Forex Forward Rates
What Exactly Are Forex Forward Rates
Forward trades are the result of a number of factors and it is here that you will encounter forex forward rates. As you know, most of the volume in the forex markets relates to the spot market. What is not widely acknowledged is that a large volume of currency trades mature past the spot value date, which the best forex broker will tell you is the standard two business days.
Traders in the foreign exchange markets have different interests and requirements in terms of currencies and delivery dates. How rates are calculated and to what purpose they are used can lead to many a heated discussion amongst the uninitiated. The forward currency market consists of two instruments, forward outright deals and swaps. This market generally includes only cash transactions and as such, this excludes currency futures contracts which are a topic for a separate discussion.
The forward market has no norm with regard to settlement dates which can range between 3 days and 3 years in some cases. Provided that the settlement date is a business day for both currencies it is conceivable that any date past the spot date which falls within the range above may be a forward settlement day.
In order to understand the forex forward rate, the best forex brokers will explain that you need to understand the forward price. The forward price consists of two parts; the spot exchange rate and the forward spread. You my also hear the forward spread referred to as the forward points or forward pips. The spot exchange rate is self explanatory being the building block from which the forward price is derived.
There is a general misconception that the forward prices represent an expectation as to the direction of one currency in terms of another. Any such expectation is false as we will show in the rest of this article.
It is true that any currency price, spot or forward, will generally reflect an expectation of the future price behaviour. This expectation though, is not based on the relative strength or weakness of the currencies. The forward rates are merely the result of the interest rate differential between the traded currencies; the differential being adjusted for the number of days until the maturity date of the contract.
The market expectation of the future variation in the interest rate differential is the essential ingredient for forward currency pricing according to best forex brokers.
An example of this would be a country that has a long history of stable interest rates. If the Producer Price Index (PPI) or the Consumer Price Index (CPI) show a consecutive 2 or 3 month rise then the central bank of that country may very well be expected to take action that will raise interest rates. Higher interest rate are of course the mechanism of choice to fight rising inflation.
The best forex brokers will know that this expectation that the central bank will raise interest rates in the short term, results in the strong potential of the interest rate differential increasing for the one month term. It does not however have anything but a limited effect on the settlement dates in excess of 1 month and consequently the forex forward rates will remain stable.
