You’ve probably noticed this, whenever the Fed hikes rates, the USD spikes…and when the BOJ stays dovish, USD/JPY runs wild.
But why does this happen, really? Let’s unpack it.
1. Interest Rates = The Price of Money
Think of interest rates as the rent you pay for capital. When central banks raise rates, they’re basically saying: “Money is expensive now.” Investors hunt for higher returns, capital floods in, and the local currency strengthens. Lower rates? The opposite — capital escapes to where it’s treated better.
👉 That’s why a 0.25% change in the Fed Funds rate can move trillions across currencies, bonds, and equities in seconds.
2. How Central Banks Pull the Strings
• The Fed (USD): Sets the tone for global liquidity. One hawkish sentence from Powell? Markets melt.
• ECB (EUR): Often stuck balancing Germany’s inflation with Italy’s debt problems — messy, but impactful.
• BOJ (JPY): Masters of ultra-low/negative rates. They keep the yen weak so exporters win.”
But here’s the kicker: it’s rarely the actual number that moves markets. It’s the guidance. Traders price in expectations weeks in advance. The surprise comes from the tone — one word like “persistent” or “temporary” can flip a market.
3. How This Hits Your Charts
• Forex – Interest rate differentials drive carry trades (ever wonder why AUD/JPY was a classic?).
• Bonds – Rates up → yields up, prices down.
• Equities – Growth stocks hate higher borrowing costs; banks love them.
• Gold – Watch real yields. When rates rise faster than inflation, gold usually bleeds.
4. Real-World Example
Remember 2022? The Fed went aggressive with rate hikes. The result: the dollar crushed the yen, hitting levels not seen in 20 years. Traders who understood the playbook — rate hikes strengthen USD, divergence weakens JPY — rode that wave for months.
5. The Trading Edge
Here’s what separates seasoned traders:
• They don’t just react to the decision.
• They track what’s already priced in using tools like Fed Funds Futures.
• They trade the surprise. Because surprise = volatility = opportunity.
So here’s where we’re heading next: if interest rates are the steering wheel, then inflation is the fuel tank. Tomorrow, we’ll dive into how inflation pressures central banks into making those very decisions — and how traders can catch the moves before they even happen.
