Online Trading & Investing

Investing in today’s modern era of globalization is often difficult due in part to the many undisclosed interdependencies that have developed over the past few decades.  As much as we would like to believe that our local economies are independent efforts, the new reality is that we are interconnected more than ever with what happens outside of our national borders.  One constant in this ever-changing milieu, however, is the impact of central bankers on the money supply, especially when monetary policy involves interest rate modifications.

The “fundamentals” do move the forex market, and one of the most important considerations is the role of interest rates.  One of the first lessons in any forex tutorial instructs the student to watch interest rates like a hawk, for both countries in your currency pair of choice.  This guidance sounds simple enough, but in practice it becomes difficult because central banks have many ways, both public and private, to modify the interest rate environment in their respective markets.

Central banks can change the prevailing discount rate with a public announcement, or they can maneuver behind the scenes buying and selling treasury securities, sometimes referred to as “open market activities” or “intervention”.  They may even issue new securities, thereby expanding the money supply, diluting the purchasing power of the currency, and forever changing the supply/demand demographics going forward.

The Indian Rupee has declined by 20% versus the U.S. Dollar over the past year for several reasons, but the correlation with declining interest rates in 10-Year U.S. Treasury securities is unmistakable, as depicted in the following chart:

Developing economies in today’s world face many challenges, but one issue that can be very destructive on a local economy is how quickly investment capital flows can suddenly shift from being positive inflows that are supportive to negative outflows that have the opposite effect.  The “carry trade” is part of the problem.  Positive growth and profitable returns will attract global capital like a magnet.  Banks and companies tend to borrow in Yen or Dollars, where interest rates are low, and then invest in countries like India where opposite conditions prevail.  If the Yen or Dollar suddenly appreciates, generally during a financial crisis, traders must suddenly “unwind” these carry trades or risk losses if their positions were un-hedged.

Occasionally, the actions in rates can be counter-intuitive, requiring further analysis to determine the causes at hand.  The debt crisis in Europe and the declining nature of the global economy in response to it have combined to create a level of uncertainty in the minds of the global investment community, like none other in recent memory.  Each day is an “either-or” proposition – either “Risk on” or “Risk off” in today’s vernacular.  The aversion to risk is ongoing, a detriment to economic growth in general, but a common expectation that causes capital flight to “safe havens” in an instant.

In the above chart, interest rates on long-term U.S. securities have dropped 45% from 3.00% down to 1.65% in just twelve months.  The rush in capital flows to safety has created increased demand on the Dollar, forcing an appreciation in the greenback and the reverse in nearly all currency-pair combinations, the Rupee included.  The capital inflows necessary to support these changes have come primarily from developing economies around the world.  As a result, the Rupee declined 20% in response.  Free trading charts at forexcharts.net reflect this general strengthening of the Dollar.

There are most definitely many other factors at play here, but pay close attention to changes in the interest rate arena if you want more consistent forex trading results.