Macroeconomic factors have always driven forex markets, as they influence traders’ decisions and determine the value of a currency. Overall economic strength depends on many events and information that may rapidly change. Some of the factors that influence an economy’s stance and drive changes in its currency are the following.
The global capital markets are perhaps the most visible indicators of an economy’s health. It is important to take into account the release of public information in capital markets, as there is a steady flow of media coverage and up-to-the-second information on the reports of corporations, institutions and government bodies. A change in investors’ beliefs provoke a rally or sell-off of securities.
Some economies are commodity-driven, such as Russia. The Russian rouble is strongly correlated to the movements of crude oil and gas. A rally in gas prices leads to the appreciation of the rouble relative to other currencies. Commodity traders, like forex traders, rely heavily on the same economic data, so both markets are affected in the same way.
The fixed income markets are similarly critical to what happens in the forex market, because both sovereign bonds and currencies depends heavily on interest rates. Sovereign bonds price fluctuations factor in to movements in currencies, meaning that a change in yields will directly affect currency values. Therefore, it is important to understand how government bonds are valued in order to excel as a forex trader.
Another key macro factor is the balance of trade. The trade levels among nations is a proxy for the relative demand of goods from a nation. An export-oriented nation will typically see an appreciation of its currency. For example, in order to purchase goods from the United States, global buyers must convert their currencies into U.S. dollars. The increased demand for the dollar will put upward pressure on its value.
Trade surpluses and deficits also exemplify a nation’s competitiveness in international trade. Countries with a large trade deficit are net buyers/importers of international goods, resulting in their currency being sold to purchase the currency of other nations in order to pay for the international goods. This has a negative impact on the value of an importing country’s currency.
The political environment plays also an important role in the economy of a country and, consequently, influences the value of its currency. Forex traders constantly monitor political events to evaluate their consequences on countries. These can include fiscal policies (i.e. increasing government spending) and industrial policies (i.e. subsidising a sector or industry). For instance, an upcoming election is always a major event for currency markets, as currencies will often react more favourably to parties with fiscally responsible platforms. A remarkable example is the Brexit referendum, which had a great impact on the pound, soon after the Britons voted to leave the bloc. The sterling fell to its minimum levels since 1985 after the referendum because the UK’s economic prospects became suddenly highly uncertain.
The fiscal and monetary policies are other important factors in its economic decision making. Central bank decisions on interest rates and forward guidance are keenly watched by forex traders.
Economic reports are the core of a forex trader’s playbook. Building an economic report calendar is crucial to staying current. GDP is the most important economic variable to be observed, as it is the base of a country’s economic strength, notwithstanding it is a lagging indicator, meaning that it reports on events and trends that have already occurred.
Inflation is another important indicator, as it signals increasing price levels and falling purchasing power. However, inflation is a double-edged sword, as many analysts view it as placing downward pressure on a currency due to reduced purchasing power, while others believe it can also lead to currency appreciation, as it may force central bankers to increase rates to tackle rising inflation levels. Inflation is a controversial issue among economists, and its effects on currencies are hard to evaluate.
Employment, investment, retail sales and PMIs also provide important information on the current and future strength of an economy and its currency, serving as a suitable complement to the factors we have described above.