Forex traders need to understand the fundamental economic drivers that affect price fluctuations for the specific currencies they are trading. The most heavily traded currency is the U.S. dollar which means all financial traders should be aware of what drives this currency’s prices. Some of the most important economic factors include interest rate expectations, U.S. trade balance, strength of the American economy, global events and the U.S. dollar’s reserve currency status.
Interest Rate Expectations
Currency market participants who trade the U.S. dollar pay close attention to the U.S. Federal Reserve in order to attempt to predict when the Fed will raise or cut interest rates. Raising interest rates is considered bullish while cutting rates is considered bearish.
U.S. Trade Balance
When U.S. companies export their products or services to customers in foreign countries, the buyers need to exchange their home country’s currency to U.S. dollars. Essentially, the customer is selling their home country’s currency and then buying U.S. dollars, therefore increasing the demand for the U.S. dollar which provides upward pressure for the American currency’s price. This is why traders pay close attention to U.S. trade balance data. A trade surplus is bullish for the U.S. dollar while a deficit is bearish.
Strength of the U.S. Economy
Forex traders keep tabs on the strength of the U.S. economy for a variety of reasons. One reason is that they know when the American economy is healthy foreign investors become more interested in investing in American companies and other U.S. dollar-denominated assets. In order to do this investors need to obtain U.S. dollars by exchanging their home country’s currency.
Global Events and Turmoil
Price movements in the U.S. dollar has historically been correlated with global events and international turmoil. The currency has tended to strengthen during periods of global chaos. This could be caused by political instability, war or global economic stability. On the other hand, during times of sanguine global conditions investors tend to diversify their portfolios away from the U.S. dollar. Therefore, the U.S. dollar can sometimes act as a sort of safe-haven currency. However, this is a highly simplistic view without taking into consideration various other factors as well as changing market correlations.
Reserve Currency Status
The U.S. dollar has generally been considered the world’s reserve currency, acting as the standard currency for many types of international transactions. For instance, international oil trade is denominated in U.S. dollars. However, when other currencies begin to become more popular as alternative reserve currencies, this can weaken the demand for the U.S. dollar.
On the other hand, economic fundamentals may not always be the driver of a current trend in the U.S. dollar. This is especially true for shorter time frames. Market sentiment as well as technical factors many times come into play and override fundamental economic factors for a period of time.
Le Bach Pham has been writing professionally after receiving his Bachelor’s of Art in English Literature from the University of California, San Diego in 2002. He now specializes in writing about legal, business and financial topics. Pham also earned a Paralegal Certificate from the University of San Diego and has experience working in the legal field. He also has experience in writing business plans for clients from various fields, including banking, finance, retail, education, beauty and various other sectors.