Factors Influencing Foreign Exchange Market

12 Key excerpts on "Factors Influencing Foreign Exchange Market"

• 

  eBook - ePub

  FX Trading

  A Guide to Trading Foreign Exchange

  • Alex Douglas, Larry Lovrencic, Peter Pontikis(Authors)
  • 2011(Publication Date)
  • Wiley

    (Publisher)

  Chapter 7: Factors influencing FX markets

  Over the longer term, it is undeniable that underlying economic fundamentals will drive the currency markets in one direction or the other. In the shorter term, however, elements of fear, greed and herd behaviour drive the foreign exchange markets. This herd mentality can be reflected in short-term movements that are often a reaction to market rumours, or might evolve as a longer term phenomenon because traders are paying undue attention to one area of market influence while virtually ignoring another. We saw this in the late 1990s, when the United States and the USD became the ‘flavour of the month’ among global investors, despite the everpresent trade deficit.

  Many factors in each country can and do affect the economy of that country and the value of its currency. To make matters worse, it is the interrelationship between these factors that drives the markets. This is complex enough when just looking at one country, but in the currency markets we are looking at how all of these factors interrelate, not just within the borders of each country, but how they interrelate across borders around the world. This makes it extremely difficult to accurately pinpoint exactly which factor is responsible for any particular movement in a market. This is the challenge for the FX trader.

  Nonetheless, it is worth having a broad understanding of the theoretical way in which various fundamental and economic factors are generally seen to affect the foreign exchange market, and this is what we examine in this chapter.

  Supply and demand

  Prices (or exchange rates) are ultimately determined by the relative influence of the forces of supply and demand. If there is very high demand for a particular currency, its value would be expected to increase in relation to currencies that there is less demand for. On the other hand, if there is a desire among holders of a particular currency to dispose of that currency in exchange for another, its value is likely to decline in relation to other currencies.

  Sign up to read

  Learn more about book
• 

  eBook - PDF

  Microeconomics

  A Contemporary Introduction

  • William A. McEachern(Author)
  • 2016(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Chapter 20 International Finance 459 20-3 Other Factors Influencing Foreign Exchange Markets So far, the market for foreign exchange has been presented just like any other market: Demand and supply come together to determine the equilibrium exchange rate, or price of foreign exchange. Simple enough, but the market for foreign exchange is complicated by the types of actors in this market and by the types of regulations and restrictions involved. In this section, we look at how these other factors shape this market. 20-3a Arbitrageurs and Speculators Exchange rates between two currencies are nearly identical at any given time in markets around the world. For example, the dollar price of a euro is usually the same in New York, Frankfurt, Tokyo, London, Zurich, Hong Kong, Istanbul, and other financial centers. Arbitrageurs —dealers who take advantage of tiny differences in exchange rates across markets by buying low and selling high—ensure this equality. For example, if one euro costs $1.09 in New York but $1.10 in Frankfurt, an arbitrageur could buy, say, $1,000,000 worth of euros in New York and at the same time sell them in Frankfurt for $1,009,174, thereby earning $9,174 minus the transaction costs of the trades. Because an arbitrageur buys and sells simultaneously, little risk is involved. In our example, the arbitrageur increased the demand for euros in New York and increased the supply of euros in Frankfurt. These actions increased the dollar price of euros in New York and decreased it in Frankfurt, thereby squeezing down the difference in exchange rates.

  Sign up to read

  Learn more about book
• 

  eBook - PDF

  International Trade and Agriculture

  Theories and Practices

  • Won W. Koo, P. Lynn Kennedy(Authors)
  • 2008(Publication Date)
  • Wiley-Blackwell

    (Publisher)

  As a result, nations have come to the realization that changes in both domestic macroeconomic and trade policies impact the world market. While these policy impacts play a significant role in the trade and welfare of countries, there are other factors at work. The exchange rate is one of these factors. Changes in the currency exchange rate, or the value of a country’s domestic cur- rency in terms of foreign currency, have an immediate impact on the amount of foreign currency that an exporter is willing to receive for its product or that an importer is willing to spend for merchandise. As a result, the impact of changes in domestic and foreign policies can be either compounded or negated by currency exchange rate fluctuations. BOX 13.1 AGRICULTURAL TRADE AND THE EXCHANGE RATE US agriculture is highly dependent on the exchange rate. The primary factors determining demand for US agricultural exports are the exchange rate and income in major foreign markets. As agricultural exporters compete to gain access to foreign markets, their competitiveness is determined by the exchange rate, because foreign income affects all exporters. In other words, competition in a foreign market depends on domestic import prices measured in local currencies. Export competitiveness depends on exchange rates between importers and exporters. Exchange rates affect trade by determining the relationship between interna- tional and domestic prices. Changes in the real exchange rate result in the raising or lowering of prices of US goods in local currency around the world. As detailed previously, an appreciation of the dollar raises the price of US goods on the international market, while a depreciation lowers prices. These movements in the exchange rate are particularly important for the agricultural sector in coun- tries such as the USA, where a major portion of agricultural production is exported.

