Market Mechanics 1: Interest Rates

As a trader, it is always useful to have as much information at your disposal as possible, so understanding market mechanics is essential.  In this series we will look to address topical news and how it relates to the rest of the market, we hope these prove useful both now and as a reference point further down the line.

So you might be able to read technicals in a chart as well as anyone but if you aren’t aware of an economic release such as an upcoming interest rate announcement and its potential effects then you aren’t as prepared as you could be and may want to read on.

In early August, Q2 GDP results showed that the UK economy shrunk for the first time in almost 7 years and although the Bank of England had been working steadily towards interest rate increases it seems these numbers paired with Brexit uncertainties mean interest rate cuts are now the more likely scenario.  This is similar to the US who have already turned around on their previous attempts to increase rates with two recent rate cuts and if you are a regular reader of our Rhino reports you will have been aware of this potential turnaround from back In January (which you can read here).

General thinking has always been such that interest rates are the main proponent to moving the markets and it makes sense if you think about it.

The FED did go on to cut rates in July and made a further 0.25% cut this month with a statement of one further cut expected this year, a real change to the sentiment of this time last year.

Well what does this mean for the markets we trade? 

General thinking has always been such that interest rates are the main proponent to moving the markets and it makes sense if you think about it.  If rates increase then the Equity market it relates to should decrease as returns on cash are suddenly higher in relation, so Bonds and savings accounts are more desirable than placing your funds into shares. Conversely if interest rates drop then the equity markets offer a better relative return so money shifts across accordingly.  Furthermore, if you pair a potential cut with a current weakening Pound for example then as foreign investors see less value in holding Sterling versus other currencies, both of these in theory would lead to a growth in Equities.

The current example for the FTSE is that most of its constituents do the bulk of their business overseas and have profits in Dollars or Euros, so once converted back into Sterling they are worth more the more the pound falls so the FTSE is therefore a more attractive offering.

This 4hour chart shows the relationship between the FTSE and GBP/USD.  You can clearly see that as the FTSE (on the left) has recently risen, the GBP/USD has fallen over the same time.  To be clear the market is not that easy to read and this isn’t seen 100% of the time as many forces are at work but it’s a good relationship to understand and one that you should be aware of.  We will touch on more of these as the series progresses.

To conclude, interest rates are getting closer to all-time lows so savings accounts will be offering minimal returns and it might be an idea to look at your current situation and where you can get better returns.  If you aren’t currently trading and have a view of your own then you can easily set up an account with Tradeview by clicking here or contact us to find out more at uksupport@tvmarkets.com We are also very keen to get feedback on this series so please feel free to let us know what you think.