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The Foreign Exchange Matrix: A new framework for understanding currency movements by Barbara Rockefeller, Vicki Schmelzer

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Chapter 4 – Interest Rates and Interest Rate Differentials

“Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency.”

John Maynard Keynes, The Economic Consequences of the Peace, 1919

Of all the factors FX traders look at, relative interest rates and relative inflation expectations are at the top of the list. Interest rates are the single strongest conduit linking economic fundamentals to exchange rates – except when consideration of relative interest rates is overwhelmed by risk aversion.

In this chapter we will look at circumstances when interest rate differentials matter to a currency pair and circumstances when they do not. We will discuss interest rate ...

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