The Foreign Exchange is one of the fastest moving financial markets in the world.Forex trading valuations can change in minutes due to market reactions to macroeconomic and political data, for example, if Country A reports lower-than-expected economic growth, the currency markets react and Country A’s currency value could decline in minutes!
Successful Forex traders understand the impact these market fundamentals can have on currency valuations, which is why traders spend time forecasting, preparing and planning responses to unexpected economic scenarios.
In Forex trading, understanding the market fundamentals is essential for your success – recognising these four major factors can put you in a position of power as you trade:
Interest rates – especially interest-rate changes – can have a significant and immediate impact on currency valuations. Currencies with higher interest rates attract more foreign investors, which in turn increases demand for the currency. As such, an increase in a country’s interest rate typically results in rising values for that currency – the opposite would be true if a country reduced their interest rates.
In saying that, market participants are arguably just as interested in the predicted direction for interest rates. For example, a change of tone or messaging during a central bank’s meeting might indicate forthcoming changes to interest rates; although it’s only speculation, these rumours can cause dramatic movements in valuations.
There are a number of economic factors that can affect currency valuations, but employment is one of the most important in Forex trading.
Employment is particularly significant because it influences consumer spending: higher employment means that more people will be spending on durable goods. Plus, improving employment can have an impact on interest rates – higher employment often leads to a rise in inflation, and the central bank is more likely to increase interest rates to slow this inflation.
Unexpected shifts in employment – whether positive or negative – can cause volatility in the Forex markets.
There are numerous indicators that traders use to measure economic growth, for example: regularly released reports on consumer spending indexes and housing market data. Documents like these provide key insights at the likely direction for and confidence in a country’s economy. For example, an increase in consumer spending indicates relative confidence amongst consumers that the economy is healthy.
In many cases, an economic report that shows evidence of an improving housing market or increases to consumer spending and wages can boost a currency’s valuation.
The price of commodities like oil or iron ore can have an impact on currency prices depending on how the country uses the commodity. In many cases, countries that are net-exporters of a particular commodity experience declining currency values as commodity prices drop.
For example, as a net-exporter of petroleum Canada’s dollar tends to rise as petrol prices rise. The United States, on the other hand, is a net-importer of oil. Rising oil prices cause U.S. consumer spending to fall, which can result in a weaker U.S. dollar.