The Forex Trading market is much more complicated compared to the bond or stock market. As for predicting the rate of foreign exchange, you will have to predict the performance of the whole economy. There are also multiple factors that need proper consideration when determining the exchange rate. Below are some of the considerations that you need to keep in mind when joining the FX market.
Expectations in the Future Pricing
The Forex market is also a financial market. The price seen in the financial market does not mirror the price available today. Instead, it reflects the future expectations with bases coming from the information which is already available today. That being said, the most important way to determine the rates of a currency pair is through expectations about the future.
The Monetary Policy Comparison
The exchange rate is something like a comparison of the policies of two different countries. It is important to understand that these exchange rates are more like absolute instead of relative. Here are the factors that affect exchange rates.
Inflation – Exchange rates are the ratio of the expected unit counts and the expected unit counts of another country. But inflation causes an increase in the number of currency units. For instance, if your particular currency is facing an inflation rate of 6% while the other is at 2%, then there’s a huge possibility that the ratio between the currencies will change. But inflation rates play a vital part in determining the exchange rate.
Interest Rates – By the time an investor gets a hold of a currency, they often get yielded when it comes to the terms applied on the interest rate of that particular currency. Currency valuation also gets subjected to changes in the interest rates.
Fiscal Policy Comparison
The Central Bank of your country controls the monetary policy. Meanwhile, the fiscal policy is mandated by the government. The Fiscal policy also plays an important role since the monetary policy is subjected to changes at any time.
Public Debt – A country facing a large amount of public debt signifies that the government will be making large interest payments as well. Investors will then see if this amount can be collected through tax. If this isn’t possible, then it means that the country will be monetizing their debts.
Budget Deficit – Aside from public debts, another factor that can influence changes in the FX rates is the budget deficit. A budget deficit is known to be the forerunner of the public debt. When a government has more money than they currently have, this will result in a budget deficit. If this deficit happens, it will be financed through debt.
Another factor that holds prime importance when it comes to the FX rates is political stability. This modern monetary system that we have nowadays is Fiat money. In this case, the money is considered nothing but a promise held by the government. If dangerous situations happen, the promise will become worthless after a new government takes place.