Fundamental Factors That Affect Currency Values

As a forex trader, you will be affected by a number of fundamental variables that help form the long-term strength or weakness of the main currencies.

For your reading enjoyment, we've listed what we believe are the most important:

Economic Growth and Outlook

Let's start with the economy and consumer, business, and government perceptions.

When customers see a robust economy, it's easy to see why.

Consumers are content and secure, and they spend money as a result. Companies gladly accept this money and proudly proclaim, “Hey, we're earning money!” Wonderful! Now... well, what are we going to do with all this cash？

Companies who have a lot of cash spend it. All of this generates a sizable amount of tax money for the government.

They hop on board and begin spending money as well. Everyone is now spending, which has a beneficial influence on the economy.

Weak economies, on the other hand, are frequently accompanied by consumers who aren't spending, firms that aren't generating any money and aren't spending, leaving just the government to spend. However, you get the concept.

Economic outlooks, both favourable and bad, can have a direct impact on currency markets.

GDP is the most often used indicator of economic growth.

The term “Gross Domestic Product” refers to the total monetary worth of all final products and services produced (and sold) inside a nation over a certain time period (typically one year).

GDP is a measure of a country's economic health that is used to determine its size and rate of growth.

HowMuch.net has created a visualisation that depicts the $86 TRILLION global economy in one graph:

As may be seen:

· The United States continues to have the greatest economy in the world.

· China's economy is the world's second-largest.

· Together, the United States and China account for almost 40% of global economic GDP.

· The top 15 economies account for over three-quarters of global GDP.

Capital Flows

Globalization, technical advancements, and the internet have all made it possible to invest your money almost anywhere in the globe, regardless of where you live.

You may invest in the New York or London Stock Exchanges, trade the Nikkei or Hang Seng index, or create a forex account to trade U.S. dollars, euros, yen, and even exotic currencies with just a few mouse clicks (or a phone call for those of you who grew up in the Jurassic period of the 2000s).

The amount of money flowing into and out of a country or economy as a result of capital investment purchases and sales is measured by capital flows.

The capital flow balance, which can be positive or negative, is the most crucial factor to keep track of.

When a country's capital flow balance is positive, foreign investments into the country outnumber foreign investments out of the country.

The polar opposite is a negative capital flow balance. The amount of money leaving the country for some international destinations exceeds the amount coming in.

As more foreign investment flows into a country, demand for that country's currency rises as foreign investors sell their currency to purchase the local currency.

The currency's value rises as a result of this demand.

It's as simple as supply and demand.

And, you got it, when a currency's supply is high (or demand is low), the currency tends to lose value.

When foreign investments reverse course and domestic investors follow suit, the local currency becomes oversupplied as everyone sells and buys the currency of the foreign country or economy they're investing in.

Nothing attracts foreign capital like a country with high interest rates and strong economic growth. Even better if a country's local financial market is booming.

High interest rates, a flourishing stock market... What's not to like about this？ Investment from other countries is pouring in.

And, once again, the value of the local currency rises as demand rises.

Trade Flows and Trade Balance

International commerce may be divided into two categories: products (merchandise) and services (services). Physical products make up the majority of international commerce, with services accounting for a far smaller portion.

Over the previous decade, global goods commerce has risen considerably, from over $10 trillion in 2005 to more than $18.89 trillion in 2019.

We now live in a global economy. Nations export their own commodities to ones that desire them, while also purchasing things from other countries.

Examine your surroundings. The majority of the items you have sitting around (electronics, apparel, even puppy toys) were most likely manufactured outside of the nation you reside in.

Look at all of the nations with which the United States trades if you live in the United States.

You have to give up part of your hard-earned money every time you buy something.

Everyone who sells you a widget has to do the same thing.

When buying products, importers in the United States exchange money with Chinese exporters. When Chinese importers buy goods, they swap money with European exporters.

All of this buying and selling is accompanied by currency exchange, which alters the flow of money into and out of a country.

The ratio of exports to imports for a given economy is measured by the trade balance (also known as the balance of trade or net exports).

It indicates the demand for that country's goods and services, as well as the value of its currency.

A trade surplus arises when exports exceed imports, and the trade balance is positive.

A trade deficit arises when imports exceed exports, and the trade balance is negative.

So:

Exports > Imports = Trade Surplus = Positive (+) Trade Balance

Imports > Exports = Trade Deficit = Negative (-) Trade Balance

Trade deficits have the potential to lower the value of a currency in comparison to other currencies.

Net importers must first sell their own currency in order to purchase the currency of the overseas merchant offering the commodities they desire.

When a trade deficit exists, the local currency is sold to fund the purchase of foreign products.

As a result, a country's currency with a trade deficit is in lower demand than a country's currency with a trade surplus.

Net exporters, or countries that sell more than they import, have their currency purged by countries eager to buy their exported commodities.

Currency appreciation is common when there is a trade surplus.

It is in higher demand, assisting in the strengthening of their currency.

It's all owing to the currency's DEMAND.

This is because when exporters change the foreign currencies they earn overseas into their home currency, the local currency is put under upward pressure.

Currencies that are in more demand are valued higher than those that are in lower demand.

It's the same with pop stars. Taylor Swift being paid more than Pink because she is in more demand. It's the same with Justin Bieber and Vanilla Ice.

The Government: Present and Future

Following the Great Financial Crisis (GFC), which resulted in the Great Recession in the late 2000s, all eyes were on their respective governments, wondering about the financial difficulties they were facing and hoping for some sort of fiscal responsibility to alleviate the financial woes we were experiencing.

A decade later, the globe finds itself in a similar scenario as it attempts to negotiate a worldwide health catastrophe and economic collapse brought on by the coronavirus (COVID-19) pandemic.

Instability in the existing government, or changes in the current administration, can have a direct impact on the economy of that country, as well as adjacent countries. And any economic consequence will very certainly alter currency rates.