Interest rates are one of the most important leading indicators to which most people (retail traders, governments and even federal banks) pay special attention.
If we look back in history we can see that the interest rates are historically low since the crash in 2008.
In theory an economy needs almost 10 years to recover from a crisis, and if we look closely, it is almost 10 years since the last crisis.
The mechanism by which the Fed manipulates the prevailing Fed funds rate is by the buying and selling bonds.
A country’s currency/exchange rate is affected by the central banks interest rates policy/Fed funds target.
In low interest rate environment, money is 'cheaper' and all things being equal: currency will lose its value.
In a high interest rate environment, money is more 'expensive' and all things being equal: a currency will increase its value.
So… what impact do interest rates have in an economy?
We can look at three points (triple T’s):
- The borrowing becomes more expensive (for consumers and companies)
- Troubles for stocks and bonds (as mentioned previously)
- Turns the dollar stronger (normally, the dollar become more appreciated)
The borrowing becomes more expensive
It happens in everywhere, when the federal banks increase the interest rates then the banks have to increase their interest rates as well. People or companies that need finance have to pay more because of interest rates.
Therefore, is not a benefit for consumers or companies.
Troubles for stocks and bonds
Bonds yields and interest rates are correlated.
Normally, when federal banks increase the interest rates, then the bonds yields move in the opposite direction.
Turns the dollar stronger
Higher rates make investing in treasuries and assets more attractive.
Therefore, the dollar appreciate face others currencies.