5 Factors Affecting the Foreign Exchange Market

Currency values are always changing, rising, and falling in value. Australian dollars were worth $0.90 five years ago. At the time of this writing, it is currently valued $0.66.

The number of factors determines how something performs, and it is not completely random. Five factors influence the value of a currency, and we'll examine them all in this paper.

Rates of interest

The Reserve Bank of Australia sets interest rates in Australia (RBA).

When interest rates rise, owning that country's currency creates larger interest payments, which opens up additional potential for-profit development. This attracts traders who want to buy it up, raising the currency's price.

Conversely, lowering interest rates reduces profit potential and makes the currency less attractive, encouraging individuals to attempt to sell it. The currency's price lowers as demand declines.

Economic security

A stable economy is seen as low risk, which attracts foreign investment. This demand raises the value of the country's currency.

In contrast, a weaker economy causes investors to lose confidence and remove their investments, causing the currency to fall.

A multilateral exchange rate index is the trade-weighted effective exchange rate index (TWI), which is a typical variant of the effective exchange rate index. It is calculated as a weighted average of home currency exchange rates vs foreign currency exchange rates, with the weight for each foreign nation equal to its percentage of the trade.

When exports exceed imports, an economy is considered to have a 'trade surplus,' which strengthens the economy's stability. The currency's value grows when overseas customers buy it to buy exporting products.

When imports exceed exports, an economy is said to be running a “trade deficit.” The nation must sell its currency to acquire the imported products, causing the currency's value to fall.

The TWI is a method of quantifying the foregoing in a single value.

Global events

Geopolitical events, crises, and upcoming elections may all have an impact on currency strength depending on how they influence the perception of a country's stability. A favorable event may attract international investors, with an increase in foreign money improving the currency's value. A nation in crisis may cause a loss of trust and a decline in the value of its currency.

The national debt

Government debt by itself is not always a bad thing. It has the potential to enhance local infrastructure while also spurring economic development. When it is too high, though, it might cause inflation and currency depreciation.

When the government's debt is lowered, the economy becomes more stable, attracting more investors and enhancing the value of the currency. If the national debt rises, the government may issue additional money, increasing the amount in circulation (known as quantitative easing). This devalues current currency holdings, leading prices to fall.

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