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International Trade

Another key factor is balance of trade levels and trends between nations. The trade levels between nations serve as a proxy for the relative demand of goods from a nation. A nation with goods or services that are in high demand internationally will typically see an appreciation of its currency. For example, in order to purchase goods from Australia, buyers must convert their currency into Australian dollars (AUD) to make the purchase. The increased demand for the AUD will put upward pressure on it.

Trade surpluses and deficits exemplify a nation's competitive standing in international trade. Countries with a large trade deficit are net buyers/importers of international goods, resulting in more of their currency being sold to purchase other nations' currencies in order to pay for the international goods. This type of situation is likely to have a negative impact on the value of an importing country's currency.




Political ConditionsThe political landscape of a nation plays a major role in the economic outlook for that country and, consequently, the perceived value of its currency. Forex traders are constantly monitoring political news and events to gauge what moves, if any, a country's government may take in the economy. These can include measures from increasing government spending to tightening restrictions on a particular sector or industry.

An upcoming election is always a major event for currency markets, as exchange rates will often react more favorably to parties with fiscally responsible platforms and governments willing to pursue economic growth. A good example is the Brexit vote, which had a major impact on the British pound (GBP) when the UK voted to leave the EU.The currency reached its lowest levels since 1985 after the vote because the UK's economical prospects were suddenly highly uncertain.

The fiscal and monetary policies of any government are the most important factors in its economic decision making. Central bank decisions that impact interest rates are keenly watched by the forex market for any changes in key rates or future outlooks. (For a closer look into monetary policy, see How The U.S. Government Formulates Monetary Policy.)




Economic ReleasesEconomic reports are the backbone of a forex trader's playbook. Maintaining an economic report calendar is crucial to staying current in this ultra-fast paced marketplace. GDP may be the most obvious economic report, as it is the baseline of a country's economic performance and strength. GDP measures the total output of goods and services produced within an economy. One key thing to remember, however, is that GDP is a lagging indicator, meaning that it reports on events and trends that have already occurred.

Inflation is also a very important indicator as it sends a signal of increasing price levels and falling purchasing power. However, inflation is a double-edged sword, as many view it as placing downward pressure on a currency due to retreating purchasing power. On the other hand, it can also lead to currency appreciation as it may force central bankers to increase rates in order to curb rising inflation levels. Inflation is a hotly contested issue amongst economists and its effects on currencies is never black or white.

Other reports such as employment levels, retail sales, manufacturing indexes and capacity utilization also carry important information on the current and forecasted strength of an economy and its currency.




Bottom LineThe forex market is ultimately driven by economic factors that, in turn, are indicators of a country's economic strength. The economic outlook for a country is the most important determinant of its currency's value, so knowing the factors and indicators to watch will help you keep pace in the competitive and fast-moving world of forex. 

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