  Sign up to read

  Learn more about book
• 

  eBook - PDF

  Macroeconomics for Managers

  • Michael K. Evans(Author)
  • 2008(Publication Date)
  • Wiley-Blackwell

    (Publisher)

  One reason is the tendency of many countries to try and ‘‘manage’’ their currencies. From time to time, even the US manipulated the value of the dollar, although it intervenes in foreign exchange markets much less often than other countries, and generally does so only to insure orderly markets, not to try to determine the value of the currency. The only major exception to this rule was the Plaza Accord, reached on September 22, 1985, when all of the G-7 countries agreed to reduce the value of the dollar. In the remainder of this section we consider the economic factors that determine short-term fluctuations in foreign exchange rates, while realizing that rates may deviate from these values for substantial periods of time for political reasons as various central banks attempt to hold the value of their currencies constant. By the same token, though, the longer this practice continues, the more likely that the currency will face a major devaluation when the logjam finally breaks. Even if we focus only on the equilibrium determinants of foreign exchange rates, it is still important to differentiate between the dollar and all other currencies, given that the world is on a de facto dollar standard. In the case of the dollar, the key determinant of the currency is the gap between ex ante investment and ex ante domestic saving. When ex ante investment is stronger than saving, for- eign funds will tend to flow into the US economy, hence boosting the value of the dollar; when ex ante investment is weaker than saving, funds will tend to flow out, hence reducing the value of the dollar. The mechanics of these flows are dis- cussed in more detail in the next chapter, where the Mundell-Fleming model is presented. From the manager’s viewpoint of explaining what determines foreign exchange rates, it may be well to state our objectives here.

  Sign up to read

  Learn more about book
• 

  eBook - PDF

  Money, Markets, and Democracy

  Politically Skewed Financial Markets and How to Fix Them

  • George Bragues(Author)
  • 2016(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  Louis Fed; calculations based on Fed trade weighted US dollar index—Major Currencies *Obama administration evaluated as of November 20, 2015; Total Democratic and Republican percent- ages do not add up to the Total figure from 1977 to 2015 because those percentages are calculated from different bases THE CURRENCY MARKETS 247 POLITICIZING TRADE AND BRETTON WOODS II Let us now step back for a moment and reminisce about the more placid days when the euro’s existential crisis was not regularly in the headlines. Back then, a publicly-minded citizen of an advanced liberal democracy would most likely hear about their own currency in relation to interna- tional trade. He or she might watch a news report featuring a politician complaining that the prevailing exchange rate is harming the nation’s export competitiveness. They might read a newspaper article quoting a group of CEOs alleging that recent strength in the currency is allowing imports to decimate local industries. Or, they might listen to an oppo- nent of the sitting government argue that its current approach to the FX rate is responsible for chronic trade imbalances and impending balance of payments difficulties that calls the present level of the currency into ques- tion. Implicit in these statements is the notion that currency prices help determine the quantity of exports and imports along with the proportion between these two variables. Implicit in those statements, too, is the claim that the FX rate impacts how trade with the rest of the world is financed. Such assertions as can be gleaned from everyday political life are correct for the most part. Still, they are in need of elaboration, refining, and some emendation. To begin with, the currency market does not so much cause exports and import activity as it does facilitate it. By making it possible for national currencies to be converted into one another, the FX market enables firms and individuals to export and import goods with confidence.

  Sign up to read

  Learn more about book
• 

  eBook - PDF

  Money, Banking, Financial Markets and Institutions

  • Michael Brandl(Author)
  • 2016(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  © The Financial Times Limited 2014. This article touches on a number of things that can affect the value of a currency in the foreign exchange market: economic growth performance, international trade levels, labor market behavior, and monetary policy. The author of the article implies that of these, monetary policy changes are the most important. Do you agree? Would your view be different if this was for the United States instead of Australia? Why or why not? 19-5 Copyright 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Copyright 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.

