Interest rates are rising...what does that mean for USD?

This week the Fed elected to raise interest rates another 25 bps to 5.5%. Leading many other major economies, traders may wonder what that could mean for the future of the US dollar.

Interest rates can create demand

Typically higher interest rates create greater demand for a currency, which can lead to stronger forex markets. In the example below, a long position in the pair AUD/JPY allows the trader to collect the interest of the Australian dollar at 4% at a cost of 0% from the short yen. While various forex costs and price action could negatively impact this theoretical example, the difference in interest rates give traders a reason to hold the currency.

Global interest rates converging

In the case of USD, an interest rate increase does not guarantee greater strength. In the current landscape, major economies like the UK and Euro Area are also raising interest rates to fight inflation. With speculation that these economies could eclipse the US in interest rates in the next year or two, forward looking traders could prefer to hold their currencies over USD.

Traders can use fundamental analysis by tracking additional economic data releases such as inflation rates or GDP to better gauge a currency's future expectations.

How to trade USD

1. Open an account to get started, or practice on a demo account
2. Choose your forex trading platform
3. Open, monitor, and close positions on USD pairs

Trading forex requires an account with a forex provider like IG. USD pairs can be found in IG's platform under the 'USD Pairs' pairs tab. Many traders also watch major forex pairs like GBP/USD and USD/JPY for potential opportunities based on economic events such as inflation releases or interest rate decisions. Economic events can produce more volatility for forex pairs, which can mean greater potential profits and losses as risks can increase at these times.

You can help develop your forex trading strategies using resources like IG’s Trading Academy. Once your strategy is developed, you can follow the above steps to opening an account and getting started trading forex.

Your profit or loss is calculated according to your full position size. Leverage will magnify both your profits and losses. It’s important to manage your risks carefully as losses can exceed your deposit. Ensure you understand the risks and benefits associated with trading leveraged products before you start trading with them. Trade using money you’re comfortable losing.