Things have been topsy-turvy in the forex markets, with innovation, volatility and ups and downs.
The basic rules that have kept things in play don’t seem to work anymore.
This has led to all kinds of issues-newbies turned experts, one hit wonders, gamblers posing as investors, scams and much more.
We decided to find out what factors govern the forex markets.
Our panel of experts were more than happy to spill the beans.
Here’s the scoop!
Gary Thomson, the Chief Operating Officer at FXOpen UK
“The removal of the Gold Standard back in the 1970s has been instrumental in allowing for monetary policy to be affected very quickly by central governments and central banks across the world. The US Dollar may be the sovereign currency of the United States, but as it has been used as the world’s benchmark currency for many decades now, monetary policy within the United States affects the settlement of trade and supply and sale of goods and commodities almost everywhere globally.
One of the main changes since the removal of the Gold Standard is that fiat currency is not pegged to any commodity, meaning that it can be printed ad infinitum should a government or central bank wish to do so, and can also have its circulation increased or decreased in keeping with economic or political policy, rather than have its value pegged to a physical precious resource.
Over the past few decades, the US Dollar has been very stable in its value, and between the early 1990s, which was the dawn era of retail FX trading, and the late 2010s, there was very little volatility in the FX markets among major currencies, therefore being unpegged to a precious metal or commodity was of very little consequence. However, since the lockdowns of 2020 and subsequent geopolitical events, volatility has returned and the US Dollar has demonstrated significant movements against other majors and even more notably, exotic currencies that are sovereign tender in regions where no such lockdowns or sanctions on oil producing nations have been present.
Thus, what we can glean from this is that the FX market, with its liquid nature and unpegged fiat currencies, is very quick to respond to economic factors such as inflation, conflict, government policy and sentiment such as national credit ratings or risk due to consumer behaviour. Given that the FX market is so instant and that currency values can change rapidly as a result of news releases and national circumstances, this can be considered the key difference between today’s FX market and the market of several decades ago when the US Dollar’s value was tied to that of gold.”
Michael Ashley Schulman CFA Founding Partner and Chief Investment Officer (CIO) at Running Point Capital Advisors
“Multiple factors affect the forex markets and their impact varies depending on the specific currency pair, the current economic and political climate, and future expectations. Some of the most important factors that can affect forex markets include economic indicators, central bank policies, political events, market sentiment and expectations, and wars, natural disasters, and other unforeseen events. It’s critical to note that these factors do not operate in isolation and often interact with each other in complex ways, which can lead to unexpected market movements. Forex traders and investors should keenly follow socioeconomic and political developments and be prepared to adjust their trading strategies accordingly.
Economic data such as GDP, inflation, employment figures, interest rates, economic growth, and trade balance can have a significant impact on currency values. If economic data is better than expected, traders may become more optimistic about the economy, which can lead to an increase in demand for the currency. Conversely, if economic data is worse than expected, traders may become more pessimistic about the economy, leading to a decrease in demand for the currency. Additionally, economic data releases can cause significant volatility in forex markets, as traders adjust their positions based on the new information; this volatility can provide opportunities for traders to profit, but it can also increase risk, particularly if the data release is unexpected or significantly different from market expectations.
Central banks play a key role in shaping currency values through monetary policy decisions such as interest rate changes, quantitative easing, and other policy measures. For example, if a country’s central bank raises interest rates, this could make the currency more attractive to investors, which can lead to an increase in its value. However, if the increase in interest rates is unexpected or seen as excessive, it can have the opposite effect. Higher interest rates can make borrowing more expensive and slow down economic growth; in turn, this can lead to a decrease in demand for the currency as investors anticipate slower growth and potentially lower investment returns. Overall, the impact of an increase in interest rates on a currency will depend on a variety of factors, including the economic and political climate, market sentiment, and the actions of other central banks. Additionally, changes in defensive policies or overnight currency devaluations or will have harsh and immediate effects on valuation! For example, on June 16, 2022, the Swiss franc soared against the U.S. dollar and the euro after the Swiss National Bank surprised with an interest rate hike.
