Currencies can be defined by their effective market or trading conditions. Governed by macro economic factors, foreign exchange or currency can either take the form of floating or fixed (pegged). Economists have identified that each has distinctive characteristics, both positive and negative. It is important to understand the motive behind a country deciding on whether or not to float its currency or peg against another country or commodity. [Read more...]
The Relationship Between Commodities and Currencies
February 1, 2011 By Leave a Comment
The Commodity and Currency markets have long been correlated due to the risk complexities and yield dynamics of the global economy. Economists have focused on identifying the various factors that influence the currency markets, with gold and silver highlighted as key commodities. It is important to truly understand why currency prices move before gauging the relationship with commodities. [Read more...]
Reserve Currencies And Their Role
December 9, 2010 By Leave a Comment
Reserve currencies play a considerably important role in world trade and economics. Defined as the ‘pricing currency’ for international transactions, many governments carry reserve currencies to hedge their risk against adverse fluctuations. Historically the concept of a reserve currency grew out of the need to set a uniform standard for world trade after the Second World War. The dominance of the US during the Bretton Woods agreement led to the introduction of the greenback as the global reserve at the time. Identified as a trade standard due to its stability, the US dollar was key in providing liquidity into the marketplace. As part of the Bretton Woods agreement, countries were provided with an assurance that the US dollar could be valued at a fixed rate of Gold. Economists at the time viewed this as potentially risky, due to the instability of the World economy and the short term negative outlook on trade. In the 1970s, the fixed gold pricing system ended with the US government dissolving the agreement. [Read more...]
How Do Central Banks Add Liquidity
December 9, 2010 By Leave a Comment
The key determinant of a functioning economy is the level of liquidity and the accessibility of money flow in the system. Recent global economic events have highlighted the impact that lack of liquidity has had on lending and credit. To define the concept as a whole, one must look at the relevancy monetary supply has on the financial markets and how it can be controlled. Central Banks fall into this category as they are key players in determining the level of supply within a marketplace. Some of the effective strategies that Reserve Banks will utilise to induce or reduce money flow in the economy include: [Read more...]
Economics And The Forex Market
December 3, 2010 By Leave a Comment
The volatility in the Forex market in the last 12 months can be attributed to significant shifts in the economic landscape. Some of the major currencies that have experienced increased daily and weekly ranges have been subject to tighter monetary policies. Although fiscal policy and taxation reform have contributed to the volatility, traders have concentrated on the carry trade opportunities within the market place.
Forex is the largest financial market with almost 3.5 trillion traded on a daily basis. The key economic factors that have a consistent impact on the market include: Interest Rates, Inflation, Unemployment, Taxation, and Debt.
Interest Rates in the majority of cases account for a large percentage of directional change and volatility. Traders looking to expose themselves to overseas interest rates, will purchase one currency over the other to gain the interest rate differential. A classic example in recent times has been the AUDUSD. The AUD saw significant strength from 85 to 96 cents due to the high interest rate. As the Reserve Bank’s cash rate stood almost 4% higher than the Federal Reserve, many traders increased their risk appetite by holding AUD and selling USD. This lead to a significant appreciation in the AUD. Another important economic factor that has an impact on the forex market is unemployment. Economists highlight that unemployment will impact trader and investor sentiment and can cause significant volatility. Each month Non Farm Payroll figures report on changes in the labour sector and can be an effective barometer for the health of the economy.
Although interest rates and unemployment are the two key indicators in forex trading, fiscal policy and taxation reform are tracked very closely by the institutions and professional investors. The concept of tightening or increasing taxation on the whole economy can impact spending levels and interest rates. Recent developments in Australia with a proposed mining tax are being watched by economists closely, as this could impact the overall economic growth. The impact on consumer and investor sentiment could well weaken the AUD against the major currencies. Debt is also a major contributing factor to volatility in the forex markets. A perceived level of leverage can be indentified as dangerous. A good example of this is the Dubai Property market saga and recently Greece. Both economies had significant sovereign debt which could not be refinanced at an adequate level due to market conditions. Within the space of 2 months the base currencies in both locations weakened substantially. Talks of default within Europe were instrumental in the sudden and sharp fall in the EURUSD. When trading the forex market it is key to identify the important economic dynamics that affect each currency pair. Each pair reacts in a different manner and research is extremely important.
For more information online forex trading, please visit Vantage FX.
