The Power of Backtesting in Forex Trading

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Central banks around the world are no longer moving in tandem. In 2025 we see a clear interest rate divergence: some economies are cutting interest rates to support growth while others keep rates high or even hike them.

For forex traders, these policy differences are a big deal. They create shifts in currency values and fresh trading opportunities.

This article breaks down what interest rate divergence means, why it matters for FX, how major central banks like the Fed, ECB, RBA, and RBNZ are charting different paths this year, and what it all means for currency pairs like NZD/USD, AUD/USD, AUD/NZD, and EUR/USD.

Table of Contents

What Is Interest Rate Divergence (and Why Traders Care)

"Interest rate divergence" simply means central banks are going in different directions with their monetary policy. One bank might be raising or holding rates, while another is cutting rates.

These differences matter because interest rates heavily influence currency demand. In general, higher interest rates tend to attract foreign capital seeking better returns, boosting demand for that currency and causing it to appreciate, while lower rates can have the opposite effect.

For example, if New Zealand's interest rates fall well below U.S. rates, holding money in NZ dollars becomes less attractive relative to U.S. dollars. Traders respond by moving capital accordingly – a dynamic that shifts exchange rates.

Diverging interest rates can also spur carry trades (borrowing in a low-rate currency to invest in a high-rate one), further strengthening high-yield currencies.

Diverging Central Bank Paths in 2025

The start of 2025 has made one thing clear: the world's major central banks are not on the same page. Economic conditions vary across regions, so policymakers have taken different monetary paths – from aggressive easing to cautious pauses and even tightening.

According to Reuters, early 2025 saw the United States holding rates steady, the euro zone cutting rates, and outlier Japan hiking – a sharp change from 2024 when most banks were easing in unison.

Let's look at the distinct approaches of four key central banks and the reasons behind them:

Federal Reserve (USA) – Cautious Hold at High Rates

The U.S. Federal Reserve (Fed) entered 2025 with interest rates at multi-year highs and has opted to hold them steady for now.

After a series of rate hikes in 2022–2023 to fight inflation (and a few modest cuts in late 2024), the Fed's benchmark rate is sitting around 4.25%-4.50%.

Fed Chair Jerome Powell has signalled no rush to cut rates again until inflation is convincingly back to target and the labour market cools.

The U.S. economy has remained surprisingly strong, with solid growth and only "somewhat elevated" inflation, so the Fed is being very cautious about easing policy too quickly.

In December, Fed officials even revised their forecasts, indicating they expect only two small rate cuts in 2025 (down from four expected earlier).

By keeping U.S. rates high relative to others, the Fed is supporting the dollar's value – a point we'll see reflected in currency moves like EUR/USD.

European Central Bank (Eurozone) – Pivoting to Rate Cuts

Across the Atlantic, the European Central Bank (ECB) is taking the opposite route.

With eurozone inflation finally coming under control (somewhat) and growth fading, the ECB has pivoted to cutting rates in order to strengthen the economy.

They cut in late January, by 25 basis points – its fifth consecutive cut since mid-2024. This, in turn, brought the deposit rate down to about 2.75%.

Notably though, ECB policymakers have kept more easing on the table, reflecting confidence that euro-area inflation is headed firmly toward the 2% target.

In fact, markets have been pricing in multiple further ECB cuts in 2025 (around three more 0.25% reductions) as the eurozone economy struggles to gain some momentum.

Figure: Change in policy rates by major central banks (Mar 2024 vs Feb 2025). Orange dots indicate central banks (like New Zealand, Canada, Eurozone, etc.) that have cut rates; yellow shows those that held steady (e.g. the U.S. Fed), and purple indicates rate hikes (e.g. Japan). Diverging policies are evident, with the RBNZ and ECB easing while the Fed stands pat and the Bank of Japan tightens.

Actionable Ideas for 2025

Global interest rate divergence has become a defining theme for forex in 2025. The Fed and RBA are cautiously standing pat or easing only slightly, whilst the ECB and RBNZ are more aggressively cutting rates to combat economic weakness.

These divergent paths have shifted interest rate differentials, in turn driving notable moves in FX markets – a stronger U.S. dollar relative to the euro, Aussie, and Kiwi; a surging AUD against a soft NZD; and other carry trade dynamics playing out.

Conclusion

Global interest rate divergence is reshaping forex markets in 2025, creating clear winners and losers among currencies.

By understanding each central bank's policy trajectory and its impact on currency pair interest differentials, even beginner and intermediate traders can better navigate the trends.

Keep an eye on the data and use this knowledge to make informed trading decisions.

Whether you're capitalising on USD strength, taking a carry trade, or managing risk on a volatile EUR/USD, the key is to align your strategies with the underlying interest rate story.

As always, combine fundamental insights with sound risk management. Interest rate divergence is offering opportunities – and with the right approach, forex traders in 2025 can position themselves to take advantage of these global shifts in monetary policy.

1. The U.S. Dollar’s Strength and Global FX Implications 
   
   

2. Carry Trade Opportunities in High-Yielding Currencies 

3. The Euro’s Structural Weakness and Political Uncertainty 

Figure 1 – EURJPY Weekly Chart 

Figure 2 – Euro Volatility Index, daily chart 

4. Commodity Currencies 

Figure 3 – XAUUSD (gold), daily chart 

5. Geopolitical Crossroads and FX Volatility 

Figure 4 – USDCNH, weekly chart 

Final Thoughts