Factors that Affect and Move Currency Markets

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There are numerous factors that affect the rise and fall of financial instruments like currency values of whole countries. Investors usually analyse the economic stability and strength of a country before investing in that country’s currency. They always make sure to invest with the highest possible rate of return that they can achieve. Investors and banks look at the underlying economic conditions that affect the value of a country’s currency.

Foreign exchange markets always involve the exchange of one currency with another. An exchange rate is always determined by the supply and demand of the corresponding currencies. In fact, a currency price dramatically changes based on the supply and demand of each currency. A country with a strong and strengthening economy will have a stronger demand for their currency, and a lesser supply will drive up the value of the currency. More demand means a currency will have a higher price, and less demand means the currency price will fall. A large supply of currency will diminish its value, and less currency supply will increase its value and price. A currency typically rallies when demand increases. These fundamentals of economics explain the ever-changing values of different countries’ currencies.

Major economic factors that affect the supply and demand of a currency

Monetary policy

The intervention of a country’s Central Bank in an attempt to either raise or lower the value of their own currency by controlling money supply, inflation, and interest rates cause large fluctuations in currency prices. They use substantial foreign exchange reserves to try and stabilize the market at its realistic or ideal level by buying and selling the domestic currency. This is not the only method used by central bank to intervene in the currency market but it is one of their most-used strategies.

Take Japan as an example…   Japan’s central bank has used this strategy on more than one occasion. As an export country, the central bank will intervene in the Forex market in an attempt to lower the value of its currency. Through this strategy, more foreign countries, especially the United States, are further enticed to buy Japanese products. While this lowers the value of a country’s currency, it is a boon because of the increase of trade/export the intervention will often create.

Gross domestic product (GDP)

The GDP quarterly report is one of the most important economic indicators. It is the principal measure of the overall economic output of a country during the quarter being measured—where all of its goods and services are given a corresponding market value. However, this does not include international activity/trade. GDP is an indicator of a country’s standard of living and wealth since it reflects the total production, income and consumption within the country.

GDP reflects in country’s economic strength, and therefore the strength of its currency. The total amount of a country’s money is directly proportional to the total amount of its economic output. The higher the GDP, the stronger the currency and its purchasing power.

Trade balance

global tradeA country’s trade balance is the measure of difference between the total value of its imports and exports of tangible goods and services. As an important indicator of a country’s overall economic strength, it is more favorable to have more exports than imports. Exports strengthen a country’s economy and reflect the overall condition of the manufacturing sector.

Trade balance directly impacts the supply and demand of a currency. A currency will strengthen if there are more exports than imports since foreign buyers must exchange more of their home currency in order to purchase exported products. If there are more imports than exports, which cause more of the home currency to leave the country, it will result in a currency’s depreciation.

Consumer price index (CPI) and purchasing power index

The CPI and PPI are the two most important measures of inflation. CPI measures the price change of common household goods. It quantifies the cost paid by consumers for goods. This reflects how the inflation in the economy impacts the average urban civilian.  In contrast, PPI measures the price of goods at wholesale, or producer level. It is how much producers are receiving for the goods.

CPI is the most critical inflation indicator. Inflation is directly proportional to the purchasing power of a currency. In normal conditions, an increase in CPI leads to an increase in all basic interest rates. Increase in basic interest rates often leads to an increase in the attractiveness of a currency.

Employment Indicators

These indicators include the unemployment rate, the number of new jobs created, the average hours worked per week, and the average hourly earnings. Unemployment reports will significantly move a currency price. In a strong economy, new jobs are being created, and large percentage of the workforce is actively working.

The United States’ Non-Farm Payroll/Employment (NFP) report causes the largest movements in the currency markets. It is the key economic indicator of United States. It represents the total number of paid workers in any business excluding agricultural employees, private household employees and non-profit organization employees.

Durable goods orders

This is an economic indicator that measures how much people are spending on longer-term purchases of factory hard goods (durable goods) and other products that are expected to last more than three years. This report provides insights for investors in the manufacturing industry. It provides information on how busy the factories may be in the near future. The more product orders, the larger the workforce needed to fill the orders.

Retail sales index

Retail Sales Index shows the overall strength of consumer spending and retail industry. It measures goods sold within retail stores by taking samples from companies engaged in the business of selling consumer products. Data samples are from companies of all sizes, from large and super-sized Wal-Marts to smaller local stores. This economic indicator is important for investors who invest in retail companies. It is also a large contributor to the total gross domestic product.

constructionHousing data

Housing data also impacts a country’s currency prices. The data includes the number of new homes that a country has built, and the number of homes that has been sold over a specific period of time. Residential construction activity can usually predict what is happening in a specific economy. Real estate numbers are a good measure of economic strength of a country. Low new home starts and low home sales are a sign of a weak or sluggish economy.

