Factors Affecting Forex Rates

Foreign exchange rate refers to the price ratio of one currency to another. It reflects the economic strength and market supply and demand between different countries or regions. Changes in foreign exchange rates will have a significant impact on international trade, investment, tourism, financial markets, etc. Therefore, it is very important to understand the factors that affect foreign exchange rates. Generally speaking, factors affecting foreign exchange rates can be divided into the following categories:

1. Economic Fundamentals

These factors include gross domestic product (GDP), inflation rate, interest rate, fiscal policy, trade balance, foreign exchange reserves, etc. They reflect the level of economic development and competitiveness of a country or region. Generally speaking, a country or region with fast economic growth, low inflation, high interest rates, healthy finances, trade surplus, and sufficient foreign exchange reserves will have its currency appreciate relative to other currencies; conversely, its currency will depreciate relative to other currencies.

For example: In 2020, due to the outbreak of the new coronavirus epidemic, the global economy was severely impacted, and many countries implemented blockade measures and stimulus policies, resulting in shrinking economic activities and rising inflationary pressure. In this case, the US dollar, as the global reserve currency and safe-haven currency, has been favored by the market and has appreciated relative to other currencies. Some countries that rely on exports and tourism, such as Australia, New Zealand, Thailand, etc., have seen their currencies depreciate relative to other currencies.

2. Political and Social Factors

These factors include political stability, degree of rule of law, social security, changes in public opinion, international relations, etc. They reflect the political and social environment of a country or region. Generally speaking, a country or region with political and social stability, sound rule of law, social harmony, public support, and international friendliness will have its currency appreciate relative to other currencies; conversely, its currency will depreciate relative to other currencies.

For example: In 2016, the United Kingdom held a referendum on leaving the European Union, and the result was a narrow majority in favor of leaving the European Union. The result sparked shock and uncertainty in markets, causing the pound to depreciate sharply against other currencies. In the following years, the negotiation process between the UK and the EU continued to affect the exchange rate trend of the pound. It was not until the end of 2020 that the two sides reached a trade agreement, causing the pound to recover against other currencies.

3. Market Psychological Factors

These factors include investors' expectations, confidence, sentiment, etc., which reflect the market's judgment and attitude towards future exchange rate changes. Generally speaking, when investor demand for a certain currency increases or supply decreases, the currency will appreciate relative to other currencies; conversely, the currency will depreciate relative to other currencies.

For example: In 2018, a trade war broke out between the United States and China. The two sides imposed tariffs and sanctions on each other, triggering market pessimism about the global economic outlook. Under this circumstance, the currencies of some emerging market countries have been under selling pressure, such as the Turkish lira, Argentine peso, South African rand, etc., which have depreciated significantly relative to other currencies. Some traditional safe-haven currencies, such as the Japanese yen and Swiss franc, have appreciated relative to other currencies.

4. Technical Analysis Factors

These factors include historical data, trend graphics, technical indicators, etc., which reflect the market's rules and trends in exchange rate changes. Generally speaking, technical analysis can help investors discover the support and pressure levels that exist in the market, as well as signals of breakthroughs and reversals, so as to formulate corresponding trading strategies.

For example: At the beginning of 2021, the U.S. dollar index showed signs of rebound after falling below the 90 mark, forming a double bottom pattern on the daily chart. This is a common reversal signal in technical analysis, which means that the U.S. dollar index is expected to end its previous downward trend and turn upward. In this case, some technical analysts will choose to buy the U.S. dollar index or sell the exchange rates of other currencies against the U.S. dollar to gain profits.

The above are some of the main factors that affect the foreign exchange rate. Of course, there are also other special or sudden factors, such as natural disasters, war conflicts, terrorist attacks, major events, etc., which will have short-term impacts and fluctuations on the exchange rate. Therefore, when investing in foreign exchange, investors need to comprehensively consider the impact of various factors and choose appropriate currency pairs and trading strategies based on their own risk preferences and investment goals.