When traders can predict appreciation or depreciation, they’re good forex traders cause they’ve learned the causation. The five key factors that affect currencies are the economy, politics, interest rates, trade balance, employment, and market sentiment.
These factors influence currency because they provide traders and politicians with renewed equity in investments and intentions based on what they feel or know (whether positive or negative) or what they believe.
Interest Rates and Central Bank Policies
The single biggest factor that alters currency value over time is interest rates which are set at the highest level by central banks and the Federal Reserve. Central banks partake in specific monetary policies to limit inflation and stabilize the macroeconomy.
When a central bank raises interest rates, the value of currencies increases. This is because higher interest rates translate into higher returns on investments held in that currency, and foreign investors want to take that advantage.
Also, when a central bank lowers interest rates, a subsequent decline in the value of the currencies occurs as investors look for better prospects elsewhere. For instance – if the Bank of England announces it will increase interest rates due to inflation, the price of the British pound will appreciate relative to foreign currencies.
Economic Indicators and Performance
Economic factors are another aspect that influences currency strength. The most influential types of economics are GDP, employment, and manufacturing.
- GDP – A country that realizes GDP growth on a consistent yearly basis indicates that such countries maintain a stable, growing economic environment, therefore, such currency becomes strong because investors want to get in and operate within a consistently growing market.
- Employment – When unemployment rates are low or when job growth rates are positive in certain countries, it essentially means that their populations can maintain high employment levels while simultaneously enjoying high levels of consumer spending. Such currencies become strong because people have high faith in these economies.
- Economic Indicators – Economic indicators give insight into how a currency will behave in the future. For instance, inflation numbers are reported at various times independent of regular fluctuations, and unemployment claims are assessed and reported weekly.
Political Stability and Geopolitical Events
Currencies appreciate political stability. Investors want stability, so when politics is in upheaval, this means currencies are in upheaval.
- Election/Change of Leadership – When an election takes place, policy changes, or a scandal riles politicians markets get unsettled. When there isn’t a concrete understanding of what’s to come, it shows that investors will pack up their bags and leave, reducing currency value.
- War – Wars, conflict, and trade wars/sanctions disrupt what may have been established in the past with international and intra-state relationships and equities. When nations go to war or decide to not “play nice”, it assesses what’s the value of a stable trading arrangement.
Experienced forex traders know how to address such information which can help them to understand and predict how a currency is likely to move in the near future.
Market Sentiment and Speculation
Even without major underlying fundamental forces justifying the action, it can still be done by traders to change currency values. Traders usually buy and sell under the assumption that changes will happen in the future. If a market seems to be going one way, traders will buy the currency (or sell it) to position themselves in advance of anticipated changes. Such speculative trading, which merely adds to volume, can support trends and drastically change currency values, even if just for a short time.
However, people determine what they want based on fear and greed – we could see that Fear & Greed index behavior in the Cryptocurrency market in the past 2 months, indicating how people are very emotional when it comes to currency trading. If a trader is fearful of an unstable economy, he may quickly sell out and purchase US dollars or the Swiss franc, both considered “safe-haven” currencies that create demand and subsequently drive up value.
Trade Balance and International Capital Flows
Balance of Trade and International Capital Flows means that a country’s trade and international capital flow status always impacts its currency. Countries with a positive balance of trade usually have a currency appreciation because there is a demand for their goods and services.
A country with a consistent negative balance of trade usually has a depreciating currency relative to another country. Countries with high direct foreign investment inside the country versus direct investment from abroad usually have a currency appreciation. Hence – the greater the foreign interest is, the greater the demand.
For The End
Knowing what causes changes in currency values is essential for proper trading in the forex market. Interest rates, current and forecasted economic conditions, geopolitical conditions, market sentiment, and trade balances cause changes in currency values. News-hungry traders will have an advantage over those who fail to pay attention.
So, while we live in a globalized world, and who’s to say these incidents don’t happen around the clock, those traders ready to educate themselves and make their moves with enough equity placed will essentially exist in a realm of power to uncover and avoid such dangers in the forex market.