Interest rates

Interest rates are one of the main drivers of currency markets. Interest rates in different countries will impact many different currencies at the same time. Interest rates are closely watched by the Federal Open Market Committee in the US in order to measure the overall strength of the economy. Depending on the economic data it has gathered, the Fed can lower, raise, or leave the interest rates unchanged. Since dollar is involved in nearly 90% of all currency transactions, interest rates announcement by the United States’ Federal Reserve impacts the rest of the currencies.

Political conditions

Currency markets tend to reflect the political landscape of a nation. Political events play a major role in the economic activities of a country and can also impact monetary policy. These events include upcoming elections and changes in a government. A new party could make big changes that could impact economic activity and trade, for the better or worse. Exchange rates often react favourably to parties with responsible governmental platforms that support stronger economic growth.

Market sentiment and judgement

The US dollar is the number one traded currency in the world. As a result, traders around the world pay close attention to the dollar at all times. Market sentiment or the opinions of traders about the US dollar invariably affect the value of the currency. If the US dollar is gaining strength, traders would buy the currency pairs with USD as the base currency and sell currency pairs with USD as the quote currency because they believe that the US dollar will continue to strengthen.

Currency price is also influenced by the emotions, judgements, and analysis of market participants. In fact, before the economic reports become available to the public, market participants have already made their predictions and judgements of the market and are often placing trades ahead of noteworthy events.

Speculation

In the Forex market, most of the transactions are actually speculative trading which influences exchange rates. If speculators (Forex retail traders) believe that the US dollar will rise in the future, they will demand/buy more USD to be able to make a profit. Thus, movements of the currency prices do not always reflect economic events but are often controlled by greed, fear and emotion.

Currency historical patterns

Currency prices generate patterns over certain periods of time. These patterns are repetitive and thus enables technical traders to make decisions as to future trades and potential profits based on this historical analysis.

Public debt

A country with a huge amount of debt attracts less foreign investors. Public debt increases inflation which decreases the value of the domestic currency.

All of these reports can be used to evaluate the potential future currency prices. A fundamental analyst may study all of these indicators. The numbers and what they mean and how they affect a country’s economy can be an invaluable resource for a fundamental trader. But for technical traders, all the currency price footprints have been already carried out and are visible on a Forex price chart. Since currency patterns tend to be repetitive, he can successfully predict the probable future currency prices.

While these are the most important factors that move the currency markets, there are many other complex factors that affect currency markets and global currency prices.

How news releases affect currency prices

“News moves markets”. This is a prevalent belief among Forex traders which holds to be true in many ways. Because currency market trading is highly leveraged, the impact of news is exaggerated, making a small change in a currency price turn into a large one. There is a lot of news being released every day in the foreign exchange market, with some releases having a lot more impact than others. The government regularly issue statistics which provide information on how the economy of a country is performing. Surprisingly, US related economic news releases have a significant effect on other currencies. This is due to the fact that US dollar is the most traded currency in the world.

The impact of a news report depends on the timeliness regarding current economic situations. Reports that are regularly announced at a known release time often have the greatest impact. If the news contradicts the current market direction, its impact will last for only few hours generally. But if it’s in line with market trend, the currency price will move aggressively and will last for several days and even weeks. Moreover, bad news had a greater impact than good news in many cases.

Trading the news

question mark japanese candlesBecause news announcements create drastic currency price movements in just seconds after the release, many Forex traders wait and watch the initial movements to get the right direction of the news impact and profit from the news. Although it can be very rewarding, it is also quite risky due to the high volatility and spread that can be generated by the news report. Traders are more prone to price slippage and false breakouts because of short-lived and high speed price movements.

There are many economic news figures that are released on a regular basis… but not all directly affect currency prices. It is important to know which releases matter and which don’t. There are several Forex websites that provide global economic calendars that rate the impact of each news release as High, Medium, and Low.  High impact news releases are announcements and policies made by the central banks like the Federal Reserve (Fed), Federal Open Market Committee (FOMC), and the European Central Bank (ECB). The following are the four most important economic news reports that should be taken into consideration with all currency trading.

Nonfarm Payroll (NFP)

Nonfarm Payroll is released every first Friday of the month by the US Bureau of Labor Statistics. It shows the total number Americans employed in the government, non-government organizations, and in any business (excluding agricultural farms). It also displays the average working hours per week and average weekly income. If the employed citizens are growing in number together with the average income, it means that the economy is growing. On the contrary, decreasing NFP data shows a major economic problem.

On average, the NFP news release can move the currency market (EURUSD) by 100 pips or more within just minutes after the release. If the difference between the forecasted and actual number reported is large enough, it’s possible for traders to make quick profit in a very short time.

