Forex is a global market where people from around the world trade currencies daily. Because Forex trading is a globalised activity, worldwide events affect the market more than ever.
You can gain great income if you can foresee when the foreign exchange of a country is about to change. But how can you predict when these changes happen? Certain macroeconomic factors influence the trends of the market, and this article will try to identify them.
Let’s check the list.
The global political landscape
If a government adopts laws and measures that enhance the living standards of the residents, the economy of the state grows. When entrepreneurs want to expand their businesses overseas they choose investor-friendly countries with a stable economy. Why? Because when the economy has great chances to grow, their businesses have better chances to succeed.
How does this affect the Forex market trading? Traders always prefer to buy currencies of countries with stable political conditions. For example, Brexit led to a drop in the value of the GBP in comparison with the US dollar.
The inflation rate
It surprises no Forex trader to find out that the inflation rate influences the trading market. When a country has a low inflation rate, in comparison with the other ones, it’s expected its currency’s value to appreciate.
How does this affect the trading market? Investors prefer to buy currencies from countries with low inflation rates. They constantly check the news to identify when it’s expected the inflation of a country to reach its lowest point.
For example, when inflation grew in Zimbabwe the local currency quickly lost its value. Forex traders don’t find the Zimbabwean dollar an attractive currency to invest in.
The interest rate
This time we will list the example first because it’s simpler to explain how the interest rate affects the forex market. Let’s say you are selling shoes with $10 a pair. Three customers come to you with, but the problem is you have only a pair left. How do you choose the buyer? One solution is to ask them who is willing to bid more for the pair of shoes.
The other solution is to find out which one of them needs the pair of shoes right now. You ask the other two clients to deposit the $10 with you and when the pairs get back in stock you inform them. To sweeten the deal, you tell them that they will receive an extra 1$ together with the pair of shoes. If the other two clients agree with the solution you quickly solve the problem.
As you can imagine, this is a simplification of the process. The real thing happens like this, when the inflation rate of a country gets out of control, the central bank intervenes to control it, and does it by growing the interest rates. Investors benefit every time the interest rate grows because the currency they purchased is also growing.
How does this factor influence the Forex market? Investors choose economies with high interest rates because they allow them to get a higher return on their investment.
A great example is when the RBI boosted the interest rate to stop the fall of the Rupee.
The government debt
Let’s put it this way, would you offer money to one of your friends if they are already in debt?
Traders apply the same rule when they have to choose the country, they want to invest in. The higher the debt of a state is, the lower are the chances to attract foreign investors, and this leads to lower exchange rates.
How does government debt influence the forex market? Investors analyse government debt trends before deciding if it’s profitable for them to start a business there. Forex traders stay away from the markets that have low chances to attract foreign investors.
For example, the Indian government has a great external debt, and no chances to pay it back any soon because of the rise of oil prices, so the Indian Rupee experienced a value drop.
The terms of trade
We connect the terms of trade with export and import prices. A country has large terms of trade when they have more exports than imports, and their currency grows in appreciation. The currency value is higher than the one from another state with lower terms of trade.
How does the terms of trade influence the Forex market? Investors always choose countries that have higher exports than imports. If you are a beginner investor, you should check a Forex trading platform to see what the countries with the most positive terms of trade are.
China is a state with positive terms of trade, so Forex traders prefer it.
Speculation isn’t exactly a factor used to measure the Forex market. Most of the times, when a country has speculation, the currency rate grows, investors buy more of the currency. And its rate grows even more.
How does speculation affect the forex market? Investors need to research to identify the bandwagon effect and to ensure they close the business before the effect wears away.
A great example gets back to 2005-2006 when the US real estate market registered low lending rates and the speculation stated that property rates will probably grow. This led to an increase in the US dollar.
The capital market
Investors can understand how the economy of a state goes, by checking the trend of the capital markets. A lengthy dive of the stock market is a sign that investors have low confidence in the country’s economy. This helps them predict the currency rate compared with those of other countries.
How does this influence the Forex market? When investors identify an uptrend on the capital markets, they know the currency rate will probably grow.
An example is the Chinese capital market that registered a drop in the pair USD/CNY, and this shows that the yuan is stronger than ever.
All the above factors affect the Forex market, and if you want to ensure your investments have high chances to succeed, you should check them before placing a trade.