What Moves the
Foreign Exchange Market?
The primary factors
influencing exchange rates include the balance of payments, the state of
the economy, implications drawn from chart analysis as well as political
and psychological factors.
Ebb and flow of capital
between nations, otherwise known as Purchasing Power Parity (PPP) is the
central factor that determines market momentum. In addition, fundamental
economic forces such as inflation and interest rates are constantly
influencing currency prices. Faith in a government's ability to stand
behind its currency will also impact currency price. This is done in two
ways: controls and intervention. Controls restrict citizens from doing
things, which have a negative effect on the exchange rate (such as
sending money abroad). Intervention takes two forms: changing the
interest rate on the currency to make it more or less attractive to
foreigners, or buying/selling the currency to raise or lower its market
Any of these broad-based
economic conditions can cause a sudden and dramatic currency price swing
if such conditions are seen to be changing. This is a key concept
because what drives the currency market in many cases is the
anticipation of an economic condition rather than the condition itself.
Activities by professional
currency managers, generally on behalf of a pool of funds, have also
become a factor moving the market. While professional managers may
behave independently and view the market from a unique perspective,
most, if not all, are at least aware of important technical chart points
in each major currency. As major support or resistance levels approach,
the behavior of the market becomes more technically oriented and the
reactions of many managers are often predictable and similar. These
market periods may result in sudden and dramatic price swings as
substantial amounts of capital are invested in similar positions.