Real Interest Rate Differentials Model

The Real Interest Rate Differentials Model indicates that movements in the price of currencies are determined by the levels of interest rates of the countries. Thus, the currencies of countries with high-interest rates should grow in value while the opposite should happen with nations whose interest rates are low.

As we will see below, this model is not able to explain all the movements in the currency market, although much of what happens in the Forex (and in other financial markets) is related directly and indirectly to interest rates.

Bases of the Model

Whenever a country raises its interest rates, international investors discover that the currency of that nation has a higher yield and therefore these investors start buying the currency. This theory was very successful in 2003 when the spreads of interest rates were quite close to the highest levels of the past years.

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Fundamental Analysis in Forex

Fundamental Analysis of the Forex Market Forex fundamental analysis is a type of market analysis that identifies and measures factors that determine the intrinsic value of financial instruments such as economic and political environment. It is included in the fundamental analysis any factor affecting supply and demand of the instrument traded. For example, a study of fundamental analysis for a … Read more

Gross Domestic Product (GDP) – Definition and Importance

General definition The GDP or Gross Domestic Product is a report that includes the total value of all goods and services produced within a country in a given year, which is equal to the total of consumption, investment and government spending, plus the value of exports, minus the value of imports. The GDP report is disclosed at 8:30 am EST on the … Read more

Inflation and its impact on financial markets

We can define inflation as the general increase in prices of goods and services in connection with a currency at a specific time period. When the price of these resources increases, the purchasing power of the country’s monetary unit drops so the people of the country can buy fewer goods and services and this has an overall impact on the economy. In other words, this means that inflation causes the purchasing power of a currency to decline.

Inflation has a negative effect on all members of society regardless of their socioeconomic level, and obviously, it affects all consumers in the economy of a country, for this reason, is one of the most important economic indicators for Central Banks and investors of financial markets such as Forex. 

Many economists believe that inflation can be positive if it has a moderate level. Meanwhile, central banks invest huge efforts to keep inflation within well-established limits, so that the economy of the country can take advantage of the positive aspects of inflation while at the same time the negative effects of it are minimized.

One of the main measures implemented to counter the inflationary pressure is rising interest rates. When interest rates rise, commercial banks proceed to increase the interest of the loans they make to their customers.

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The Consumer Price Index (CPI)

General Definition

The Consumer Price Index or CPI is a measure that estimates the average price of consumer goods and services. The CPI measures the price change for a set of market goods and services from a fixed term until the next within the same area, be it a city, region or country. This is a monthly figure, which always refers to the previous month in which the Bureau of Labor Statistics issued the report.

The Bureau of Labor Statistics of the U.S. measures two kinds of CPI statistics:

  • CPI for urban wage earners and administrative staff (CPI-W).
  • CPI for All Urban Consumers (C-CPI-U).

Of the two types of CPI, it is considered that the latter is the most representative of the general population, accounting for 87% of the population of the country.

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Durable Goods Orders Indicator – Definition and Relevance

Durable Goods Order definition

The Durable Goods Orders report is an economic indicator that reflects new orders placed with domestic manufacturers for delivery of durable goods (hard goods) from the factory, in the short term or in the future. This is a monthly published data, which always refers to the previous month in which the Department of Commerce’s Census Bureau issued the report.
The term durables goods applies to those who are expected to have a duration of more than three years. The report Durable Goods Orders comes in two monthly emissions:
  • The progress report on durable goods.
  • Manufacturers’ shipments, inventories and orders.

The reports are broken down by industry, which serves to eliminate the effects of a single volatile industry such as defense spending.

Currency wars

currency wars

Definition of currency wars

It consists of manipulating the currency to sell more. You lower the value of your country’s currency and artificially lower your products to make them more attractive in other countries and increase your exports.

How can a country manipulate its currency? There are many ways, but simplifying, the two main ones would be:

  1. Lower interest rates. You pay less to have the coin. People prefer to invest in other currencies with higher interest rates.
  2. Sell a lot of your currency in exchange for other foreign currencies. In this way, you flood the market with yen, for example, and that depreciates the currency.

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The Interest rates

What is the interest rate? The interest rate is the rate paid by a borrower for the use of money borrowed from a lender. For example, a company (borrower) asks borrowed capital to a bank (lender) to buy new assets for their businesses, in exchange for lending money, the lender receives interest at a predetermined rate. The interest rate is … Read more