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2020 was a year in which the US dollar became something of the world’s punching bag – it benefited from a flight-to-safety early in the year (which drove it to a three-and-a-half year high in March as the coronavirus pandemic spread to the US) but later slumped rapidly to a two-year low. When looking at the causes of this type of volatility in the forex market, it’s important to know which economic indicators to look out for. Most financial advisors agree with forex trading platform AvaTrade that a currency may enjoy strength or experience weakness depending on the underlying country’s interest rates, employment, trade, and other economic factors such as whether the country is influenced by the prices of commodities or not. Here are the most important indicators to bear in mind:
🏦 Interest rates and the reserve bank
Interest rates play an important role for day traders. In fact, they are the biggest factor influencing the foreign-exchange market because they are an indication of the state of affairs of a country and they are calculated by examining the consumer price index, consumer spending, employment levels and various other factors.
One way to predict interest rate movements is by watching the reserve banks (central banks) of major currency pair countries. There are eight major currency pairs around the world and they all include the US dollar. Major announcements from the governors or leaders of these reserve banks have an impact on the value of the currencies of these countries.
The South African Reserve Bank’s Monetary Policy Committee (MPC) for example, meets six times a year to set the repo rate by assessing a number of statistical measures, the most important being inflation. The ideal inflation range is between 3% to 6% and the aim of the MPC is always to protect the value of the rand. But a trader must always be ahead of the decision. As Standard Bank FX’s Tom Anderson says, “Efficient market hypothesis dictates that most ‘news’ is already in the price.” Anderson advises understanding exports and imports, current account movements, growth, and real rates.
The tone of the MPC’s decision is set by the Reserve Bank Monetary Policy Review. It is a six-monthly publication and draws attention to what the governor and the MPC use as factors that influence their decision-making process. It is important to remember that their job is to protect the value of the currency. Factors highlighted by the MPR can thus be viewed as influential in the value of the currency.
Before the actual MPC announcement however, traders can also analyse forecasts of what the decision will be. All major banks in South Africa release their predictions ahead of time, including Standard Bank.
Based on this, a trader will then be able to predict whether there will be an interest rate hike or cut. A hike will result in the appreciation of the currency and a cut will result in depreciation.
However, watching the major reserve bank’s around the world is not enough. Being able to read economic data and predicting how that will influence interest rates is also important.
🛒 The CPI
The consumer price index (CPI) is an indication of how much consumers need to spend for the same basket of goods and services year on year and is used as a measure of inflation. Higher inflation may result in a rise in interest rates as the reserve bank tries to stabilise prices.
In South Africa’s case, the CPI is monitored, and that figure is released by Stats SA. It is important to keep an eye on the CPI as it has a major influence on the repo rate decision by the Reserve Bank – which ultimately influences currency value.
💸 A country’s current account movements
As noted by Anderson, current account movements also influence the value of a currency. If an economy has a current account deficit, it means there are more imports coming into the country than there are exports being sold internationally by the country. Because businesses and individuals buy from other countries using their own currency, this leads to an increase in supply and a potential surplus of their currency in the market, which can then depreciate the value of that currency, as supply can either exceed demand or is edging closer to it. Currently, the United States of America has the world’s largest current account deficit and Germany has the largest surplus.
As noted by Anderson, current account movements also influence the value of a currency. If an economy has a current account deficit, it means there are more imports coming into the country than there are exports being sold internationally by the country. Because businesses and individuals buy from other countries using their own currency, this leads to an increase in supply and a potential surplus of their currency in the market, which can then depreciate the value of that currency as supply can either exceed demand or is edging closer to it. Currently, the United States of America has the world’s largest current account deficit and Germany has the largest surplus.
👨💻 Unemployment rates
A high unemployment rate may be an indication of weak economic activity, low domestic investing and an economy that’s unattractive to foreign investors. However, for traders this is not necessarily a bad omen according to Anderson. “It completely depends on one’s position,” he says. He further explains that when a trader is long equities/EM FX and an unforeseen negative piece of data emerges, that trader will lose money. However, the same piece of data will result in gains for a trader who is into long cash such as the US dollar, gold and US10yr bonds.
⚠️ And those unexpected curveballs…
Traders must also be aware of the unexpected. To drive home Anderson’s point, Refinitiv, a global provider of market insight and data, recently held a webinar on the impact of Covid-19 on foreign exchange markets and how it cannot be underestimated. It was determined that Covid-19 will continue to have a profound impact on the demand of the US dollar. For example, in the US (as in much of the world), unemployment levels have risen, which has caused demand for the dollar increase as investors seek a safe-haven currency. Wilson Leung, chief market strategist at currency trading advisory firm Trendsetter found that this demand was driven by short-term emotional gauges, which do not factor in the long-term effects of mass unemployment and vast government borrowing.
When it comes to buying, sending and storing global currencies, timing is everything. Whether investing in forex, sending money to family overseas or buying rands with the forex you own, you want to act when the exchange rate is in your favour. The Shyft app is designed as a one-stop-shop where you can follow the latest exchange rates and buy forex at the touch of a screen whenever the rate is advantageous.