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“It is not what we eat but what we digest that makes us strong; not what we gain but what we save that makes us rich; not what we read but what we remember that makes us learned; and not what we profess but what we practice that gives us integrity.”

                                                            Francis Bacon

FX Trading –Central Bank Interest Rate Decisions Back On The Radar

If you’re in currency trading and became tired of only hearing about interest rates … or tired of only hearing about the carry-trade dynamic … or tired of only hearing about yield differential as the primary force impacting the foreign exchange market, then the global lending crisis and impending economic meltdown has offered a refreshing change of pace!

But as traders and investors begin to adapt to the new investing environment, interest rates (as set by central banks) are making a comeback.

I mentioned briefly in Tuesday’s issue (The Dollar’s Side of the Teeter-Totter is Least Heavy) that the European Central Bank and the Bank of England are now widely expected to embark on a rate-cutting campaign. This has been responsible for the continued decline of the euro and British pound this week.

But let’s shift some focus away from the big-two dollar counterparts and turn our attention to some lesser-watched currencies.

You may or may not have heard that the central bank in Hungary decided to HIKE interest rates yesterday. At a time when rate cuts are becoming as common as hollow political promises (redundant, I know), the Hungarian central bank took a hefty step in the opposite direction. They increased rates by three full percentage points.

It may sound crazy at first. But this is their hope of alleviating economic pain. Because household debt in Hungary is made up largely of foreign currency loans, the last thing they can afford is a slumping currency. As the value of the forint collapses, paying back those loans denominated in other currencies becomes more difficult. And the country has already found itself smack in the middle of the global lending crisis. Hungary, like so many, can’t afford any more financial burdens. Their hope lies in making their currency more appealing so capital does not flee their country.

A more conventional and expected decision came from Sweden’s central bank today. They sliced off 50 basis points from their main rate. They’re being hit with the same financial hardships as the rest of Europe and hope that rate cuts will encourage borrowing and subsequently stimulate their economy.

The current situation in Sweden’s is of high/rising prices and sluggish growth. Interest rate cuts ultimately will make the Swedish krona far less appealing.

But right now, despite the efforts being taken to shore up their respective economies, each currency (the forint and the krona) is at the mercy of the US dollar. Global deleveraging is the culprit. Money is flowing out of emerging markets as quickly as it flowed into them. The dollar has been the beneficiary.

This is the game changer.

And even though our expectations have the dollar climbing plenty higher, we’re at a point where a corrective move may be long overdue. In other words, the buck could use a breather and fall back for a few days.

Evidence may lie in the reaction to the Reserve Bank of New Zealand. They cut rates by an entire percentage point overnight, and after some sharp ups-and-downs the New Zealand dollar is starting to rally. And many of the major are experiencing the same boost as I wrap up this piece.

Good luck out there!