Currencies work the same way! The higher a country’s interest rate, the more likely its currency will strengthen. Currencies surrounded by lower interest rates are more likely to weaken over the longer term.
How do you trade interest rates?
When an interest rate swap transaction (trade) is agreed upon, the value of the swap’s fixed rate flows will equal its floating rate payments as denoted by the forward rates curve. When interest rates relevant to the swap change, investors and traders will adjust the rate they demand to enter into swap transactions.
What happens to a currency when interest rates are cut?
So, they exchange other currencies for dollars, and their increased demand for dollars raises the dollar exchange rate. Conversely, when the Fed cuts interest rates, investors sell dollar-denominated assets and buy foreign assets, which tends to weaken the dollar’s exchange rate.