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changes in how an economy is growing is clearly an important part of gaining a sense of whether a currency will be strengthening or weakening. The relationship of growth and currencies applies throughout the world. While there are many aspects to economic growth, the forex trader's main focus should be on interest rates. An increase in interest rates tends to strengthen the currency. Traders need to go further than just knowing what the rate levels are. They need to assess whether the economy is expected to be strengthening or weakening. As a result, the forex trader should keep track of housing data when deciding on the direction of trading a currency, as housing data affect the decision to increase or decrease rates, or keep them the same.

      Chapter 2

      The Role of Inflation, Reflation, and Deflation

      Inflation and its inverse, deflation, are fundamental forces in currency trading. Central banks are always concerned about managing inflation so it doesn't turn too high, into hyperinflation, nor too low, and into a deflation. It's interesting to note that at first blush the fear of deflation seems unreasonable. Isn't lower price a good thing? To a consumer, it would seem so. But to an economy it means there is less growth. Therefore, fear of deflation is a major concern. For central banks, monetary policy is a balancing act.

      Containing inflation in the Western World has in many ways been achieved. In the period of 1973 through 1987, inflation levels in industrialized countries were near the 7.5 percent range. A decade later, in 1989, inflation levels ranged at the much lower level of 3 percent. Today, a reversal of expectations has occurred in the world of trading, where inflation growth, partly due to the financial collapse of 2008, is low.9

      Central banks around the world monitor inflation and raise interest rates to try to slow down inflation. Central banks often include in their statements accompanying interest rate decisions that they will be vigilant over potential risks of inflation. This is commonly known as being an inflation hawk. Whenever inflation is feared to be lingering in the economy, traders interpret this fear as raising the probability that interest rates will increase.

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      1

      Richard Fisher for Federal Reserve Bank of Dallas, “On the Record: An Appreciation of Milton Friedman, Champion of Economic Freedom,” Southwest Economy (December 2006), http://www.dallasfed.org/assets/documents/research/swe/200

1

Richard Fisher for Federal Reserve Bank of Dallas, “On the Record: An Appreciation of Milton Friedman, Champion of Economic Freedom,” Southwest Economy (December 2006), http://www.dallasfed.org/assets/documents/research/swe/2006/swe0606e.pdf.

2

Damon Darlin, “Your Money; Mortgage Lesson No. 1: Home Is Not a Piggy Bank,” The New York Times (November 4, 2006).

3

National Association of Housing Builders, “What Is the NAHB–Wells Fargo Housing Market Index (HMI)?” http://www.nahb.org/generic.aspx?genericContentID=532.

4

Wall Street Journal (March 1, 2007).

5

Anna White, “Why First Time Buyers Are Still Piling into a Hot Housing Market: Lending to First Time Buyers Hits Record Levels, as the Desire to Own a Home Negates High Prices and Looming Interest Rate Rises,” The Telegraph (August 11, 2014).

6

Ibid.

7

Financial Policy Committee, Financial Stability Report, Bank of England No. 35 (June 2014), p. 22, http://www.bankofengland.co.uk/publications/Documents/fsr/2014/fsrfull1406.pdf.

8

Ibid., p. 23.

9

Good sources for locating interest rates and inflation are: www.global-rates.com/economic-indicators/inflation/inflation.aspx and www.usinflationcalculator.com/inflation/current-inflation-rates.

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