If you’re a Forex trader from your living room in France or Italy, it can be difficult to understand how a political or economic event in a faraway country like China can affect the value of the currencies you’re trading.
Economic forces have always had an impact on currency exchange values. In this blog we connect the dots between monetary policy, politics, the wider economy and globalisation.
Let’s start with your home country.
Hypothetically, you’re trading Euros against Dollars from France, which has the eighth largest manufacturing sector in the world. Monetary policy makers in France need to make sure that French goods are competitively priced for export, so it’s in their interest to keep the Euro at a level where it is liquid against other currencies.
Negative interest rates in Europe are a symbolic indicator of the value of the currency, they mean that policy makers want to keep the Euro devalued relative to other currencies, particularly the USD.
In this scenario, as a French Forex trader, you expect that the Euro will maintain a floating rate that’s close to par with the USD.
Now, switch focus to the gigantic US economy which has ample domestic markets to absorb goods and services. If you’re a trader in the US, by now you’re used to a strong USD. Policy makers may prefer the USD to be strong because it increases purchasing power for importers. A strong currency keeps trade ‘in the family’ as it were, meaning it encourages manufacturers to focus on internal markets.
In the case of a huge market like the US or China, this may work in the short term because there are enough consumers to absorb production of goods and services.
Whenever a Forex trader places a trade on a currency pair, he or she is actually placing odds on a complex equation of monetary policy, economic development and political events.
Essentially, globalisation of trade and currencies means that Forex traders can take advantage of unexpected opportunities or be taken by surprise when things go sideways.
Examples of this could be the Venezuelan Bolivar, which is next to worthless after a series of political upheavals and devaluations. If you live in Venezuela, the USD is the currency of most value, reflecting another feature of globalisation – dollarisation.
In the final analysis, no matter which currency you’re trading, it’s well worth researching the originating country’s monetary policy, political stability and foreign exchange policy before taking a position.
One of the key questions to ask is whether the exchange rate is fixed or floating.
A fixed rate would mean that policy makers want a stable, predictable price regime and are focused on the domestic market rather than export markets. A floating rate would indicate that policy makers want the currency to be liquid or exchangeable according to market forces. It could also imply that policy makers are sitting on enough foreign currency to balance out any adverse economic or political events. In short, globalisation and Forex are closely linked in a financial marriage for better or worse.