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Forex Market Movers

Interest Rates Basics

Unlike most markets, the forex market is moved most notably by macroeconomic and geopolitical events.  The forex market is so huge that events in a particular industry in a particular country – unless they are of massive proportions – tend to take a back seat to events that effect entire economies or the global economy. 

The very most basic, classical theory behind how exchange rates fluctuate:  Growth in exports will increase demand for a country's currency.  Eventually, this growth will cause the currency to grow in value so much that the home country's exporters lose their competitive edge, and the export sector of the economy will accordingly slow in growth or even recede.  This causes demand for the home currency to fall, which helps exports.  Rinse and repeat.

In reality, export and import levels effect the demand for a currency only in the long term.  These days, they are by no mean the only major mover of forex markets.  That being said, trade balances between countries will often effect that specific currency pair.  For instance, if a report shows the US is exporting much more to the euro-zone and importing much less, that means that, all things the same, the dollar will rise against the euro. 

Interest rates are another part of the classical model of forex markets, and here the classical model is a bit more pertinent.  The interest rates found in home banks is the benefit of holding a certain currency for an extended amount of time.  The higher the rates, the greater the demand for that currency.  So, when a central bank raises rates, it not only usually signals they are confident in the growth rate of country's economy, it makes holding money in that country's currency more attractive.

Why Interest Rates Move the Forex Market

When central banks decide to raise or lower interest rates, it is a big, dramatic event.  Indeed, the attention such actions garner usually outstrips the actual economic consequences of the moves.  But, simply because the media and investors are paying so much attention, it makes interest rates all the more important in the forex market. So, the actual, direct economic consequences of changes in interest rates by central banks combines with the all the investor and media attention that such changes garner in a way that makes it a very big deal in the forex markets when a central bank acts on key interest rates.

Inflation is a related, tricky indicator.  If a report comes out showing the GBP suffers from unexpectedly high inflation, that effectively pushes real interest rates – the interest rate minus the inflation rate – down, and so makes holding money in that currency less valuable. Sometimes, though, slightly higher than expected inflation might make speculators think the central bank is going to be forced to raise interest rates.  So, in that case, it might actually help the currency. 

Other than completely unexpected economic news – for instance, a jobs report that was expected to show a decline in US employment levels by .1%, but actually showed a .3% increase – the only thing that effects the forex market in the short term as much as changes in interest rates is geopolitical events.

Other Factors That Influence the Forex Market

To give an example of the interaction of global politics and forex markets, when the US invaded Iraq in 2003, the value of the US dollar shot up dramatically during the first weekend, when it seemed as though the war would be over quickly, and the US economy would not get dragged down by a protracted war.  Furthermore, the consequences of a brilliantly victorious war on the American economy would have been significant:  The world's greatest economic and military power now seemed to have an incredible number of oil fields under its control, and would be divvying out contracts (in dollars) to its pleasure... forex traders were betting that demand for the dollar would grow significantly. Of course, it didn't happen, and as the reality of the situation became clear – and as confidence in the relatively new euro grew – the US dollar fell significantly. 

Also, as the resulting geopolitical turmoil unfolded and the situation began to look likely to spill over to the rest of the region, the value of gold grew rapidly.  Gold, like the US dollar used to be, is a waiting station for investors in times of turmoil.  If no one knows quite what's going to happen, they go to a liquid asset that is a relatively safe investment. 

That brings us to another important variable:  There is generally an inverse relationship between the value of gold and the value of the US dollar.  When one is strong, the other usually is weak. With all of these variables, though, especially if you are focusing on the short-term, it is important to consider the psychology of the market.  When news breaks, whats important during that actual day is not the actual effect it might eventually have on, say, the Swiss Franc, but what people think it will have.  Of course, this is true in all markets, but in the forex market, where speculation often relies on the agreed-upon – as opposed to the actual – effect of macroeconomic news and trends, it is even more important.