How interest ratesmove currencies.
Interest rates and currencies are closely linked. Money flows to where it earns more, so when 1 country is expected to pay higher rates than another, its currency tends to strengthen against the other.
What matters is not today’s rate, but where the market expects rates to go. That is why central bank speeches can move a currency as much as a decision.
The rate spread
Take the 2-year government yields of 2 countries and subtract 1 from the other. That is the rate spread. When it widens in favour of the US, USDJPY usually rises. When it narrows, USDJPY usually falls.
Why expectations matter more than decisions
A rate decision is usually expected. The market moves on changes in the path of future rates: a hint of an extra cut, a pushback against a hike. The Interest Rate Probability tool shows what the market currently prices for the next meetings.
Use it in real trading
The tool informs the decision, it never makes it. Here is how it plays out on real trading days.
The US-Japan spread widens for 4 weeks and the Smart Bias on USDJPY is bullish. You favour USDJPY longs.
The spread narrows but USDJPY keeps rising. Something else is driving it, often risk mood or flows. You slow down.
Mistakes to avoid
- Looking at today’s rate instead of expectations.
- Using 10-year yields for short-term FX moves.
- Ignoring risk mood, which can override rates for a while.
What makes it different
Rate spreads are 1 of the drivers shown behind every Smart Bias verdict, so you see when the rate story supports your idea.
Questions
Which yields should I compare?
2-year government yields are the best proxy for rate expectations.
Does a rate hike always strengthen a currency?
No. Only if it was not fully expected, see what "priced in" means.
Where do I see rate expectations?
In the Interest Rate Probability tool and the drivers of the Smart Bias.