  Sign up to read

  Learn more about book
• 

  eBook - PDF

  The Political Economy of Chinese Finance

  • J. Jay Choi, Michael R. Powers, Xiaotian Tina Zhang(Authors)
  • 2016(Publication Date)
  • Emerald Group Publishing Limited

    (Publisher)

  Third and more importantly, the Chinese government faced huge pressures from major Western countries, global financial governance institutions and even international academia, as mentioned before. The 2005 US Treasury Department Report on International Exchange Rate Policies asserted that Chinese exchange rate policies ‘are highly distortionary and pose a risk to China’s economy, its trading partners, and global economic growth’, and, without substantial alteration, ‘China’s policies will likely meet the statute’s (Omnibus Trade and Competitiveness Act of 1988) technical requirements for designation’. In the 2003, 2004 and 2005 IMF China Article IV Consultation , the Fund continuously expressed its desirability for a more flex-ible Chinese exchange rate. In addition, many scholars from central banks, research institutes and academia, including but never limited to Eichengreen (2004) , Bernanke (2005) and Frankel (2005) , enunciated their views on China’s exchange rate policy, most of which concur with the US govern-ment’s view ( Laurenceson & Qin, 2006 ). Although these international factors influenced China’s decision to reform its exchange rate regime to some extent, according China’s exchange rate reform to these factors, especially interna-tional pressures, is simplistic and misleading ( Goujon & Gue´ rineau, 2005 ). Domestic factors, as governor of the PBC Zhou Xiaochuan remarked, are key factors in making China’s currency policy ( Xinhua, 2010 ). The domestic environment is the principal determining factor of China’s national interests or Guojia Liyi that guided China’s exchange rate reform 348 FALIN ZHANG particularly from 2005 onward. On the one hand, as Broz and Frieden (2008, p. 591) observed, national states’ cooperation and coordination in international monetary system ‘rest on the foundation of national currency policies’, which ‘involve trade-offs with domestic distributional implication’ and ‘electoral implication’.

  Sign up to read

  Learn more about book
• 

  eBook - PDF

  Global Marketing Management

  • Masaaki (Mike) Kotabe, Kristiaan Helsen(Authors)
  • 2020(Publication Date)
  • Wiley

    (Publisher)

  However, if the domestic economic growth attracts a large amount of investment from abroad, it could offset the negative trade effect, thus potentially resulting in appreciation of the domestic currency. 5. Government Spending: An increase in government spending, particularly if financed through deficit spending, causes increased inflationary pressures on the economy. Inflation leads to domestic currency depreciation (as in point 1). 6. Money Supply Growth: Many countries’ central banks attempt to stave off recession by increasing the money supply to lower domestic interest rates for increased consumption and investment. An increase in money supply usually leads to higher inflation rates and subsequently currency depreciation. 7. Interest Rate Policy: As in point 6, the central bank may also control its discount rate (interest rate charged to banks) to raise domestic lending rates so as to control inflation. Higher interest rates discourage economic activity and tend to reduce inflation and also attract investment from abroad. Reduced inflation and increased investment from abroad both lead to currency appreciation. Political Factors 1. Exchange Rate Control: Some governments have an explicit control on the exchange rate. The official rate for domestic currency is artificially overvalued, thereby discouraging foreign com- panies from exporting to such a country. However, as long as there is a genuine domestic demand for imported products, the black market tends to appear for foreign currency. Black market exchange rates for a domestic currency tend to be much lower than the government‐imposed artificial rate. Thus, a wide spread between the official exchange rate and the black market rate indicates potential pressures leading to domestic currency devaluation. 2. Election Year or Leadership Change: Expectations about imminent government policy change influence exchange rates.

  Sign up to read

  Learn more about book
• 

  eBook - PDF

  Macroeconomics

  A Contemporary Introduction

  • William A. McEachern(Author)
  • 2016(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  2. Foreign exchange pays for transactions across international borders. In the absence of government intervention, the demand and supply of foreign exchange determines the market exchange rate. According to the theory of purchasing power parity (PPP), the exchange rate between two countries will adjust in the long run to equalize the cost of a basket of internationally traded goods. 3. Under a system of flexible, or floating, exchange rates, the value of the dollar relative to foreign exchange varies with market forces. An increase in the demand for foreign exchange or a decrease in its supply, other things constant, increases the value of foreign exchange relative to the dollar, which is a deprecia- tion of the dollar. Conversely, a decrease in the demand for for- eign exchange or an increase in its supply, other things constant, decreases the value of foreign exchange relative to the dollar, which is an appreciation of the dollar. 4. Under a system of fixed exchange rates, monetary authorities try to stabilize the exchange rate, keeping it between a specified ceiling and floor value. A country may try to hold down the value of its currency, so that exports will be cheaper to foreign- ers and imports will cost more to domestic consumers. One ob- jective here is to increase domestic production and employment. 5. For much of the twentieth century, the international monetary system was based on fixed exchange rates. A managed float sys- tem has been in effect for the major currencies since the demise of the Bretton Woods system in the early 1970s. Although central banks often try to stabilize exchange rates, fluctuations in rates persist. These fluctuations usually reflect market forces, but they still raise the transaction costs of international trade and finance.

