Attempting to predict the markets is possibly one of the most ‘hit and miss’ professions there is. Analysts, commentators, economists and futurists all have a 50/50 chance of being on the money when it comes to calling the ups and downs of ticks and pips. Perhaps the most spectacular surprise of 2016 was Donald Trump’s victory in the US presidential election and the fact that the markets rallied despite predictions. If pundits were willing to wager their homes on Trump losing, they would have bet their entire estates on the markets falling. Subsequently, much of the investment fraternity would have been left without homes.
Presidents and government officials come and go and, while their exits are mostly predictable, elections and oustings of key government officials are sure to play a huge role in the direction of markets and exchange rates.
Jameel Ahmad, VP of Corporate Development & Market Research of ForexTime, an award winning brokerage firm says: “A changing of the guard, or major shifts in government policy, shines the spotlight on stock and bond movements. Even a relatively small change in exchange rates can have a massive impact on a country. An exchange rate is one of the most important indicators when determining a country’s economic health. It provides a portal through which its economic stability can be viewed.”
The ins and outs of currency movements
“There are many factors that contribute to the stability of a currency. Understanding them can assist those who are vulnerable to fluctuations. Business owners and pensioners in particular, feel the impact of sustained currency movements, but it is governments that are the biggest losers when their currency takes a hit – it’s bad for the economy and bad for electoral support,” Ahmad continues.
Inflation also plays a significant role in exchange rates. A country with a consistently low inflation rate generally experiences a rise in currency value, while a country with higher inflation typically sees depreciation in its currency, which in turn can increase interest rates.
If a country has a rising currency, it makes its products more expensive for foreign buyers. This is bad news for exporters and can be especially worrying if the country’s GDP is heavily dependent on exports. On the flip side, if a country depends heavily on imports and its currency drops against major currencies, everything becomes more expensive and this in turn pushes up inflation.
Foreign exchange rates (forex), interest rates and inflation are inextricably linked. A country with a higher interest rate may experience currency appreciation, since higher interest rates provide better returns to lenders and attract more foreign capital. In a country with lots of foreign investment, the exchange rate may also be stronger. However, this is not always the case, higher interest rates often curb inflation and these two factors can signify underlying negative economic issues, such as poor growth or political instability.
Trade
Another influencer of currency values is a country’s balance of payments: think of this as its current account. The balance of payments reflects the earnings on foreign investment and outgoing payments. If it imports more goods and services than it exports, it has a trade deficit. If it exports more goods and services than it imports, it has a trade surplus.
Imports, foreign aid, domestic and investment spending abroad all deplete the trade account. Credit figures include exports, foreign spending in the domestic economy, and foreign investments in the domestic economy. To calculate a country’s trade balance, you subtract the credit items from the debit items.
A trade surplus or deficit does not dictate the health of a country, which must also take into account other indicators and business cycles. A deficit in the current account, caused by overspending on imports or a decline in the sale of exports, can cause depreciation of a currency. Feeding into this currency influencer is government debt. A government that is heavily reliant on foreign capital to fund operations leaves its country extremely vulnerable to currency fluctuations.
Politics and foreign investment
We know politics and economic stability play a significant role in currency values. A country that has stable leadership and support from its citizens and a sound economic policy captures the attention and confidence of foreign investors. Countries with unconvincing leadership and a troubled economic outlook do not attract investors and their currencies are generally weaker than their more stable counterparts.
According to Ahmad: “The wild card in the equation, is speculation. If a country’s currency value is expected to rise, investors will be buying the currency for profit; this pushes up demand and the price. All of these factors determine foreign exchange rate fluctuations.”
Speculation by traders used to be the domain of financial institutions, but it is now accessible to individuals. Institutional markets react strongly to the effects of announcements and do not always base their judgements on their available technical data. The result is that fluctuations can occur for no other reason than fear, nervousness, hope or optimism. So, while Presidential elections catch the attention of the markets, a whole host of other factors combine to determine the direction of currencies.
The jury is still out on whether speculation is a good or bad thing for currencies. Regardless of the pros and cons, the uptake and interest of investors in the practise of currency trading has helped regulation and control of the monetary policies practised by governments and it has also improved transparency.
Currencies are an exciting investment option for people with a penchant for current affairs. However, the key to successful trading – and indeed any kind of short term investing – is education. An informed investor who uses both fundamental and technical data to determine trades has a good chance of being on the right side of the momentum. “Education is the key differentiator between successful and unsuccessful traders. This is why FXTM has invested so much of their resources into developing tools and tutorials that assist traders to become professionals,” Ahmad believes.
Data and software can be used to predict how a currency is likely to react but, the truth is, unpredictable events will always derail or delight investors. It’s not just big corporations who can cash in on these market fluctuations. Traders big and small can try their hand under the guidance of experienced brokers like FXTM. Investors who don’t want to jump in the deep end can trade on demo accounts.
Currency trading can be an interesting addition to an investment portfolio as long as you take the time to educate yourself, stay informed on current affairs and keep a level head.
Further information
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The content in this article comprises personal opinions and ideas and should not be construed as containing personal or investment advice. Trading Forex and CFDs involves significant risk. Please read FXTM’s full Risk Disclosure.
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