[Definitive Edition] Why Long-Term Interest Rates Fall When a Rate Hike Is Clearly Stated
Even though it’s a rate hike, interest rates fall.
Hearing that might feel contradictory. Last time, I talked about how if inflation is left unchecked, interest rates rise (and the currency is sold). This time, it is the flip side of that.
It is the long-term interest rates that “fall”
First, let’s clarify. When I say “fall” here, I am referring to long-term interest rates.
The policy interest rate moved by the central bank, which is the short-term interest rate, rises straightforwardly when a rate hike is implemented. What falls are the longer maturities, such as 10-year or 30-year bonds.
The flow is as follows.
The central bank clearly mentions a rate hike
→ Anxiety about future inflation decreases
→ The risk of lending for a long term becomes smaller
→ Ultra-long-term interest rates fall
At this time: Short-term interest rates ↑ Ultra-long-term interest rates ↓ Currency ↑ Gold ↓
If you look only at the short term, it settles into a healthy form of “interest rate rise + currency appreciation.” The direction of the currency is actually determined by this decline on the long-term side.
Why do long-term interest rates fall just by clearly stating it?
Long-term interest rates are determined by the outlook for future inflation. The more it is perceived that inflation will continue to rise, the higher long-term interest rates will go.
Therefore, if the central bank clearly indicates that it will “go to suppress inflation,” anxiety about future inflation decreases accordingly. Since the market judges that the portion eaten away by inflation will be smaller even if lending for a long term, a downward force acts on long-term interest rates.
This is exactly the flip side of the story I covered last time, “if inflation is left unchecked, long-term interest rates rise.” If left unchecked, anxiety accumulates and interest rates rise; if a clear response is shown, anxiety decreases and interest rates fall. Both can be explained by the same single axis of “anxiety about future inflation.”
However, there is a prerequisite
There is one condition for this phenomenon. It is a case where long-term interest rates were originally rising due to anxiety about inflation.
Even if a rate hike is carried out in a state where there is no anxiety at all, long-term interest rates will not fall significantly. This is because there is no room to lower them in the first place.
Therefore, when you want to find this phenomenon, first check, “Were the long-term interest rates before that rising due to anxiety about inflation?” If they were rising, there is room for long-term interest rates to fall when a clear statement is made toward that.
Connection to the previous article
Last time, I talked about how “even with the same interest rate rise, the currency moves in the exact opposite direction depending on the reason.” The content was that if inflation is left unchecked, interest rates rise but the currency is sold, whereas with sound tightening, both interest rates and the currency rise together.
This story corresponds to how that case of leaving inflation unchecked is resolved afterward. When the central bank responds with clear words to the anxiety that had been left unchecked, the accumulated long-term interest rates begin to fall. The scene where anxiety is born and the scene where anxiety is resolved are the front and back of the same axis.
Summary
1. It is the long-term interest rate that “falls,” not the short-term (policy) rate
Short-term rates rise directly in line with the rate hike.
2. A clear announcement of a rate hike reduces anxiety about future inflation
Less anxiety means lower risk for long-term lending, which causes long-term interest rates to fall.
3. This is the flip side of the scenario where interest rates rise due to unchecked inflation
Situations where anxiety builds up and situations where anxiety is resolved exist on the same axis.
4. As a prerequisite, there must be existing anxiety about inflation
If a rate hike occurs when there is no such anxiety, long-term interest rates will not fall significantly.
Conclusion
The seemingly contradictory price movement where “interest rates fell despite a rate hike” is not a contradiction at all when you distinguish between short-term and long-term rates.
Instead of viewing interest rates as a single number, track them by separating which maturity period is being discussed. Along with the previous two articles, I believe you have gained another perspective for breaking down interest rate news.
For those who want to learn FX systematically from the basics or want to organize the connection between interest rates and exchange rates, I recommend taking a moment to organize the learning content you need. Just by determining the order, the way you see the news will change significantly.
Thank you for reading until the end.
*This article is educational content intended for learning FX. It does not provide instructions for trading decisions, nor does it recommend specific methods or timing. The market mechanisms described are general explanations and are not guaranteed to apply in all situations. FX carries the risk of loss of principal and other losses; please make investment decisions at your own responsibility.