introduced by "Global Currencies" for an IB margined forex transactions. FOREX.com is a trading name of GAIN Capital - FOREX.com UK Limited and is authorised and regulated by the Financial Services Authority. FSA No. 190864.
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