What Are The Key Drivers of The Forex Market

Several factors like inflation, economic reports, political stability and more can affect the forex markets. Any positive or negative economic event leads to the currency pair prices fluctuating to a great degree, providing traders with the opportunity to profit from the volatility.  

In this article, we learn about the top factors that affect the forex market.

1. Balance of trade

Balance of trade refers to the difference in the value between the exports and imports of a particular country. Exports are how many products and services the country is selling to the world, and imports are how many products and services it is buying from the world. 

The higher the Balance of trade (meaning exports are more than imports), the stronger that particular currency's value globally. This leads to an appreciation in the price of that currency in the foreign exchange market and signals traders to buy more of the appreciated currency. 

When the value of imports is higher than exports and the balance of trade for the nation is low, it depreciates the currency in the forex market and signals traders to shift to some other currency.

2. Political stability

When a country is politically stable, its currency prices in the forex market are also stable. Whereas political instability, unrest and negative shocks lead to high volatility in the currency’s prices.  

Traders keep a close eye on the political events and news to see if any possible changes could affect the forex market. The changes can include new reforms, a change in the governing body, new regulations, amendments, industry rules, etc. All pro-growth political changes appreciate the country’s currency in the forex market, and all anti-growth changes lead to a currency price depreciation.

3. Central bank interest rates

A central bank interest rate is the rate at which a country’s central bank lends to or borrows from the country’s domestic banks. When a central bank decides to increase its interest rates, it means that the economy is flourishing and the money supply is increasing. This leads to a currency appreciation, signalling traders to buy more of the currency. 

On the other hand, when the central bank cuts interest rates, it indicates that the economy is facing hard times and the money supply is contracted, leading to a currency depreciation that signals traders to sell the currency pair.

4. Economic reports

A nation’s economic report analyses the economic development in the country, prospects, and overall economic growth. It talks about each and every economic aspect like employment, monetary policy decisions, payroll report and more that is significant for a country’s betterment.

Whenever these reports portray a positive economic outlook for the country, its currency appreciates in the market and signals trades to enter the market. However, when the economic reports are not so positive and depict an economic turmoil, it depreciates the currency and signals traders to exit the market. 

5. Inflation

Inflation refers to an increase in the prices of goods and services in the economy that decreases the purchasing power of its people. When inflation in a particular economy increases, it devalues the currency in the forex market, which results in a fall in the prices. As the currency weakens against other currencies in the market, it signals traders to sell it. 

On the other hand, when inflation in a country is under control, it indicates that the currency’s buying power in the market is still solid. This leads to an appreciation in the currency prices that signals traders to buy more of it.

6. Government/public debt

Government or public debt is the amount that the central government of a country owes to its lenders. The outstanding debt can be in the form of bonds, loans, ROI, other securities and more. 

When a country is not able to repay its government debt and keeps on adding onto the same, it affects the forex market negatively. The value of the country’s currency depreciates as lenders lose faith in the nation's governing body. This leads to more and more traders exiting their trades from that particular currency. 

On the other hand, when a nation’s government debt is under control, it leads to a currency appreciation as lenders have faith in the country, its governing body and its currency. This leads to more and more traders entering trades with respect to that particular currency.

7. Employment rate

Employment rate refers to the number of people employed in a country who are of the working age, able and willing to work. The higher the employment rate in a country, the stronger is the country’s GDP and overall global performance. This leads to an appreciation in the currency value and provides traders with long opportunities. 

On the contrary, when the employment rate in a country is low, it indicates a weak economy, low GDP and overall global performance. This leads to the depreciation in the currency value and provides traders with an opportunity to sell off the currency.

8. Capital market

The capital market, also known as the stock market, comprises various small, mid and large-cap companies that raise capital by selling the company’s shares, bonds and other investment securities.  

Whenever a country’s stock market performs positively, it indicates that the overall economy is rising and increases the investors’ confidence in the economy. This leads to a price appreciation in the country’s currency in the forex market as foreign investors increase the demand for the domestic currency. 

On the other hand, when a country’s stock market crashes, it indicates that the overall economy is not performing well and decreases an investor’s confidence in the economy. This leads to price depreciation in the country’s currency in the forex market as foreign investors decrease the demand for the domestic currency. 

Closely observe the key drivers of forex for successful trading

Watch out for the factors affecting the forex market as they leave a significant impact on the currency exchange rates regularly.

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