How to Prepare for an Interest Rate Hike

The U.S. Federal Reserve is nearing a decision to raise interest rates. According to Bloomberg Markets the Fed Vice Chairman Stanley Fisher says the U.S. economy is nearing Fed goals where they would increase rates.

“We are close to our targets,” Fischer said in a speech at the Aspen Institute in Aspen, Colorado on Sunday. “Looking ahead, I expect GDP growth to pick up in coming quarters, as investment recovers from a surprisingly weak patch and the drag from past dollar appreciation diminishes,” he added, without giving explicit views on his rate outlook.

Fischer’s remarks come less than a week before Fed Chair Janet Yellen speaks Aug. 26 at an annual symposium hosted by the Kansas City Fed in Jackson Hole, Wyoming. Investors are looking for clues from central bankers on the timing of potential interest-rate increases amid modest economic growth, strong job gains, and only moderate increases in inflation.

If interest rates go up so does the U.S. dollar against virtually all world currencies. Is it time to buy dollars? If so which pair should you be trading? Or should you consider options while you wait for the Fed? How do negative interest rates seen in some countries effect your decision?

Timing, Buying Dollars or Purchasing Calls

With the Federal Reserve the issue is always on of timing. If you possess an infallible crystal that tells you exactly when the Fed will raise or lower rates you simply need to buy or sell dollars just before the announcement. Because none of us owns such a device a decent alternative is to buy calls on the dollar with the currency of your choice. You will pay a premium for this transaction but will hold on to your dollars until the time is right to make your move. We wrote years ago about Forex options.

When a trader purchases Euros for dollars or Yen for British pounds he or she invests a given amount of trading capital in the trade. When he or she purchases an options contract the trader invests a substantially smaller amount in the trade. However, when the currency pair performs as expected the trader gains the same amount is if he or she had purchased or sold short for the sum total of the value of the trade. Part of the work of the successful Forex options trader is to pick inexpensive options contracts which further reduce the cost of the trade. When the trader chooses correctly he commonly gains a multiple of his trading capital instead of a small percentage from the change in Forex currency rates.

How to best prepare for an interest rate hike is to have your plan in place and ready to execute in a timely fashion. Pick the most advantageous currency to trade against and decide up front just how much profit you want so that you can execute your trade and then get out before the dollar turns around again. As always do your own homework before trading directly or with Forex options.