What factors affect the currency markets?

Economic Growth-Countries with stable, growing economies tend to be viewed more favourably and attract capital. There are a number of regular economic releases that can impact attitudes toward economic growth and in turn, the outlook for monetary policy. These include: Gross Domestic Product, Purchasing Managers Indices, employment, retail sales, industrial production, consumer confidence and other data.

Inflation -Inflation erodes the value of a currency. Countries with high inflation rates tend to be less attractive and see their currency values fall. Key measures of inflation include consumer price indices and producer price indices. Core inflation rates tend to be used by central banks when setting policy as they exclude more volatile prices such as energy and food. The problem is that consumers still have to budget for the purchase of food and fuel which can impact economic activity. Rising inflation pressures tend to accompany strong economies (too much money chasing too few goods and services) and tend to put pressure on central banks to tighten monetary supply through increasing the price of money (interest rates) or reducing the supply of money.

Trade Balance -Importers need to buy other currencies in order to pay for the goods or services that they want. Countries with consistent trade surpluses tend to find their currency in demand relative to those who run trade deficits.

Financial Risk- Investors tend to prefer stable, well managed economies. Countries running big deficits, high national debt levels or carrying other problems such as corruption tend to be viewed less favourably and tend to see their currencies depressed to compensate for higher risks. One widely used measure of financial risk is national credit ratings from the three main agencies, Standard and Poors, Moody’s and Fitch Ratings. The specific ratings themselves tend to not be as important, but actual upgrades and downgrades and indications of changes in outlook can have an impact on FX trading.

Political Risk-For currency markets political risk tends to reflect the potential that political change could impact fiscal or monetary policy. In many major countries the risks tend to revolve around elections and the potential that a new party could make big changes. In other countries, a change in government could lead to nationalizations or foreign policy changes that could impact economic activity and trade.

Interest Rates-Generally speaking, investors tend to borrow in countries with low interest rates and invest in high interest rates. Investors may also demand higher interest rates to compensate for some of the risks outlined above such as high inflation, instability or trade deficits. Anticipation of changing interest rate trends can influence FX pricing. There can be considerable speculation in currency markets around central bank decisions. The Bank of England and European Currency Board tend to decide around midday European time on the first or second Thursday of each month. The US Federal Reserve Board meets every six weeks and usually makes its announcement at 2:15pm ET on a Tuesday or Wednesday. The Bank of Canada meets about every six weeks and usually announces policy at 9:00 am ET on a Tuesday. One exception is the People’s Bank of China which does not schedule interest rate decisions. Instead it makes announcements whenever it decides to do something which can include weekends and major holidays. The release of minutes from meetings also tends to be widely read by traders looking for hints of changes in policy or voting trends.

Attitudes Toward Risk- Over the long haul, some countries tend to be more cyclical than others. During times of uncertainty and fear, traders may flock to defensive positions such as government bonds in countries considered to be defensive such as the US, Japan, Switzerland and precious metals. During times when confidence improves and sentiment turns positive the street may move into more cyclical, resource or emerging markets.