subject: Forex Training Basics - How The Fed Uses Interest To Move The Usd [print this page]
Although most Forex training focuses on technical analysis, market fundamentals actually cause the market to move.
Fundamental factors affect the supply and the demand for each and every currency. Invest the time and energy to include fundamental analysis as part of your Forex training and you will take great strides in your quest to becoming a profitable Forex trader.
Everything from the performance of the FTSE to the number of barrels of oil that the members of OPEC produce affects the market. It would be impossible for one person to factor in the many thousands of fundamental factors that affect the foreign exchange at any given point in time. So what should you concentrate on?
Luckily, if you focus on only a handful of the most important fundamentals you will gain enough insight to be able to make rather astute and profitable Forex trading decisions.
One of the most important fundamentals is the US government.
How the US Government Impacts the Value of the USD
The United States government impacts the value of the US dollar more than any other factor. It does this through its policy and spending decisions. If you watch the federal interest rate you will gain phenomenal insight into which direction the dollar is heading.
U.S. interest rates have the most direct effect on the value of the US dollar and it affects it more than any other fundamental factor.
The target interest rate is controlled by the Federal Reserve. When the target interest rate increases, the dollar becomes more valuable. And, conversely, as the target interest rate drops the dollar becomes less valuable.
How the Fed Uses Interest Rates to Make the USD Go Up
If the Fed believes that the economy might overheat and that inflation could take off they will try to remove money from the economy by selling debt. That's because by selling debt and holding the dollars from the purchase of debt outside the flow of capital, the Fed will decrease the money supply. A reduced money supply increases the dollar's value.
And once the value has increased, the Fed can charge a higher rate of interest.
How the Fed Uses Interest Rates to Make the USD Go Down
Conversely, if the Fed feels that the economy's slowing down and might stall out, it usually combats such a scenario by trying to inject money into the system.
To do this the Fed buys debt and holds it outside the flow of the general economy. Since the Fed is increasing the supply of money, if the demand remains pretty much the same, the value of the USD will decrease. As a result the Fed will have to charge a lower interest rate.
The idea behind injecting money into the economy to prevent a slowdown is that if there is more money available, people will spend more. As a result, the economy will heat up.
Although buying and selling debt is only one of the many tools the Federal Reserve has at its disposal, it is a very effective one that they use widely to control interest rates.
Keep your eye on the Fed as part of your Forex training and you will have a good feel for where the dollar is heading.
