The Influence of External Factors on FOREX Exchange Rates
For many people who are unaware of what FOREX is, it is an acronym that may have just struck your head. But in essence, it is all about the world’s currencies. In finance, an exchange rate is how the value of one nation’s currency compared to another nation’s currency. You will hear traders and investors talk about this all the time and it is very important for everyone to know about it. However, there are several differences between the exchange rates between various currencies.
One major difference is in respect to inflation. When the prices of commodities like oil, gold, silver, etc. increase, so does the value of each unit of currency. This is because the commodity prices tend to follow the general inflation. While the exchange rates between currencies can fluctuate based on overall inflation, they also depend on the supply and demand for that particular currency.
Take the United States for instance. The dollar has been the international standard since the early days of the forex trade. However, after the onset of the Great Depression, the American dollar lost much of its strength against other currencies. Japan started trading under the dollar but recently the Japanese government purchased a lot of Treasury Bonds to keep their economy afloat. So you can see that when the dollar weakens versus other currencies, the value of the dollar goes down.
Right now, the U.S. dollar is the most sought after currency because it is strong and most people prefer to purchase U.S. dollars. On the other hand, the Japanese yen is valued lower than the dollar. The reason for this is that the Japanese economy is growing at a very fast pace. This has made Japanese consumers more affluent as well as many companies have located in Japan and this has increased the demand for the Japanese yen. On the other hand, the U.S. dollar demand is currently stronger so traders often trade the two currencies simultaneously for a better profit potential.
The other major factor that influences the direction of the forex exchange rates is the political situation of any country. The two major countries which are involved in currency trade are the U.S. and Japan. The American dollar depreciates when the political situation of the country worsens and this is due to the fact that the American economy is suffering from the effects of the global recession. On the other hand, when the political situation is stable the Japanese yen appreciate since that makes the Japanese currency worth more. There are lots of factors that influence these currency values and traders will need to be knowledgeable about all of them if they wish to make consistent profits on the forex market.
In order to understand the political situations of the two countries involved, we need to look at the economic conditions of both countries. Since the U.S. dollar is weak because of the economic conditions in the country, traders will usually purchase the U.S. dollar when the economic conditions of the country are good and then sell it when the economic conditions in the country are bad. On the other hand, the Japanese yen is highly valued due to the fact that the country is experiencing economic growth. Due to this reason, many Japanese people prefer buying U.S. dollars rather than the Japanese yen in order to increase the earning potential as well as the exchange rates between the two countries.
Other economic factors that affect the movements of the forex exchange rates include political stability of the country, inflation and interest rates. When there is low inflation, the exchange rates between the currencies can be controlled to a certain extent. However, high levels of inflation reduce the trading profit possibilities. On the other hand, low interest rates make the purchasing power of the domestic currencies drop since this tends to put extra burden on borrowers. It has also been observed that a country with a low level of interest rates enjoys more foreign investment compared to the ones with high interest rates.
In addition to these factors, fluctuations in the exchange rates between the currencies can be influenced by the weather conditions. Low liquidity conditions in one country can lead to a fall in the exchange rates while strong winds in another country may increase the demand for the euro or the dollar. Similarly, weak currencies can result in the rise of the other currencies. These changes are mostly positive, since the fluctuations are in the favour of buyers and sellers. However, fluctuations due to the external factors have an adverse effect on the prices as well as the supply and demand of the currencies.