Economic Factors that Affect the Forex Market
The market for foreign exchange is always in a constant change as a result of the economic factors around it. Currency exchange is entirely down to the level of demand in the surrounding markets. The demand itself is influenced by the strength and performance of goods in both the local and foreign markets. There are of course other factors that are outside of the economic realm that can influence the foreign exchange market. Political factors and natural calamities are particularly influential outside the economic realm. Sticking to economics though, here are the main economic factors that have huge effects on the foreign exchange market.
In any successful economy, the employment data plays a crucial role. Higher employment rates are desired in order to have a strong economy. Human resources are crucial for achieving economic goals since productivity levels are dependent on people. With a strengthening economy also comes a strengthening local currency compared to foreign currencies. Generally, when the economy is strong and people are employed, consumption and demand rise to desirable levels and this improves the health of the local currency.
2. Inflation & Interest Rates
Both inflation and interest rates are related and they all affect the forex market. Interest rates are specifically observed by investors and other shareholders in the economy. The monetary policy and the interest rates come out of it are responsible for influencing how investors will be interested in the economy. Inflation, on the other hand, is the overall increase in the prices of goods. When the prices are high, the indication is that the inflation is high. High inflation shows that the currency has weakened and this is crucial for adjusting the exchange rates in the forex market.
3. The GDP
The gross domestic product measures the total productivity levels in an economy usually in the span of one year. The GDP is the only metric that shows actual growth or contraction of an economy. The GDP is thus a vital measure for the currency exchange rates. In overall, the GDP directly affects:
- Total government expenditure
- Consumption of goods by the local market
- Business expenditure
- Total net exports
All of these factors are directly responsible for the value of a currency. Government expenditure, for instance, determines how much infrastructure is built and thus shows how the economy will perform. The other factors as well as determine the health of the economy and thus affect the foreign exchange market.
4. Durable Goods
Durable goods can also be viewed as a store of wealth. Durable goods are those that can be expected to last for up to three years or more. These goods are crucial for showing how healthy the economy of a particular country is. A country that does not have enough stock of durable goods is generally not performing well as it does not have the necessary stock for promoting other sectors of the economy. This has an impact on the currency market because both the perception and effects on the economy can be influenced. In general, economic spending is important in keeping the local currency at desirable rates in the currency exchange markets.
5. The Flow of Capital
Finally, the flow of both capital and goods is crucial for determining how the currency exchange market performs. Just like any other market, the volumes and frequency of trade are important for the economy. The flow of capital is responsible for checking trade balance or trade imbalance. If a particular country is receiving more goods than it is exporting, then the local currency will definitely become weaker as there is no demand for it outside. The opposite is also true where the currency of a country becomes attractive owing to its dominance in international trade. The flow of capital is also indicated by the investment that flows into or out of a country. Higher FDI results in healthy levels of foreign currency in the local market.
The foreign exchange market is ultimately heavily determined by many economic factors. Even though political and natural calamities have a role to play, economic factors are the final determinants of the value of a particular currency compared to others in the foreign exchange market. All shareholders in the economy usually keep an eye on the various factors that influence the value of the currency.