  Sign up to read

  Learn more about book
• 

  eBook - PDF

  Global Marketing Management

  • Masaaki (Mike) Kotabe, Kristiaan Helsen(Authors)
  • 2022(Publication Date)
  • Wiley

    (Publisher)

  However, if the domestic economic growth attracts a large amount of investment from abroad, it could offset the negative trade effect, thus potentially result- ing in appreciation of the domestic currency. 5. Government Spending: An increase in government spending, particularly if financed through deficit spending, causes increased inflationary pressures on the economy. Inflation leads to domestic currency depreciation (as in 1). 6. Money Supply Growth: Many countries’ central banks attempt to stave off recession by increasing the money supply to lower domestic interest rates for increased consumption and investment. An increase in money supply usually leads to higher inflation rates and subsequently currency depreciation. 7. Interest Rate Policy: As in 6, the central bank may also control its discount rate (interest rate charged to banks) to raise domestic lending rates so as to control inflation. Higher interest rates discourage economic activity and tend to reduce inflation and also attract investment from abroad. Reduced inflation and increased investment from abroad both lead to currency appreciation. Political Factors 1. Exchange Rate Control: Some governments have an explicit control on the exchange rate. The official rate for domestic currency is artificially overvalued, thereby discouraging foreign com- panies from exporting to such a country. However, as long as there is a genuine domestic demand for imported products, the black market tends to appear for foreign currency. Black market exchange rates for a domestic currency tend to be much lower than the government-imposed artificial rate. Thus, a wide spread between the official exchange rate and the black market rate indicates potential pressures leading to domestic currency devaluation. 2. Election Year or Leadership Change: Expectations about imminent government policy change influence exchange rates.

  Sign up to read

  Learn more about book
• 

  eBook - PDF

  International Economics

  Global Markets and International Competition

  • Henry Thompson(Author)
  • 2000(Publication Date)
  • WSPC

    (Publisher)

  Jacob Frankel (IMF) thinks better fiscal and monetary policy should be the focus. While these experts differ, they all recognize die power of the foreign exchange market and its ultimate governing effect. Foreign exchange intervention means little unless the fundamental policies of a balanced budget and steady monetary growth are met. Foreign exchange markets have grown and matured over the past 30 years and now link all economies into a functioning system of trade and investment. No system of fixed exchange rates could last, and government foreign exchange intervention cannot have much lasting influence. Fixed versus Floating Exchange Rates Governments may have learned that it is impossible to indefinitely sustain a currency value far out of line with its underlying market rate. Some economists, however, believe that central bank control is desirable to ensure an orderly foreign exchange market. The typical argument is that speculators feed on instability and want to create wild exchange rate movements. Speculators are pictured as scoundrels bent on profit causing the collapse of innocent currency values. Most often, however, speculative attacks occur on fixed or managed currencies out of line with market prices. The real experts are the banks, dealers, traders, and speculators who make their living working in the FX market. Central bank intervention destabilizes exchange rates and changes market expectations. There are good reasons that governments should not try to direcdy influence the foreign exchange value of their currencies. The goal of monetary policy should be zero inflation. A prime historical example is the Mexican peso, whose value has typically been kept above its market level. Unquestionably, Mexican central bank support will ultimately collapse and a sharp depreciation of die peso will occur. The only question is when. Traders all sell the peso short. Episodes of support and sudden depreciation repeat themselves over and over again.

  Sign up to read

  Learn more about book
• 

  eBook - PDF

  Economics for Investment Decision Makers

  Micro, Macro, and International Economics

  • Christopher D. Piros, Jerald E. Pinto(Authors)
  • 2013(Publication Date)
  • Wiley

    (Publisher)

  In each case, the sudden unwinding of those leveraged long speculative positions triggered the attacks on the currencies. Surges in capital inflows often are driven by a combination of pull and push factors, with both factors capable of generating bubblelike conditions. Pull factors represent a favorable set of developments that encourage overseas capital to flow toward a particular country. These factors include:  Better economic management by policy makers.  Expected declines in inflation and inflation volatility.  More flexible exchange rate regimes.  Improved current account balances.  Declines in public-sector and private-sector debt burdens.  A significant buildup in FX reserves, which can be used as a buffer against future speculative attacks.  Privatization of state-owned entities.  Liberalization of financial markets.  Lifting of foreign exchange regulations and controls.  Strong and sustained economic growth, which works to enhance the expected long-run return on real and financial assets.  Improved fiscal positions.  Sovereign ratings upgrades. Push factors represent a favorable set of factors that emanate not from the recipient country per se but rather from the primary sources of internationally mobile capital, notably the investor base in industrial countries. The pursuit of low interest rate policies in industrial countries has often encouraged investors in those markets to move funds offshore to earn higher returns than can be earned domestically. Japan’s ultralow interest rates encouraged investors to move funds into higher-yielding markets in Australia, New Zealand, and else- where in Asia. The pursuit of a low interest rate policy by the Federal Reserve encouraged U.S. investors to allocate more of their funds to emerging markets in the mid and late 2000s. Another important push factor is the long-run trend in asset allocation by industrial country investors.

  Sign up to read

  Learn more about book