FACTORS AFFECTING FOREIGN EXCHANGE RATE (CURRENCY VALUE)
There are many factors that can contribute to the forming of the exchange rates however such of them as supply and demand are the major ones. The changes in supply and demand data also cause the corresponding changes in the price of one currency against another one. The Forex market provides the most comprehensive information about the current situation in the world.
Usually a complex of several elements can impact the supply, demand for currency as well as its value. We can divide them into three categories:
1. Economic/Fundamental Factors.
2. Political Conditions
3. Market psychology/Technical Factor
Economic factors imply the economic policy pursued economic conditions that can be estimated on the basis of economic reports and surveys as well as other important indicators.
Economic policy includes the fiscal policy of the government (budget and spending) and monetary police (i.e. those methods the Central bank of the country uses to affect the supply and the “cost” of the currency. The interest rate level shows the “cost” of the currency.)
Any positive sign in economic reports will reflect good value of the currency. The economic division comprises the following components:
Government budget deficits or surpluses: the broadening of the government budget deficits as well as it’s narrowing commonly causes negative reaction of the market. And the effect shows itself in the value of the currency of the country given.
Balance of trade levels and trends: the trade flow between countries reflects the demand for the services and goods. And this demand reflects the demand for the currency of the country needed to participate in trading process. The level of the country’s economy competition is shown in the surpluses and deficits of trade of goods and services. For instance, trade deficits may cause negative consequences for the currency of the country. Trade surplus means good economic standing and currency value will appreciate as more demand on home currency.
Inflation levels and trends: usually the high or growing inflation leads to the lost of the value by the nation’s currency. This happens due to the fact that inflation destroys the purchasing power and the demand for this or that currency consequently. But growing inflation may also lead to the strengthening of the currency due to forecasts about possible growth of the short-term interest rates by the national Central bank with an aim to restrain the inflation.
Economic growth and health: the economic growth and the health of the country is reflected by the data provided in such reports and survey like GDP, the level of employment, retail sales, capacity utilization and etc. Commonly the healthy economy of the country is accompanied by the better currency and the demand for it.
The political conditions of any scale (from regional to international ones) can have great impact on the currency markets. Let’s consider following example, the instability in the political sector may affect the economy of this country in a wrong way. The strengthening of the political faction that is usually considered to respond financially may cause quite different consequences. And the events occurred in the one country may easily affect the neighboring country and contribute to some changes of its currency.
The market psychology and the way the trader perceives the events may have following impact on the forex market:
Flights to quality: some groundbreaking events at the international area can cause a “flight to quality” which is a situation when investors sell the more risky investments and buy those more safe that are also called a “safe heaven”. So those currencies considered to be stronger will be more demanded and therefore get higher price for themselves. For example AUD, CHF and NZD are considered as safe haven currency.
Long-term trends: usually currency markets follow long-term trends of their development. And despite the fact there is no seasonality among the currencies some trends can be seen from the business cycles. These cycles are considered to provide long-term price trends that can be caused by economic and political directions.
“Buy the rumor, sell the fact”: this statement is not something surprising when considering financial markets. The price of the currency usually reflects the possible affect of this or that event before it has happened, so the matter is that you should do quite opposite actions as soon as this event has already occurred. This statement also concerns the situations when the market being oversold or overbought. Moreover the statement also applies to the anchoring – the situation when investors concentrate only on the reference of the outside events to the price of the currency.
Economic numbers: the economic indicators can show the condition of the economic policy, and some reports may have strange effect – the importance of this or that report grows to market psychology and thus the report may affect some close changes in the market instantly. Over the last years such indicators as money supply, employment, inflation, and trade balance have experienced such importance.
Technical trading considerations: the changes of the currency pairs’ prices can be aggregated into charts and tables for further consideration and use by traders.
This is the most complicated ways of evaluating the value of currency. Trader and chartist could create market condition on their own to encourage currency movement. By studying and analyzing past track and trend, chartist will find their way to forecast future value of currency.
Abdul Rahim Said
DPA, BBA, MBA
Retail Forex, Retail Banking