Currencies are always fluctuating in value relative to each other. This is known as exchange rate volatility. There are a variety of factors that cause currencies to fluctuate, most relating to the economic and political conditions in a country. In the foreign exchange (forex) market, currency values are very sensitive to news and events. Traders analyze economic releases and political developments very closely to predict how they will impact currency movements.
Forex Trading
What is forex trading? The forex market is a decentralized global marketplace for trading currencies. It operates 24/7, facilitating currency trading between banks, financial institutions, businesses, and individual traders worldwide.
Currencies are traded in pairs like EUR/USD or USD/JPY. Forex traders attempt to profit from movements in these currency pairs by buying or selling them based on predicted fluctuations in their exchange rates.
The huge liquidity, volatility, and accessibility of the forex market attracts traders of all sizes and backgrounds, from large hedge funds to individual retail speculators. Advances in financial technology have also opened up forex trading to a wider audience.
Economic Indicators
Key economic data such as GDP, unemployment, manufacturing activity, interest rates, inflation and trade balances have a major influence on currency valuations. Strong economic growth and positive data tend to boost a currency’s value, while weak data can cause a currency to decline. When important economic releases like the US Non-Farm Payrolls or Australian CPI come out, traders will buy or sell currencies based on whether the results are better or worse than expected. Even small surprises can trigger significant volatility.
Monetary Policy
Central banks use monetary policy tools like interest rates to influence economic conditions. Rate decisions and any changes to policy often cause sharp currency movements. If a central bank raises interest rates, its currency will likely appreciate as higher rates attract foreign capital inflows. On the other hand, cutting rates can cause a currency to depreciate as investors transfer money to countries with higher yields. Statements and speeches by central bank officials also move rates as traders analyze the tone for clues about future policy.
Credit Ratings
Sovereign credit ratings by agencies like Standard & Poor’s, Moody’s and Fitch measure a country’s ability to repay its debt. Rating upgrades or downgrades have a direct impact on perceptions of a nation’s economic health and stability. An upgrade tends to increase capital inflows as it reduces the perceived risk, leading to currency appreciation. Conversely, downgrades typically weaken a currency. Even the prospect of a future rating change can move exchange rates.
Political Events
Major political events like elections, referendums, forming or collapsing of coalition governments, and resignations or appointments of leaders can all trigger currency volatility. These events can directly alter economic conditions and policies. Investors may buy or sell a currency depending on whether a political outcome is viewed as positive or negative for the economy. Even rumors or polls about potential election results often move rates in anticipation.
Other Factors
There are many other events and news developments that cause currencies to fluctuate including natural disasters, wars, terrorist attacks and major speeches or announcements by world leaders. In general, unforeseen and surprising events tend to create volatility as markets digest the news. Ongoing factors like trade deficits, budget surpluses, commodity prices and stock market performance also impact currency valuations over time.
Currencies are extremely sensitive to new information about economic and political conditions. Traders constantly react to news events and data releases, buying or selling currencies based on whether the information is positive or negative for that currency. Even small surprises can create substantial volatility. Staying up-to-date on major developments is essential for understanding why exchange rates fluctuate.