Double Impact of the Interest Rates on Forex

Interest rates, set by the world's central banks, are widely used in Forex trading. Their changes are monitored by traders and investors because interest rates determine fundamental value of currencies. It is important for every Forex trader to understand the impact of interest rates on currencies. It is easy to find the interest rates table to know their latest values, but how to interpret them?

In general, the higher the interest rate associated with the currency is, the better it is for that currency. Higher interest rates attract investors because they offer a higher yield. Forex traders prefer buying high-interest currencies versus the low-interest ones to gain the difference yield (such trading technique is called carry trade).

On the other hand, the lower interest rates are usually more popular among the traders when the global volatility rises and the world's financial system experiences problems. This happens because the lower yields are associated with higher reliability and stability of the underlying economy. The latest financial crisis has shown that the currencies with the lower yield are the market's favorites.

So what to do and how to react on the interest rates? The volatility index (VIX) is a good tool to measure the global interest rates preference. If it is below the "normal" level of 30%, the high interest rates act as an attracting factor, and the currencies that have high yield grow in value. If the index jumps up above that level, traders prefer to move into less risky assets, and the low interest rate currencies gain.