What are Interest Rates in Forex?

What Are Interest Rates?

Interest rates are the price of money—what borrowers pay and lenders earn. In FX, rates shape cross‑border capital flows via yield differentials and expectations for the policy path. Currencies with rising expected real yields generally appreciate versus those with falling or deeply negative real yields.

Which Rates Matter

• Policy rate: Set by the central bank; anchors the front end of the curve.
• Market rates: Treasury yields reflect growth, inflation, and term premia across maturities.
• Real rates: Nominal yield minus expected inflation; a powerful driver of FX over cycles.

How Rates Move Currencies

• Differentials: Rising 2‑year spread in favor of USD typically boosts USD pairs.
• Carry: Higher‑yielders attract capital when volatility is low and curves are steepening.
• Real yield shocks: Surges in inflation‑adjusted yields reprice FX quickly.

Monitoring the Rate Complex

• Track OIS curves for policy expectations and the terminal rate.
• Watch the yield curve; steepening vs. inversion changes FX leadership.
• Compare cross‑country 2‑year and 5‑year spreads; they lead medium‑term moves.
• Align entries with technical structure to avoid chasing knee‑jerk repricing.

Examples and Scenarios

If the Fed signals an earlier‑than‑expected hike cycle while the ECB stays on hold, 2‑year USD‑EUR spreads widen and EUR/USD typically trends lower. Conversely, if inflation collapses and markets price rapid Fed cuts, high‑beta and carry pairs can rebound as USD real yields fall. In commodity exporters, higher terms‑of‑trade plus rising domestic rates can supercharge currency gains—especially when risk sentiment is supportive.

Build a simple dashboard: OIS curve shifts, 2s/10s spread, real yields, and cross‑country differentials. Tie that to a calendar of CPI, jobs, and central‑bank events. Your goal is to align with the prevailing direction of rate expectations while managing risk during regime shifts.

Common Pitfalls

• Trading the level, not the change—FX reprices the path more than today’s rate.
• Ignoring inflation expectations—nominal yields can rise while real yields fall.
• Entering during data spikes—wait for rates to stabilize before committing.