Spot FX vs Currency Futures
November 23, 2010 By Leave a Comment
Spot Foreign Exchange and Currency Futures are key financial products that are utilised by both retail and institutional traders. With the growth in the general currency markets, both products have been highlighted as instrumental in speculation and hedging. It is important to define the characteristics to truly grasp each product and its application.
Spot FX or Spot Foreign Exchange is defined as the purchase of one currency against another with a trade settlement of T+2. The Trade Day plus two days refers to all major currencies excluding the USD Canadian dollar cross. Currency Futures on the other hand focus on specifying a future delivery price for the currency cross based on a specified time frame. For example an importer who needs to cover their currency exposure in one currency will look to use futures to lock in a future value. Spot FX on the other hand is an application where by the trader can experience the current market movements and volatility without the added haircut or interest rate component.
We have outlined the defining factors of both products below:
- Spot FX looks at the short term implications of currency movements. Traders who wish to speculate look at utilising this financial product. Currency Futures are designed to be used for hedging purposes (ie imports/exports)
- Each product is subject to a margin and leverage. The margin for Spot Foreign exchange is defined by the broker, where as the exchange defines the margin for futures. Leverage works in similar manner for Spot FX, however currency futures are subject to a predefined level, and are not adjustable.
- Currency Futures are exchange listed. Spot FX is an OTC product based on the current market value of the currency cross.
- Pricing in each product can differ significantly based on the time frame. An additional interest rate, time and risk component can affect the pricing on a currency futures contract.
Recent volatility in the markets has led to significant cross over in usage of futures and spot in the institutional market. Although considerable risk can be attributed to each product due to leverage, spot foreign exchange allows for arguably greater pricing transparency. Determining the time, risk and interest rate factors that affect futures pricing can be quite complex and detailed. Retail traders have struggled at times with this calculation.
For more information on online forex trading, please visit Vantage FX.
Central Bank Policy and the Currency Markets
September 20, 2010 By Leave a Comment
Foreign Exchange (forex) markets are governed by a number of key macroeconomic drivers which affect a country’s economic and growth. Unlike the equity markets, currency pairings are defined by change in governmental, and central bank policy. There is a distinct division between the two, with both parties playing an important role. Sometimes defined in terms of discretionary and non discretionary, fiscal policy focuses on taxation and government spending. This can come in the form of infrastructure and utilities, or social welfare.
Non Discretionary Fiscal Policy is sometimes referred to as “automatic stabilisation” or “auto stabilisers”. Economists note, that this type of policy has become less definable over the last 3 years due to the global financial crisis. In effect auto stabilisers are preset government spending, which in most cases relates to health, education and social welfare.
Discretionary Fiscal Policy however is where the government announces a new infrastructure investment, or increased spending in the housing sector. A notable recent example is the $50 billion Obama plan for infrastructure upgrades.
Fiscal Policy is only one aspect that affects the currency markets. Sometimes referred to as the deciding factor in currency movements, Monetary Policy is governed by the Central or Reserve Bank. The idea behind monetary policy is the management of inflation, through interest rates and, currency investments. Managing the inflationary cycle is the most important role that the central bank undertakes. Highlighted below is an example of how this management can lead to movements in the currency markets.
Example
Reserve Bank decides to raise the interest rate from 3% to 3.5% to combat growth in inflation and CPI. By raising this benchmark, banks follow in suit and raise their lending and investment rates. A domino style effect, the change in monetary policy also influences the debt markets, with companies now having to pay more for borrowing, whereas the lenders receive higher return. Currency traders will then look at adopting a strategy, called yield play. By investing in a higher yielding currency over another, the trader can take the difference between the two rates. Over the last few years, with the volatility in monetary policy and debt markets, we have seen a substantial increase and interest in this area.
The above example highlights the impact of interest rates on currency markets. The other key definable area of focus for the Central Bank is currency investment. In many cases the central bank will intervene in the foreign exchange markets to stabilise movements for import and export reasons. A recent important case is the Bank of Japan (BOJ) and the Yen. The appreciation of the Japanese currency has lead to a drop in export earnings, with a flow on effect to the corporate earnings and Japanese equity markets. Although the BOJ has not yet intervened, central banks have an important role in also controlling the impact on balance of payments, that forex markets have.
Foreign exchange is influenced by the above key fiscal and monetary policy shifts. Central and Reserve banks play key roles in defining the movements in currency pairs, through management of monetary and interest rate policy.