Political and geopolitical developments such as elections, tensions, and changes in government policies cause currency values to fluctuate. Political and geopolitical events can lead to changes in risk sentiment, as investors react to uncertainty and potential risks. If a political event is seen as negative or has the potential to disrupt socioeconomic stability, investors may become more risk-averse, leading to a decrease in currency demand. Conversely, if a political event is seen as positive or has the potential to promote economic stability, investors may become more risk-tolerant, leading to an increase in currency demand. Political and geopolitical events can also influence trade and capital flows, which can impact currency values. For example, if a political event leads to increased protectionism or trade barriers, it can decrease demand for the currency, as trade and capital flows are restricted; conversely, if a political event leads to increased trade or investment opportunities, it can increase demand. Political and geopolitical events can also lead to increased demand for perceived safe-haven currencies, such as the US dollar, Swiss franc, Japanese yen, Bitcoin, and gold as investors seek to reduce their risk exposure.
Additionally, changes in regulations and government policies related to how currencies are owned, held, or accessed will impact their value; positive developments, such as regulatory clarity and supportive policies, can increase demand and prices, while negative developments, such as bans or restrictions, can decrease demand and prices.
The overall mood and perception of market participants can influence currency values, as traders often respond to news and events based on their expectations of future market movements. Market sentiment can influence risk appetite, as traders become more or less willing to take on risk. If market sentiment is positive, traders may become more risk-tolerant, leading to an increase in demand for higher-yielding currencies. Conversely, if market sentiment is negative, traders may become more risk-averse, leading to an increase in demand for safe-haven currencies, gold, or crypto. Market sentiment can also influence market trends and trading strategies, as traders respond to the prevailing mood, thus creating self-fulfilling momentum trades.
Currencies can also be vulnerable to market manipulation. Large investors or groups can influence prices through coordinated buying or selling, which can cause significant price movements, as in Britain, on Black Wednesday, September 16, 1992, when George Soros and other speculators shortd the currency and “broke the pound.”
Unpredictable events such as natural disasters, terrorist attacks, wars, and pandemics can cause significant disruptions to global markets and currency values. Climate change and agricultural developments can impact commodity prices, which can in turn influence currencies. For example, if there is a drought or other natural disaster that affects crop production, it can lead to a decrease in supply and an increase in prices for agricultural commodities; this in turn can have two affects, 1) If there is a decrease in crop production or an increase in import demand for agricultural commodities, it can lead to a decrease in the trade balance for the exporting country, which can lead to a decrease in demand for that currency; and 2) It can in-turn increase demand for the currency of a country that produces or exports that commodity. Agricultural developments can also impact central bank policy decisions, particularly with respect to inflation. If there is a significant increase in agricultural commodity prices, it can lead to higher inflation, which can prompt central banks to raise interest rates; this can increase demand for the currency, as investors seek higher returns.”
Francis Fabrizi, Accountant at Keirstone Limited
Interest rates have a big impact on currency values. When a country raises its interest rates, it becomes more attractive to investors, which leads to an increase in the value of its currency. However, when interest rates are lowered, the currency can lose value.
Another factor that can have a significant impact on the forex markets is geopolitical events. Political instability and conflicts can create uncertainty, which may lead to fluctuations in currency values.
In addition to interest rates and geopolitical events, economic data releases can also have a significant impact on the forex markets. Economic data such as GDP, employment figures, and inflation can all affect currency values. Positive economic data can lead to an increase in the value of a currency, whereas negative data can cause a currency to depreciate.
Technological advancements have also had a major impact on the forex markets in recent years. The rise of algorithmic trading and high-frequency trading has fundamentally changed the way that currencies are traded. These technologies allow traders to react to market movements in real-time, which can lead to increased volatility in the markets.
