Fundamental analysis · Fundamentals
Central Banks & Interest Rates
The most powerful force in every market.
▶ Watch the free video lesson with TomWhat it is
Central banks like the US Federal Reserve set short-term interest rates to control inflation. Rates affect the value of every asset: higher rates make borrowing expensive and cash more attractive, which usually pressures stocks and lifts the currency. Markets trade on expectations, so the tone of the decision often matters more than the decision itself.
How it works
- Central banks raise rates to fight inflation and cut them to support a weak economy.
- Higher rates usually pressure stocks (especially growth stocks) and gold, and strengthen the currency.
- Markets price in the expected decision weeks ahead. The surprise, and the tone of the statement, move price.
- "Hawkish" means leaning toward higher rates; "dovish" means leaning toward lower rates.
- Big trend changes often start around central bank meetings, so mark them on your calendar.
The rules
| Entry | Trade with the new trend after the decision confirms on the chart. |
|---|---|
| Stop loss | Below the decision-day low (for longs). |
| Exit | Trail under the 20-day average. |
| Filter | Only after the statement and press conference are out. |
Pros
- Drives the biggest, longest trends
- Scheduled and well covered by news
- Affects every asset class
Cons
- Statements can be ambiguous
- Reactions can reverse during the press conference
- Requires following macro news
Common mistakes
- Trading the headline before reading the statement
- Ignoring what was already expected
- Fighting the central bank's direction
Lesson transcript
Final part: central banks and interest rates. If you remember one thing from this series, make it this. Interest rates are the gravity of financial markets. They affect the price of everything. Central banks like the U S Federal Reserve raise rates to fight inflation, and cut them to support a weak economy. When rates rise, borrowing gets expensive and cash pays more, so money tends to leave riskier assets. Here's the key. Markets move on expectations. Weeks before a meeting, traders already bet on what the bank will do. Hawkish means leaning toward higher rates. Dovish means leaning toward lower rates. The surprise, and the tone, are what move prices. Look at this index. For weeks it falls, because traders fear another rate hike. The fear is already in the price. On decision day, the bank holds rates and sounds softer than feared. The surprise is dovish. Price explodes higher and reclaims the twenty day average. A whole new trend starts from that single meeting. So mark every central bank meeting on your calendar. Don't trade the first headline. Read the statement, let the press conference finish, and then trade with the trend that the market chooses. That completes the fundamentals series. You now know why markets move: earnings, valuation, economic data, and interest rates. Combine that with the chart skills from the strategy lessons, and you'll trade with the wind at your back. Great work.
▶ Watch Central Banks & Interest Rates on TradeSchool