Forex Trading

What the Forex Market Is Telling Us About US Interest Rates


No market exists in a vacuum. It is all too easy when you are trading or investing in one market, whether that be stocks, bonds, commodities, foreign exchange, crypto, or whatever, to look at it in isolation. After all, it is the current and future prices of what you are buying or selling that concern you most, by definition. However, when you are looking for clues for what will happen in the future, other markets can often tell you a lot about the mood among those who move big money around the system, and that is what ultimately sets prices.

Right now, the obvious place to look for those clues if you are a stock investor is at the Treasury market. Stocks have been moving in response to actual and expected interest rates for so long that a consideration of the yield on the 10-Year is just about second nature to investors, but what is a “neutral” yield? What does around 4.25%, where the 10-Year yield is now, tell us? Are rates headed lower, staying at these levels for a while, or is there even a chance of a return to rate hikes?

Of course, we can’t know those things for sure, not least because based on what they have been saying recently, the FOMC members who will be setting those rates don’t know what they will do. Despite the common assumption that the Fed is looking to cut rates from here if they can in any way justify it, they claim to have no preset agenda. Future decisions, they maintain, will be dependent upon the economic conditions and available data at the time. So if the rate setters themselves aren’t offering any clues, where else can we look?

Maybe it is because my start in markets came in forex, but I have always believed that that is the first place to look if you want to know what the big money is doing. FX is a $26 billion per day market, and when a financial institution has a view on the prospects for a country’s interest rates, the first thing they do is to buy or sell its currency. So, what does the dollar tell us about expectations for interest rates?

DXY chart

As you can see from the above chart, the Dollar Index (DXY) has been basically rangebound since early last year, trading between 100 and 107, with the current level around 104 being in the mid-range. In other words, the world’s big financial institutions are essentially neutral on the dollar, and therefore on US interest rates. They are not positioning for a cut, as many stock analysts are assuming is coming soon, but nor is there any hint of concern about a surprise hike.

There are other markets that I would typically consider, but the main one, commodities, is currently being almost entirely driven by factors other than dollar strength and expectations. Usually, commodity prices are quite heavily influenced by the relative strength of the dollar: If something is priced in dollars on the global market, as most commodities are, then the commodity, oil, gold, or whatever, becomes like a currency counterpart in that the price reflects the relative strength of each side of the pair.

However, commodities, even now, four years on, are still being distorted by the effects of the pandemic, making them a bad indicator of sentiment around the dollar.

We are, then, left with forex, and the message there is quite clear. The global funds and big institutions that drive that market are not anticipating any move soon. That fits with the conclusion that I arrived at yesterday when looking at the possible impact of rate cuts this year, that investors are becoming increasingly okay with the idea of the Fed not cutting in a hurry and adopting a wait and see approach.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.



Source link

Leave a Response