The Forex Rate is the current price that a currency pair is currently valued at.
It’s important have a good understanding of how the overall economies work, with this general knowledge you can have a sense of the overall sentiments that may be strengthening or weakening towards a given currency, the overall macroeconomics works like this:
Strong Dollar Implies:
- U.S. can buy foreign goods cheaper
- Cost of purchasing goods falls – We buy imports
- U.S. goods are expensive to Foreigners
- Hurts businesses on export sales
- Strong U.S. economy
Weak Dollar Implies
- Foreigners can buy U.S. goods cheaper
- Foreign goods become expense for U.S.
- Weak U.S. economy
If the dollar weakens this helps the U.S. import/export trade imbalance.
At the end of the day the laws of Supply and Demand rule forex price action. The supply of a currency is influenced by that nation’s monetary authority or by it’s central bank. This usually coincides with the spending that is taking place in that economy. This spending is closely monitored by the Government and the central bank to keep the money supply at levels to achieve their economic goals.
For instance here are some affects if there is:
To much money:
- inflation rises
- value of the money falls
- prices for goods rise
To Little Money:
- There is sluggish economic growth
- Reduced cash flow in the economy
- Rise in unemployment
Exchange rates however respond directly to all sorts of events
- Economic Factors
- Political Conditions
- Market Psychology
The Economic factors typically move forex rates most of the time. These include economic policy and economic conditions usually in the form of economic indicators.
Economic policy is made up of government fiscal policy and monetary policy, this is the way the governments affect the money supply to achieve their goals.
Economic conditions are usually measured by economic indicators that refer to:
- Government Budget Deficits or Surpluses
- The Trade Balance Levels and Trends (Exports/Imports)
- Inflation Levels and Trends
- Economic Growth & Health Outlooks
Growing Deficits usually influence currency rates in a negative manner, and positively to shrinking deficits. In the U.S., the deficit has been growing year after year and with the added cost of the past war the deficit grew very rapidly. The resulting devaluation in the US dollar is clearly evident.
The trade flow between countries shows the demand for that country’s goods and services which indicative to the demand of that country’s currency. Trade deficits, or the lack of a country exporting goods, has a negative impact on that country’s currency rate. Trade surpluses, or more exports for a country that imports, has a positive impact on a country’s forex rate.
Inflation levels also impact foreign exchange rates, a currency will loose it’s value if it has high or rising inflation rates. Inflation takes away the power to purchase goods and takes away the demand for that currency, however sometimes when speculators expect that the central banking will raise rates to combat inflation the currency can raise in value as the investment rate for the currency is expected to increase in this situation.
Economic growth indicators have a significant impact on a currency’s value because the these are indicators of the economic conditions in that country. Indicators such as GDP, employment levels, retail sales, capacity utilization, and others paint the picture for the overall conditions for that country and whether that currency is in or out demand. Generally the better the economic conditions are the currency will perform better.
Political conditions and events can also have a significant affect forex rates. Political turmoil will have a negative impact on a currency rate.
Market psychology also plays a big role in the foreign exchange rates, trader’s perceptions influence currencies just as any other investment. Long term trends can continue until reaching very overbought or oversold levels before correcting. Political turmoil can create “flights to quality” or the pulling out of investments in an effort to seek safe havens, and economic growth indicators can be reacted upon excessively. All of these factors play into the value or currency rate.
