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Key Factors that Affect Foreign Exchange Rates

Eden

Oct 25, 2021 13:27

There are many factors affecting the medium and long-term trend of the FOREX market, including interest rates, gross domestic product (GDP), US non-farm payrolls (NFP), consumer price index (CPI), producer price index (PPI), durable goods orders, claims for unemployment benefits, industrial production index, trade balance, unemployment rate, retail sales, etc. Differences between published data and expectations will have different impacts on currency pairs.


The NFP of the US is one of the important factors affecting FOREX. Increases in NFP and average wages indicate that employment growth and potential inflationary pressure have increased. In many cases, the Fed will inhibit them by hiking interest rates, benefiting the US dollar. On the other hand, NFP's continual decline would mean that the economy is slowing down to some extent, leading to an increase in likelihood of reduced interest rates and hurting the US dollar. 

In addition, decisions of central banks' in different countries on interest rates are another important factor that affects FOREX. In the US, for example, interest rates are determined by the Federal Open Market Committee (FOMC). Interest rate decisions are important because central banks in different countries will formulate monetary policy and interest rate decisions based on a combination of economic growth, domestic inflation and unemployment. Therefore, interest rate decisions determines a country's path of interest rates for a period of time in the future.

If the central bank in a country decides to lower interest rates, future returns on cash deposits will fall, causing local currency funds to flow from banks to the market, encouraging investment and consumption, and boosting economic growth. At the same time, the market demand for the country's currency will drop due to lower yields, increasing the currency's depreciation pressure. In contrast, a rise in the interest rate will increase borrowing costs, and reduce the liquidity in the market. Therefore, it has the effect of suppressing consumption and curbing inflation. Meanwhile, higher yields will attract more money converted into the country's currency, increasing the likelihood of currency appreciation.


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