In light of the forex market being a place of trade for global currencies, it is inevitable that international conditions will impact the value of currencies.
Forex and global trade
Forex trading in itself is something that is based on relations between countries and their economies, therefore, each country does not operate in isolation. That very fact alone is indicative of the fact that global conditions heavily impact currency fluctuations and the strength of each currency relative to another. Restricted global activity has a negative impact on economies and makes trading on the global forex markets somewhat less appealing to investors. The conditions of 2020 are perhaps the most recent example of such that everyone can understand and relate to, as it led to global economies plummeting and many crashing and reaching their all-time lows. Naturally, this was reflected on the financial markets as well.
Factors that influence forex market
Although currency fluctuations are the norm and are dependent on movement or changes in the world’s economies, there are certain key factors that investors should remain mindful of to guide their trading activity. These include, but are not limited to, interest rates, economic stability, world events and government debt, as elaborated on below.
Interest rates are generally informed by the governing financial policies and reserve banks of each country. When a country’s interest rates are increased, that particular currency generates higher interest rate payments; therefore, making the conversion to it slightly more lucrative. This means that anyone conducing trade activity with that currency will have to pay more if interest rates increase, meaning that those who have invested in the currency with higher interest rates will benefit from the difference that arises from that transaction. The adverse is true, which is why investors need to stay informed so as to know when it would be best to let go of a certain position and refrain from investing in currencies that appear to be decreasing in value.
A stable economy with regular activity and trade is generally perceived as low risk and worth investing in. The likes of the US and UK are amongst those trusted economies, as they heavily involved in global trade activity and thus, form part of some of the major currency pairs on the forex market. On the other hand, weakening economies often lead to low investor confidence and many tend to shy away from investing in them, out of fear of being subjected to major financial losses instead of returns.
Naturally, any form of crisis and instability in a country will deter investors from seeing merit in that economy and its currency. Therefore, very few, if any, investors are likely to engage with that currency on the forex market as the chances of it yielding any lucrative returns are generally low at that particular point in time. In contrast, positive geo-political occurrences encourage foreign investment in a particular country.
High government debt suggests that the country is struggling to manage its finances, leading to inflation and currency devaluations. As is the case with an individual who seemingly lives off debt financing, it is not attractive to potential investors and impacts how that particular currency is performing on the forex market. When government debt is reduced, the economy is perceived as more stable and less likely to shock investors, which ultimately increases its value and builds investor confidence.