Deposit Interest Rates play a crucial role in controlling the flow of money within the economy and the international market. The interest rate differentials have always directed the flow of speculative money in and out of countries, thereby affecting the currency exchange rates. Hence, it is crucial to understand Deposit rates as an economic factor in the FOREX industry.
What is Deposit Interest Rate?
Deposit Interest Rate: It is the money financial institutions pay the depositing party. The deposit account holders put some money in the bank for which the bank pays out interest. Deposit accounts can be a savings account, Certificates of Deposit (CD), and self-directed deposit retirement accounts.
Banks give loans to its customers at a higher rate than the interest they pay out on their deposit accounts. It is this spread between the lending rate and deposit rate that banks make their profit and is called Net Interest Margin.
How can the Deposit Interest Rate numbers be used for analysis?
Potentially, banks are free to set their deposit rates at whatever rate they desire, but they have to keep competition and business into account. Deposits provide financial institutions with the necessary liquidity to maintain business and give out more loans. Banks need to give out loans to make a profit, but also needs to have depositors to provide the required liquidity. Within the country, when the deposit interest rates are low, people would be more interested in investing their money in stocks or other money markets where there is a possibility of a higher return on their capital.
Conversely, banks may increase their deposit rates to attract investors to deposit their capital providing banks with the necessary liquidity to fund their loans. Investors see bank deposits as a safe bet against the risky stock or money markets where they are subjected to a potential loss. Customers are also encouraged to save more and spend less when they get a higher return on their deposits. In the international markets, investors check and compare the lending and deposit rates of major banks in different countries. When the deposit rate of a bank in one country is higher than the lending rate of a bank in another country, there is a chance of making money.
Investors, traders, or some institutions may borrow money from a low-interest rate country and deposit in another country where the rates are high. This difference in the lending and deposit rates amongst banks of different countries is called Interest Rate Differential or ‘Carry.’ For example, let us assume when the deposit rate in Australia is 5%, and the lending rate in the United States is 3.5%. The difference of 1.5% return will move the speculative or “hot” money out of the United States and into Australia. When the Australian Dollars start to flow into the country, the global FOREX market is deprived of the AUD currency, and, hence, it is appreciated.
The below plot also shows the historical difference between the interest rates differential (AUS IR – USA IR) and the AUD USD exchange rate. As we can see, whenever the difference between the interest rates rises in favour of AUD, the exchange rate tends to follow. There is a good correlation between both in the long run. Whenever the direction changes in favour of the United States, so does the exchange rate.
Hence, the “carry” essentially directs the flow of “hot” money in and out of countries whenever there is an increase in interest rates differentials. The larger the difference and consistent the direction of the differential in the plot (positive or negative) more will be the inflow of money in that direction.
When the differential is near or close to zero, then the speculative money may be forced into other options to generate revenue. The interest rate differential may be prominent when paired against small and developing countries to that of developed countries in general. As most of the developed economies are struggling to maintain their growth and have been forced to keep interest rates low, it indeed is a little tricky to find currency pairs to generate a significant carry.
Impact on Currency
Deposit rates have a definite impact on the currency markets. It is one half of the money flow equation. When the lending rates and deposit rates are checked and compared, money flow starts in favour of the higher deposit rate country that appreciates the currency value and vice-versa.
Therefore, deposit rates alone do not determine currency value fluctuations. But in general, it is safe to say that higher deposit rates tend to appreciate currency’s value as the market is deprived of that currency. Conversely, low-interest rates on deposits discourage saving and thereby go into spending, which contributes to inflation and currency depreciation.
The deposit interest rates of local banks can be found on the respective banks from which we would want to borrow money. But in general, the deposit rates and lending rates due to market forces are subject to be close to the country’s Central Bank’s target rate.
For the United States, it is the Fed Funds target rate, and the actual rate is called the effective Fed Funds rate. The Federal Reserve publishes Monday to Friday the daily Interest Rates in its H.15 report at 4:15 PM on its official website. Weekly, Monthly, Semi-annual and Annual rates of the same are also available.
Sources of Deposit Interest Rate
The United States Fed Rates are available here. The monthly effective Fed Funds rates are available in a more consolidated and illustrative way for our analysis in the St. Louis FRED website. Consolidated Deposit Interest Rates of different countries are available here.
How Deposit Interest Rate Affects Price Charts
For forex traders, monitoring other economic indicators is usually meant to help them predict what interest rates are going to be in the future. However, since the deposit interest rates largely depend on the federal funds rate, they rarely have any significant impact on the forex markets by itself. It is worth noting that the US FOMC only meets eight times in a year to determine the federal funds’ target rate. This explains the lack of impact by the deposit interest rate.
In the US, the Fed Funds target rate, on which deposit interest rates are based on, are published every weekday at 4.15 PM ET. Below is a screengrab of the Fed Funds target rate from August 11 to August 17, 2020.
As can be seen, the rate has remained the same at 0.1%. The screenshot below is from Forex Factory, showing that the latest FOMC decision recommended that the Fed Funds target rate remains between 0% and 0.25%.
Now that we’ve established the impact that the deposit interest rate has on the economy and the currency valuation let’s see how it impacts the price action of some select currency pairs.
EUR/USD: Before Effective Fed Funds Rate Release August 17, 2020, Just Before 4.15 PM ET
The 15-minute EUR/USD chart above shows that the market between 10.15 AM and 4 PM ET on August 17, 2020, had no specific trend. The market has adopted an almost neutral stance with the candles forming just around the flattening 20-period Moving Average.
EUR/USD: After Effective Fed Funds Rate Release August 17, 2020, 4.15 PM ET
As can be seen on the chart above, immediately after the daily update on the Effective Fed Funds rate, there is a slightly bullish 5-minute candle forms. The news, however, is not significant enough to the market to cause any spikes or change the prevailing market trend. As can be seen, the pair continued with its neutral trend and a flattening 20-period Moving Average.
Let’s see how this new release has impacted some of the other major Forex currency pairs.
GBP/USD: Before Effective Fed Funds Rate Release August 17, 2020, Just Before 4.15 PM ET
The neutral trend observed with the EUR/USD pair before the daily release of the Effective Fed Funds Rate can be seen on the GBP/USD chart above. The candles formed just around the flattening 20-period Moving Average.
GBP/USD: After Effective Fed Funds Rate Release August 17, 2020, 4.15 PM ET
After the news release, a 15-minute bullish candle forms. However, the same neutral trends persist with the pair indicating that the news was not significant enough to move the markets and cause a change in the trend.
AUD/USD: Before Effective Fed Funds Rate Release August 17, 2020, Just Before 4.15 PM ET
AUD/USD: After Effective Fed Funds Rate Release August 17, 2020, 4.15 PM ET
Unlike with the EUR/USD and the GBP/USD pairs, the AUD/USD pair had a clear uptrend before the daily release of the Effective Fed Funds Rate. This uptrend was not a steady one since the candles formed just above an almost flattening 20-period Moving Average. After the news release, a bullish 15-minute candle is formed. The news was, however, not significant enough to alter the prevailing market trend.
While the deposit interest rate is vital in determining the flow of money in an economy, it plays an almost insignificant role in moving the forex markets. Cheers.