Having looked at charting techniques and fundamental analysis. We are going to take a more serious look into how economic factors can influence price movement in the stock, bond and Forex markets. While not one of the most exciting topics out there it is of fundamental importance if you are serious about getting in to spread betting or CFD trading. Today we are going to look at how interest rate changes by major central banks can have a significant effect on market prices.
In the US interest rates also known as the Fed Fund rate are set by the Federal Open Market Committee (FOMC). This rate serves as an important role in determining what the interest rate will be in over area’s such as mortgages and government bonds. The impact of the rate set by the Fed is reaches all of area’s of the economy, as well as playing a role of influencing interest rates in other countries such as the UK. The interest rate for the UK is set by the Monetary Policy Committee (MPC) and in the Eurozone the interest rate is set centrally by the European Central Bank (ECB). While US rates can have an affect on interest rates set in Europe, the large slashes the fed made to interest rates during the recent sub prime crisis weren’t copied as dramatically in Europe.
The FOMC meets around every six weeks to discuss possible changes to interest rates, while the ECB & MPC meet monthly to have similar discussions. The time frame these committee’s meet is subject to change, with emergency meetings held when there is concern about the state of the economy. There is wide spread speculation about what will be the outcome of these meetings and the speculation is widely reported in the financial press.
As a general but not immutable rule a rise interest rates is good the price of the currency, but negative for stock prices. The increase in the strength of the currency comes from the possibility of getting a better rate of return in that country, leading to hot money entering the economy. While the negative effect for stock prices is due to the fact that a rise in interest rates will often push up the costs of company borrowing affecting profits. Even very profitable companies will have often have large amounts of debt in order to fund growth and expansion. Conversely a fall interest rates normally has a positive effect on stock prices while having a negative impact on the strength of the currency. As with any rule there are plenty of exceptions especially when there are unusual circumstances.
If changes in interest rates have already been accurately predicted by the market, it is likely there may little change to prices due to the markets having already priced in the expected change of interest rates. When interest rate changes are larger or smaller than expected is when your likely to see the biggest movements in prices. For example during the sub prime crisis the Fed Fund was lowered by 0.5% when much of the market was only expecting a 0.25% decrease. This saw the US dollar fall quite dramatically compared to the value of the pound.
Part of the Beginners Guide to Strategy and Analysis for Spread Betting
