The Forex markets are in constant flux, and currency values respond each day to various macroeconomic factors. Traditionally, the economy of a specific country – its employment rate, GDP, monetary policy and inflation levels – has been the most important factor for day-traders to watch.
However, exchange rates – a highly influential element in Forex trading – are determined by a multitude of factors beyond standard economic performance benchmarks. In fact, many factors that can affect Forex trading might surprise you. The Chinese economy, for example, can have a dramatic impact on a number of major and cross-pair currencies. The same goes for commodity prices – especially the price of oil, the world’s most valuable commodity – which can increase or decrease the value of a currency.
As it’s important that beginner and novice Forex traders understand the specific macroeconomic factors that affect the Foreign Exchange markets, we have put together our top four influences on current market conditions:
- Central Bank Statements
It’s no surprise that monetary policy set by a country’s central bank – like interest rates – affects the value of a country’s currency. But even when central banks do not change policy, what they say can change currency valuation. That’s right, a central bank’s statements alone generate market reaction.
For example, the U.S. has revised their expectations for monetary policy in 2016. Before the end of the year, the U.S. Federal Reserve (Fed) was predicting four interest-rate increases for 2016. Yet, since that time, the growth of the U.S. economy has slowed, due to a number of factors including oil prices and the Chinese slowdown. Therefore, during the Fed’s first 2016 meetings, officials revised expectations, saying that they will use a less aggressive pace for increasing interest rates. Following these “dovish” statements – meaning their statements hinted at a less aggressive stance – the market has responded. Consequently, the U.S. dollar has lost ground on the euro and other currencies.
- The Chinese Economy
China is the world’s No. 3 importer, behind the U.S. and European Union. As such, a number of world economies are dependent on a healthy Chinese demand for imports, including Australia and the U.S. Starting late last year, the Chinese economy started to slow down, and in effect, the country’s demand for imports began to taper off. Both the Australian and U.S. dollars felt the impact of this decreased demand, resulting in sluggish growth for their values.
- Public Debt Levels
The amount of public debt a country holds also affects the value of a currency for a number of reasons. For one, large levels of debt encourage currency inflation, which dissuades investors from buying equities in that country and as such, the demand for the country’s currency falls. Secondly, as public debt increases above sustainable levels, the country’s risk of default increases. This is another reason investors tend to avoid investments in countries with large levels of debt.
- Oil Prices
Oil prices – like most commodities – have a direct impact on countries that export petroleum. The Australian and Canadian economies, for example, are tied directly to the price of oil because it is such an important export. In Australia, energy exports account for roughly one-quarter of GDP, and in Canada, energy accounts for about 20 percent of GDP. That means when oil prices are low – which they have been in the first quarter of 2016 – the currency value of net oil exporters remains low.
Beginning and novice Forex traders must understand all the market factors that affect exchange rates, not only is this information vital for a trader’s fundamental analysis, and it can help the trader avoid entering potentially unprofitable positions.