The currency market, also known as the foreign exchange market, is a marketplace where different currencies are bought and sold by different participants from different parts of the globe. This market plays an eminent role in the conduct of international trade.
The currency market
benefits businesses and people by allowing them to buy and sell products and
services in foreign currencies and by facilitating a constant flow of capital.
The key players in the currency markets, including big multinational banks,
corporations, governments, and retail traders, work around the clock. Members
come to the currency market with various goals in mind, and together they
increase the market's efficiency and liquidity. These markets, in large part,
are what power the vibrant world economies.
1.
Inflation Rates
Changes in market
inflation cause changes in currency exchange rates. A country with a lower
inflation rate than another will see an appreciation in the value of its
currency. The prices of goods and services increase at a slower rate when inflation
is low. A country with a consistently lower inflation rate exhibits a rising
currency value while a country with higher inflation typically sees
depreciation in its currency and is usually accompanied by higher interest
rates.
2.
Interest Rates
How do interest rates
affect money exchange rates? Changes in interest rates affect currency value
and dollar exchange rate. Forex rates, interest rates, and inflation are all
correlated. Increases in interest rates cause a country's currency to appreciate
because higher interest rates provide higher rates to lenders, thereby
attracting more foreign capital, which causes a rise in exchange rates:
3.
Country's Current Account/Balance of
Payments
A country's current
account reflects balance of trade and earnings on foreign investment. It
consists of total number of transactions including its exports, imports, debt,
etc. A deficit in current account due to spending more of its currency on
importing products than it is earning through sale of exports causes
depreciation. Balance of payments fluctuates exchange rate of its domestic
currency.
4.
Government Debt
Government debt is
public debt or national debt owned by the central government. A country with
government debt is less likely to acquire foreign capital, leading to
inflation. Foreign investors will sell their bonds in the open market if the
market predicts government debt within a certain country. As a result, a
decrease in the value of its exchange rate will follow.
5.
Terms of Trade
A trade deficit also
can cause exchange rates to change. Related to current accounts and balance of
payments, the terms of trade are the ratio of export prices to import prices. A
country's terms of trade improve if its export prices rise at a greater rate
than its import prices. This results in higher revenue, which causes a higher
demand for the country's currency and an increase in its currency's value. This
results in an appreciation of the exchange rate.
6. Political
Stability & Performance
A country's political
state and economic performance can affect its currency strength. A country with
less risk for political turmoil is more attractive to foreign investors, as a
result, drawing investment away from other countries with more political and
economic stability. An increase in foreign capital, in turn, leads to an
appreciation in the value of its domestic currency. A country with sound
financial and trade policy does not give any room for uncertainty in the value
of its currency. But, a country prone to political confusion may see a
depreciation in exchange rates.
7.
Recession
When a country
experiences a recession, its interest rates are likely to fall, decreasing its
chances of acquiring foreign capital. As a result, its currency weakens in
comparison to that of other countries, therefore lowering the exchange rate
8.
Speculation