What makes the currency market move?

The currency market is the largest investment market in the world, with an average daily volume of about five trillion dollars. Currency prices can fluctuate based on the economic situation of the countries whose currency you’re trading, world news, political actions, and several other reasons.

In this article, we have collected what we consider to be the most common factors that tend to move the markets profoundly:

Interest Rates

All major central banks set their key refinancing rate. There are two types of monetary policy: easing (lowering the interest rate if the national economy needs a boost; the impact on the currency is negative) and tightening (raising the interest rate in order to slow down the rising inflation rate; the impact on the currency is positive).

The idea is that capital naturally flows to high-interest areas where investors can see higher returns, driving up currencies in those countries. That’s why meetings of central banks such as the Fed, and the ECB, are the biggest events in the currency market calendar.

Inflation

Inflation is the relative purchasing power of a currency compared to other currencies. Typically, a country with a consistently lower inflation rate exhibits a rising currency value, as its purchasing power increases relative to other currencies.

For example, it might cost one unit of currency to buy a bag of flour in one country but cost a thousand units of a different currency to buy the same bag of flour in a country with higher inflation. Such differentials in inflation are the foundation of why different currencies have different purchasing powers and hence different currency rates.

Economic Health

Economic health or performance is another way exchange rates are determined: Output indicators: GDP, industrial production, retail sales. Any increase in the published data tells us that the economy is growing. If the releases are strong, look for the appreciation of the currency.

Sentiment indicators: business and consumer sentiment. This group of indicators serves as the barometer of the mood of consumers or investors. The more they spend/invest, the stronger the national economy and currency.

Labor market indicators: unemployment rate, payrolls, employment/unemployment change, unemployment claims. The higher is employment, the better for the national currency (the opposite with unemployment).

Housing market indicators: building permits/consents/approvals, housing starts, new/existing/pending home sales. If there is a sign of increasing economic activity in the housing market, it means that the national economy is healthy. This causes the exchange rate of nation’s currency to rise.

Trade Balance

In a globalized economy, the value of individual currencies is largely dependent on the ratio of exports to imports in the country or region that uses that currency. Any purchase of goods or services from overseas involves a currency exchange, and this affects what is known as the trade balance. The trade balance is a measure of the demand for that country’s goods and services, and ultimately, it’s currency as well. If exports are higher than imports, you get a positive balance, and therefore a trade surplus. If imports are higher than exports, then you have a trade deficit, and the trade balance is negative. Trade deficits tend to push currencies down, whereas trade surpluses tend to push them up.

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