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USDJPY and Long-Term Interest Rates
Of all the factors in fundamental analysis, interest rates are probably the most important to currency traders. As a general rule, high interest rates make a nation's currency more attractive to hold. In addition, there's the ever popular carry trade. A carry trade occurs when someone borrows a currency with a low interest rate and buys another currency paying a higher interest rate. Carry traders collect interest based on the different rates of each currency. Some would lead you to believe that a carry trade is a near sure-thing bet for a long-term position, at least for currencies of stable and well-developed nations. Their rationale is that a significantly better interest rate almost always attracts more buyers in the long run. The attached chart of the USDJPY paints a more complex picture. The chart covers about 8 years of data. During this time, the U.S. Federal Reserve raised and lowered rates numerous times. The Bank of Japan kept rates extremely low for most of the period, including a zero-rate policy for a siginicant period. Last July they raised rates for the first time in 6 years. One may expect the USDJPY to closely follow the U.S. Federal Funds rate up and down, since Japan's rate barely moved. However, that's not always what happened. The lesson? Interest rates are important, but they are just one of many fundamental and technical factors to consider. As a stand-alone indicator, they aren't always reliable, even in the long term.