Reuters recently reported that the US dollar has risen to nearly its highest point in 14 years. This is based on positive US economic data, as well as a potential lift in interest rates from the Federal Reserve. The US dollar has also been rising since the election of Donald Trump as the President of the United States of America. With the US dollar on the increase in recent times, now is a good time to look at factors that affect forex currency rates, and what causes them to increase or decrease in value.
When a country’s central bank changes the interest rate it affects the value of their currency. Generally speaking, if a central bank increases their interest rates a currency will tend to appreciate in value, as lenders of money will be able to earn more from depositing their money. The reverse is also true: if interest rates are low, money will tend to leave a country as lenders will not earn as much interest, in turn lowering the value of a currency.
In the United States, the central bank is called the Federal Reserve. Historically, the fed funds rate has been on a decline the past 10 years which would explain the long term trend of the falling US dollar. However, recently the Federal Reserve has indicated they are considering lifting rates which partly explains the US dollars recent rise.
Inflation rates are another factor which affects forex rates. Generally, countries with lower inflation rates will have their currency appreciate against countries with higher inflation rates. Over the long term, if a country has consistently high inflation rates their currency will tend to depreciate.
Country’s Balance Of Payments
A country’s balance of payments refers to the total amount of payments coming into a country, as well as out of a country. When a country’s balance of payments is negative, there are more outgoing payments than incoming, and as a result a country’s currency will fall.
If a country’s balance of payments is positive, then there are more incoming payments than outgoing, and a country’s currency will rise. Historically, the United States has a negative balance of payments, which explains the long term decline of the US dollar, despite this recent rise.
Government debt refers to the money owed by a country’s central government as is also referred to as public debt. If forex traders think that government debt will increase, then they will sell their bonds on the open market. This will result in the currency falling.
The US government has a very large government debt that has been increasing over the years. This further confirms the long term trend of a declining US dollar.
Terms of Trade
The terms of trade is related to the balance of payments, as it is the ratio between the prices of exports and prices of imports. When a country’s terms of trades improves, it means that exports prices are rising higher than import prices. Subsequently, the currency will increase in value as more people are demanding it to purchase exports.
The opposite will cause a fall in the currency’s value. This is when import prices rise faster than export prices.
The strength of a currency is affected by the political state of a country, as well as its economic performance. If a country has a stable political environment, foreign investors are more likely to invest into that country, in turn increasing the value of the currency of that country. Conversely, if a country is constantly in political turmoil, it doesn’t create much confidence for investment, meaning less money flowing to that country, and in turn the currency will fall in value.
If a country experiences a recession, interest rates are typically lower. This would in turn lower the amount of foreign capital coming into the country as they aren’t able to earn as much due to the lower interest rates. Subsequently, this would lead to a lower forex exchange rate.
There are many factors that affect the forex rates of a currency. These factors include interest rates, inflation rates, balance of payments, government debt, terms of trade, political stability and recession. If you are a forex trader using a platform such as CMC markets then you can use these factors to help you to make trading decisions on your currency pair.