The Fed’s Interest Rate Hike and the Fate of EUR/USD

The Fed’s Interest Rate Hike and the Fate of EUR/USD

The Forex market, where the world’s currencies face each other in a relentless competition, is always the scene of fluctuations and rapid changes. Meanwhile, the decisions of central banks, especially the Federal Reserve (the US central bank), can change the balance of power in this battlefield like a powerful earthquake and change the fate of currency pairs. One of the most important of these decisions is the increase in the interest rate, which can have a profound effect on the EUR/USD (Euro to Dollar) currency pair.

In this article, we will go to the heart of this battle together and by examining the effect of the Federal Reserve’s interest rate increase on EUR/USD in detail, we will help traders to step into this battlefield with more awareness and wisdom and take advantage of the opportunities created to profit.

Interest Rate: The Master Key to the Currency Market

The interest rate, as the cost of borrowing money, is one of the most important factors affecting capital flow in financial markets. When the Federal Reserve decides to raise interest rates, it is like placing a powerful magnet in front of foreign investors. Due to the higher return in the US market, these investors are more inclined to invest in the US dollar. This increased demand for the dollar causes the dollar to strengthen against other currencies, including the euro. As a result, the EUR/USD (Euro to Dollar) currency pair decreases and the dollar wins this battle.

The Federal Reserve and the Fateful Decision

The Federal Reserve, as the central bank of the United States, tries to guide the country’s economy on the desired path by changing the interest rate. But what factors drive the Federal Reserve to raise interest rates?

Inflation: The Runaway Dragon of the Economy

Inflation is the general increase in the level of prices in an economy, which, like a runaway dragon, can set the value of money on fire, devour people’s purchasing power, and lead the economy to the brink of destruction. To fight this dragon and curb inflation, the Federal Reserve usually raises interest rates. Raising the interest rate is like splashing cold water on this fire and causes the cost of borrowing money to increase, the demand for goods and services to decrease and ultimately, inflation to be curbed.

Economic Growth: A Double-Edged Sword

Economic growth means an increase in the production of goods and services in an economy. رThis growth can be like a double-edged sword. On the one hand, economic growth is desirable and leads to increased welfare and employment. But on the other hand, rapid economic growth can lead to increased demand and, consequently, increased inflation. The Federal Reserve may raise interest rates to prevent the economy from overheating and to curb inflation. 

Labor Market: A Sign of Economic Health

The labor market is one of the most important indicators of the health of the economy. When the unemployment rate decreases and the labor market moves towards full employment, it means that the economy is in good shape. But this situation can lead to increased demand and, consequently, increased inflation. The Federal Reserve may raise interest rates to prevent this problem.

Government Fiscal Policies: Cooperation or Confrontation with the Federal Reserve?

Government fiscal policies, including taxes and government spending, can also affect the Federal Reserve’s decision to raise interest rates. The government’s expansionary fiscal policies, such as tax cuts and increased government spending, can lead to increased demand and inflation. In this situation, the Federal Reserve may raise interest rates to neutralize the effect of government fiscal policies and control inflation.

International Conditions: The Impact of the World on the US Economy

International conditions, such as global economic growth, oil prices, wars, sanctions and global political and economic events, can also affect the Federal Reserve’s decision to raise interest rates. For example, if global economic growth slows or oil prices rise, the Federal Reserve may refrain from raising interest rates to support the US economy and prevent a recession.

Fundamental Analysis: The Roots of the Euro and Dollar Battle

Fundamental analysis, like an economic historian, examines the root and fundamental factors affecting the value of currencies. Regarding the impact of the Federal Reserve’s interest rate increase on EUR/USD, fundamental analysis tells us that this decision usually leads to the strengthening of the US dollar and, consequently, the decline of the EUR/USD currency pair. This effect occurs due to the increase in capital flow towards the US dollar and the decrease in the attractiveness of investing in the Euro.

Fundamental factors that can exacerbate the impact of the interest rate increase:

• Interest rate differential between the US and the Eurozone: The greater the interest rate differential between the US and the Eurozone, it is as if the US dollar magnet has more power and attracts capital more strongly. As a result, the impact of the interest rate increase on the decline of EUR/USD will be greater.
• US economic growth compared to the Eurozone: If the US economic growth is higher than the Eurozone, it is as if the US economy is running and the Eurozone economy is walking. In this situation, the demand for the US dollar increases and its value strengthens against the Euro.
• US political and economic stability compared to the Eurozone: In conditions of political and economic instability in the Eurozone, it is as if the Euro ship is caught in a stormy sea. In this situation, investors seek safe assets such as the US dollar, and this can lead to a further decline in EUR/USD.

Technical Analysis: Predicting the Future with the Language of Charts

Technical analysis, like a fortune teller using the language of charts and price patterns, tries to predict the future trend of EUR/USD after the Federal Reserve raises interest rates. This analysis helps traders find suitable entry and exit points in their trades by examining price history and identifying repetitive patterns. 

Some important points in technical analysis:

• Identifying support and resistance levels: Support and resistance levels are like walls that resist price movement. Breaking these walls can be a sign of a trend change. For example, if the price of EUR/USD breaks below an important support level after the Federal Reserve raises interest rates, it can be expected that the downward trend of this currency pair will continue.
• Identifying price patterns: Price patterns such as “Head and Shoulders” and “Double Top” can be signs of a trend change. For example, if the “Head and Shoulders” pattern is formed in the EUR/USD chart, it can be expected that the upward trend of this currency pair will change to a downward trend.
• Using technical indicators: Technical indicators are tools that use mathematical formulas to provide useful information about price trends, trend strength and the probability of trend changes. For example, the MACD indicator can help traders identify trend changes and divergence between price and indicator. 

How to Profit from This Battle?

Traders can use their knowledge and experience in the field of fundamental and technical analysis to profit from the Federal Reserve’s interest rate increase and its impact on EUR/USD.

• Sell trades: Considering that the Federal Reserve’s interest rate increase usually leads to a decrease in EUR/USD, traders can profit from this price decrease by taking a sell position in this currency pair. This strategy is suitable when fundamental and technical analysis indicate the continuation of the downward trend of EUR/USD.
• Buy trades in case of trend change: If fundamental and technical analysis shows that the downward trend of EUR/USD is changing to an upward trend, traders can profit from the price increase by taking a buy position in this currency pair. This strategy is suitable when there are fundamental factors such as a decrease in the interest rate differential between the US and the Eurozone or an improvement in economic conditions in the Eurozone.
• Using financial leverage: Financial leverage is like a double-edged sword. On the one hand, it allows traders to trade a larger volume of currency with less capital and increase their profit potential. But on the other hand, financial leverage can also increase the risk of transactions. Therefore, traders should use financial leverage with caution and observe risk management.
• Risk management: In the battlefield of the Forex market, risk management is like a protective shield that protects traders from sudden risks. Traders should always determine their stop loss before entering any trade and not risk more than the allowed amount. Also, using tools such as Stop-Loss Order and Take-Profit Order can help traders in managing risk. 

Conclusion: Victory in the Battle of the Euro and the Dollar

The Federal Reserve’s interest rate increase can shift the balance of power in the Euro and Dollar battle towards the US dollar and lead to a decline in the EUR/USD currency pair. By understanding the factors affecting this decision and also by using fundamental and technical analysis, traders can take advantage of the opportunities created to make a profit. Also, observing risk management in transactions is very important and can help traders reduce potential losses and increase their chances of winning in this battlefield.