The trend of a currency price depends on the quantities purchased and sold it. If a currency has been purchased in large quantities, there will be an appreciation of that currency and its value will increase. Some factors, such as macroeconomic data, may affect such quantities and thus affect the exchange rate of currencies.
The exchange rate by its definition is the ratio between two factors: demand and supply meet in a point determining the price. This value, if the market was ‘pure’, would depend purely on these two factors and not from others.
Macroeconomic data affect the exchange rate between two currencies and some of these data can be manipulated to affect positively or negatively the price of the currency.
Below are the macroeconomic factors that have a greater impact on currency exchange rates.
Central banks affect currency rates in a variety of ways, through interest rates and trade balance.
By increasing interest rates, it is possible to attract foreign investment flows that will increase the demand for that particular currency and thus increase its value.
By depreciating its currency, instead, the currency will become weaker than the other currency.
With devaluation, the currency loses its purchasing power so it will be cheaper to export and not to import. This creates an imbalance in the trade balance due to exports that increase more than imports. The next variation will be the rising inflation.
As we have read above, if you change interest rates flatly, inflation will undergo that change or it will be a forerunner.
In the macroeconomic environment, it happens that the higher the inflation the lower the unemployment rate. A reduction of this rate reduces also the production growth, which in turn raises the interest rate. From here you go back to what is described in the previous point.
Gross domestic product indicates the state of health of an economy: if the real situation of the economy rises positively, it leads to a strengthening of the currency while vice versa it weakens.
When the indicator exceeds 50 points it means it could happen an expansive phase for that currency, when the indicator is below 50 points then there could be a depreciation of that currency.
The GDP to be considered is both the estimated (unofficial) and the official one, as the second usually confirms the predictions or estimates of the second.
Other factors, such as employment, new orders, inventory, production, and more, depend on this indicator.
For all market movers such as the unemployment rate or inflation, we need to consider also the “psychological” factor dictated by expectations: if expectations of a given data are respected, the currency tends to strengthen.
Expectations are directly linked to what is the most influential factor on the market: speculation.
Speculating simply means doing several transactions without any real currency need. So, a trader opens a position to use the market movement to earn.
Speculators cover about 50% of the total volume of exchanges that are made on Forex daily.
That being said, it is intuitive that if most of the speculators are buying a given currency, you will (probably) appreciate that currency and its value will increase.
On the positive side, speculation has a strong influence on currency developments only in the short time.