Interest rates: risk-free income
At the master class "Be a Trader: Fundamental Analysis" with Roman Kravchenko
In May one of the hottest topics for discussion was the ECB interest rate cut. Mario Draghi scared investors even more by saying that the regulator may cut interest rates on deposits to negative values.
Why is it important for every trader and investor to know the interest rate of the world's major central banks and the principles of its formation?
Other articles of the "Be a Trader" master class:
Where are the stakes growing from?
In order to understand how the interest rate works, you need to look at the basics of investing. Theoretically, each investment is considered in relation to an investment in "no risk" assetswhich, by definition, are government bonds. It is believed that the state is always able to fulfill its debt obligations to creditors, because it has the ability to print money.
Naturally, any investor would prefer a "risk-free" investment in government bonds to something with a higher level of risk. The following is taken as a basis market price on the bond, which depends on the rate currently in effect on the market. The market rate, aka spot rate, in turn, is in direct correlation with the interest rateThe amount of the money is set by the Central Bank of the state.
By changing the interest rate level, the Central Bank affects the profitability of all assetswhich are denominated in the national currency. In a global and open market, this consequently affects the appeal of these tools For investors.
If the interest rate rises, investors increase their purchases of the currency of the country where it occurred, thereby increasing its value, and sell their national currency, which, accordingly, lowers its exchange rate. When the interest rate decreases, the yield on all types of assets falls, which negatively affects the attraction of investments. This phenomenon is called in the market "Interest Rate Arbitrage"also known as "Carry trade".
Key role in the formation of exchange rates
Interest rates, as you can imagine, are not taken "from the ceiling". Under real interest rate implied nominal interest less inflationary interest. It is noteworthy that in the case of a mismatch between the growth of the rate and the growth of inflation and GNP, the exchange rate of the national currency may even decline.
The United States is a case in point. In 1994, with stable economic growth, the growth of inflation and GNP outpaced the growth of interest rates, with the result that real interest rates tended to fall. The U.S. Federal Reserve decided several times during 1994 to raise interest rates. As a result, The U.S. dollar has been declining almost all year. For example, the exchange rate of the dollar against the deutschmark in 10 months fell from 1.76 to 1.48.
Digging deeper, it should be noted that the difference between the interest rates of the two states (the interest differential) plays a key role in shaping the exchange rate of their currencies. For example, if the level of real interest rates of two countries is approximately the same (which, as we remember, characterizes the same returns when investing in the economies of these countries), then an increase in the interest rate of one of the central banks will cause a skew in the yield in favor of investments in this particular currency and, accordingly, leads to an increase in demand for it and its growth rate.
Depending on the characteristics of the state economy, the Central Bank, by changing the level of the interest rate, performs the functions of regulating inflation, deflation, supporting or slowing down economic growth.
Interest rates of the world's largest central banks
Interest rate US FEDERAL RESERVE - Target Fed Fund Rate
The key interest rate in the United States is set by the Federal Open Market Committee (FOMC). It is called "Target Fed Fund Rate" (Target Fed Fund Rate) and is the main global interest rate.
Interest rate ECB - Refinancing tender
European interest rate Refinancing tender is analogous to the U.S. Target Fed Fund Rate. The European refinancing rate is the minimum possible rate on the bids to raise funds in the ECB tender. Every two weeks, in order to maintain liquidity in the financial system, the European regulator holds a tender for the placement of funds. That is, in fact, it is the minimum rate at which the ECB deals on the open market. Refinancing tender is the second most important interest rate in the world.
Bank of England interest rate - Repo rate
Repo rate is the interest rate at which the Bank of England makes short-term loans to British banks, which are secured by securities. The banks are obliged to repurchase their assets after a certain period of time at a certain price.
Interest rate of the Swiss National Bank - Libor Rate
Target three-month Libor rate is used by the Swiss National Bank as a tool to regulate monetary policy. It is the middle of the two percent range. It is also called the reference rate, through which the SNB influences interest rates on loans, savings and mortgages.
Interest rate Central Bank of Japan - Overnight call rate target
Overnight call rate target is an analogue of the U.S. Target Fed Fund Rate. The Bank of Japan's interest rate is its benchmark as an average value in the short-term deposit market. To bring bank deposit rates closer to the Target Fed Fund Rate, the Bank of Japan manipulates government securities.
Central Bank of Canada interest rate - Overnight rate target
Bank of Canada Overnight rate target is a benchmark for loans for banks and financial institutions. Through its changes, the Canadian regulator influences bank loans, savings and mortgage lending volumes.
Interest rate Reserve Bank of Australia - Official Cash Rate
RBA interest rate - is the rate on interbank short-term loans, which the regulator maintains through manipulation of the government bond market.
Reserve Bank of New Zealand interest rate - Official Cash rate
MFNZ interest rate is an instrument for regulating short-term interest rates in the financial market. The regulator accepts funds from commercial banks on deposit with an interest rate 0.25% less than the official rate and lends with a rate 0.25% more than the official one.
People's Bank of China Base interest rate
People's Bank of China Base interest rate is the benchmark for the prime rates of commercial banks. By changing the level of the rate, the Chinese regulator influences all types of loans. It is noteworthy that the interest rate of the People's Bank of China, because of the length of the financial year, is always a multiple of 9.
The current level of global CB interest rates