Macroeconomic Influence on Foreign Exchange Markets

Changes in a country's macroeconomic situation can have a major influence on the value of its currency. Foreign Exchange traders pay close attention to countries' economic and political situations when making their decisions.

In the long run, the relative strength of a nation's economy is often reflected in the strength of its currency. An economy that is growing quickly will likely attract investors from abroad seeking higher returns.

On a daily basis, economic data releases, policy decisions, and political events cause economists and traders alike to reappraise their outlook on a country's economy. These dynamics, along with technical factors are what may drive price movement in the shorter-term.

Interest Rates

Each country's currency has an overnight lending rate determined by that country's central bank. For example, the US Federal Reserve Bank meets periodically to set the Federal Funds rate. Higher interest rates attract foreign investment and induce domestic investors to repatriate overseas funds, increasing the demand for the currency and making it stronger. Therefore, any move to increase interest rates � or any development that could cause a central bank to increase interest rates � will tend to make traders bullish on that currency. The reverse also applies.

Equity Markets

In the United States and other countries with developed equity markets, both the overall direction in equity prices and dramatic short-term moves tend to have an impact on the value of a country's currency. Money flows into a country as its equity markets rise and reverses direction in falling markets. Additionally, the equity markets serve as a sentiment barometer for a country's economic prospects. The more positive sentiment for country's economy, the greater the demand for its assets.

International Trade

A nation's trade balance is vital in any assessment of its economic health and more specifically in measuring the strength of its currency. A trade deficit causes a weakening currency, since more of the country's financial resources flow out of the country than other nations' flow in. For foreign exchange markets, any unexpected move away from a nation's trade balance baseline will usually trigger increased trading and a price movement.

Another major international influence on the value of currency is the price of commodities � particularly petroleum. A rise, but more especially a sharp, unexpected spike in the price of oil will negatively affect the currency of oil-importing nations, such as the United States, and positively strengthen the currency of an oil-exporter, such as Canada.