FOMC Meeting Minutes

The Federal Open Market Committee is the monetary policy making body of the US Federal Reserve.  There are eight (8) FOMC meetings every year and they also hold other meetings as needed to review economic and financial developments in the United States.

The US dollar value is directly affected whenever the FOMC board decideds to increase, decrease, or maintain the interest rate. By increasing interest rates, the Fed would sell US government securities to major financial dealers. Therefore, the US dollar will appreciate in value since the supply of US dollars decreased. By cutting interest rates, the Fed would buy US government securities from major financial dealers. This would increase the supply of US dollars, and therefore, the currency depreciates in value.

Retail sales index

equilibrium in forex tradingThe Retail Sales Index is released around the 12th of the month by the US Department of Commerce and Bureau of the Census. It displays the volumes of goods sold by retailers. If the retail sales index is growing, it indicates that the country’s economy is going strong since people have money to spend. This typically increases the domestic currency value. On the contrary, low retail sales index indicates a weak economy.

Unlike the NFP release, the retail sales index doesn’t move the market hundreds of pips. Price moves for about 60-70 pips on average with EURUSD and it depends on the deviation between the actual and forecasted number.

Trade balance

The trade balance report is released every 19th of the month by the US Bureau of Economic Analysis. It is the difference between exports and imports. It is an important indicator of a country’s overall economic strength. On average, EURUSD moves about 60-65 pips after the news release.

Major economic news releases have significant impact on currency prices. Forex traders can have the possibility to gain a solid profit from the rapid price change. In order to do so, traders need to be constantly on top of the data that is available on Forex news websites. Online news calendars help traders to quickly decipher the news results. Most of these Forex calendar websites aggregate all the important articles, policy statements and data that significantly affect the currency market. Trading the news as a short term strategy can carry more risk, but at the same time it can be an effective way to make a quick profit (if done in a disciplined manner with proper risk and money management.)

Other factors that move currency markets

Domestic currency is not just affected by internal economic activity. Since foreign exchange is traded in currency pairs, it is evident that other countries affect the value of a domestic currency. In the United States, for example, not all factors that affect the value of US dollar originate from the US. Strong currency news influences can come from all over the world. Conflict, consumption, trade, and other issues can affect the dollar from outside the country.

Some of these factors are:

  • Chaos in other countries: When other countries are in chaos, their own domestic currencies may become unstable. Investors would become nervous because the chaos my increase national debt, inflation, etc. Therefore, investors chose to flee their own country’s currency and invest to the US dollar or Japanese yen, for example, because they may be safer options.
  • Stability of foreign countries: If foreign countries are more economically and politically stable than the US, for example, the US dollar weakens because investors have more confidence in investing in other countries.
  • Strengthening foreign countries: If the economy of other countries are flourishing, the dollar, for example, has the possibility to fall since it will become less attractive to investors.
  • Change of foreign reserves: Since the US dollar is the world’s reserve currency, all central banks hold more dollars than any other currency. If central banks diversify currency investments, they would sell dollars or stop buying more dollars.
  • Slow inflation of foreign products: Slow inflation of foreign products or goods will keep prices of these goods steady. Therefore, consumers choose to buy the same or more amounts of these goods. This would typically weaken the value of the dollar, for example.
  • Natural disasters: Severe natural disaster can interrupt the economic growth of a country and can even increase the amount of national debt. If a natural disaster has a very strong impact on the economy, the central bank may decrease the level of interest rates in order to achieve a faster recovery and stimulate the economy.

The wide range of factors affecting currency markets and their impact to economy extends far beyond imports and exports. Changes in currency prices are major risks to which companies and investors are exposed. These factors may increase or reduce investment returns for global investors.

Conclusion

For us as currency traders, the news is almost always on our minds.  You can use sites like Forex Factory and DailyFX to monitor coming news releases.  These sites publish information on previous news releases as well as information on what each release is about and the anticipated value/info of each report.

Strong news releases can even have the effect of reversing an overall currency pair trend, or at least interrupting it for the short term.  Some traders have rules where they will not trade a half an hour before and after a news release because of the instability caused by these news events. Continue to study the effects of the news as a currency trader because your future profitability may largely depend on it.

About the author

Rimantas Petrauskas

First I am a father, a husband and then the author of the book “How to Start Your Own Forex Signals Service”. I am also a Forex trader, a programmer, an entrepreneur, and the founder of ea-coder.com Forex blog. I have created two of the most popular trade copiers and other trading tools for MT4 that are already used world wide by hundreds of currency traders.

4 Comments

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  • Rimantas this is one of the best summaries of the various influences on the “value” of money. You have taken a complex subject and its various parts and made it simple and easy to understand. Bravo! Thanks to Frank for sharing this article with me… I also was fortunate to receive my very own copy. Thank you Rimantas.

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