Factors Affecting the Global Currency Market - Part 1

Many people find the ‘predictions game’ the most enjoyable aspect of Forex trading. In order to develop solid mid-range and long-range trading strategies, you have to acquire a fairly sophisticated knowledge of economics.

So, you ask, which factors most influence the global currency market?

There are 5 key areas you need to pay attention to in order to become a top-notch Forex investor:

- Interest Rates
- Economic Growth
- Mergers and Acquisitions
- Trade and Capital Flow
- Geo-Politics

We’ll take a look at each area now, and how you can take advantage of these factors.

Interest Rates

The Forex market allows you to profit from differences between the interest rates of different countries. Interest rates on a currency from a given country are set by that country’s central bank.

In general, you want to purchase low interest rate currencies first, and use these to finance your purchase of high interest currencies or other instruments. This tactic is known as generating interest income.

A second tactic involves generating income from capital appreciation. It has been observed that a rise in a country’s interest rate usually triggers a corresponding rise in currency value.

The main thing to understand about interest income and capital appreciation is that any shift in interest rates presents you with an opportunity to play interest rate differentials against each other.

The corresponding rise and fall in currency values means that interest rates make for powerful and generally very reliable Forex indicators.

Economic Growth

Positive economic growth is strongly tied to a rise in currency value. Why?

When an economy is in a growth period, inflation tends to follow. What do the central banks do when the threat of inflation is looming ahead? Typically, they raise interest rates in order to slow down the economic boom just a bit.

Now, when interest rates go up, investors - especially foreign investors - start putting more money into the economy. More investors means more demand for the currency. So, the value of the currency goes up.

Likewise, a slow in growth or even a significant downturn will cause the reverse of this chain reaction to take place. Central banks tend to cut interest rates to give sluggish economies a boost.

However, lower interest rates mean lower returns for investors. They respond by pulling out of the market. This results in less demand for the currency, followed by a drop in currency value.

Mergers and Acquisitions

Mergers and acquisitions are relevant indicators, though perhaps not as strong as the others discussed here.

However, mergers and acquisitions between large, multinational companies can and do have an impact on currency values for the short-term. The reason should be fairly clear when you think about it.

In order to complete an acquisition, for example, the corporation that is attempting to purchase a corporation based in another country must enter the Forex market to purchase the corresponding currency.

During the window of time that the acquisition is pending, it is not unusual to see a spike in currency value on both sides.