Clive Ponsonby, Currency Fellow at Hedder
The main driver of Forex markets (and therefore prices) is supply and demand, people selling a currency because they want to invest elsewhere in the world gives that currency supply, and people wanting to invest or buy from somewhere else in the world creates demand. These can come from trade flows, a good example would be commodities, if you want to buy copper from a mine in Chile you’ll pay them in Chilean Pesos. If people want to buy Tesla stock they’re going to need dollars, if you want BMW stock you’ll need Euros.
Interest rates are also a key driver, if you can get a higher interest rate in US Dollars than in Euros then you may be tempted (as a European investor) to sell your Euros, buy Dollars and get a better rate of return – ultimately changes in the interest rate differential between two currencies changes the balance of supply/demand between them. A higher interest rate tends to boost a currency’s value, you will often see central banks hiking interest rates to a) tempt more people to invest there and b) make it more expensive for people to speculate against the currency (go short) because in that scenario you have to borrow currency you don’t have to speculate.
Another key driver is politics, if you are investing in a country, or even just a company in a particular country, you generally want stability. If there are big changes in taxation or labour laws that might change the viability of a company’s business model. Elections and changes in government drive uncertainty which makes it riskier to invest. A stable legal and financial framework is good for business and therefore investment as it helps drive investment and innovation, and therefore currency inflows to that country.
Harry Turner, Founder at The Sovereign Investor
“The primary factor that affects forex markets is interest rates. When countries raise their interest rates, it increases the appeal of the respective currency, because investors can earn a higher return on their money in that country. Likewise, when central banks lower interest rates, the currency of the corresponding country tends to depreciate due to lower prospective returns.
Another key factor influencing forex prices is inflation. When a country experiences high inflation, its currency tends to depreciate against other currencies with low levels of inflation relative to them. This is because investors want to protect the purchasing power of their money, so gravitate towards currencies where inflation is low.”
Angelo Ciaramello, CEO, Founder at The Funded Trader
“The forex market is influenced by numerous factors that can cause fluctuations in currency values. Among the most significant factors are key economic data such as GDP, employment figures, and inflation rates, which greatly impact the forex market. For instance, the Swiss National Bank’s liquidity assistance to Credit Suisse and the new inflation forecast for 2023-2025 are expected to influence currency values and trading volume.
Central banks frequently intervene in forex markets to maintain stability and achieve economic objectives, adjusting interest rates or providing liquidity assistance to impact currency values. The SNB’s policy rate and Switzerland’s mortgage and real estate market vulnerabilities serve as prime examples. Major geopolitical developments, such as the agreement between China and Brazil to trade in their own currencies and move away from the USD, can create uncertainty and affect currency values while highlighting the potential for alternative reserve currencies to reshape the global economic landscape in the long term.
Government-implemented fiscal and monetary policies can also influence a country’s currency value. These policies, which may target inflation control, debt management, or economic growth promotion, can significantly affect the forex markets. Moreover, traders and investors base their decisions on various factors, including expectations about future events, technical analysis, or economic data releases, leading to changes in market sentiment and currency value fluctuations.”
Richard Gardner, CEO at Modulus
“The Forex markets are heavily influenced by a number of external factors, perhaps, most notably in recent times, the policies of central banks. Given that central banks set interest rates and implement national monetary policies, they move the markets significantly. When a currency sees interest rate hikes, the currency usually appreciates, while it will depreciate when a central bank cuts the rate. Recently, we saw this play out, given that, last year, the Fed began raising rates before other major central banks. It provided the USD some strength in the market.
Beyond the actions of central banks, there are other external factors at play, as well. When nations post better than expected GDP growth, often the currency is subsequently strengthened. The same is true of other economic indicators, including the inflation rate and the unemployment rate. If the inflation rate turns out to be higher than expected, the markets will price that data into the equation, given that there then becomes an expectation that interest rates may be augmented.
Events beyond those in the economic realm also affect the forex markets. One of the best examples from last year is the geopolitical events in Eastern Europe. As political instability increased with Russia’s invasion in Ukraine, forex markets responded swiftly. The Russian currency was quickly impacted as investors gauged the economic impact. These events have their own economic impact, but they also move market sentiment. The sentiment of the market has its own effect, to be sure.”