Impact of Economic Change on Currency Valuation

  • The value of a currency, as we have previously mentioned, is always in relationship to something else.  In forex, it is in relationship to another currency, hence the trading of currency pairs.  The price of the pair, therefore, depends upon changes in two different economies.  We are not only concerned with change as reported in an economic report, but how the trade perceives future changes will occur.  This is important!  How does the trade feel about the direction and strength of future economic changes?

    An efficient market, in some ways, is one that has correctly discounted, or anticipated the future.  Market surprises are not well received by the trade, and usually result in erratic price movements.  Since pairs are involved, the market is required to discount the current status and future direction of two economies, a more difficult assignment.

    In addition to economic factors and the anticipated changes in these factors, there are two other factors that may influence the value of a pair.  The first, of lesser importance, is the influence of cross currency trading.  The relationship between the USD and the CAD, because of the close geography, and importance as trading partners, may influence the trade of the CAD versus the pound in cross currency valuation.  Heavy selling of the CAD versus the USD may depress the CAD and weaken it against the pound.  The strengthening of the pound is merely the result of heavy selling in the CAD versus the USD.

    The other factor, and this is a very big one, is the current speculative attitude toward risk.  Traders are willing to assume more risk when things are going well, but put some stormy forecasts in the sky and traders become very defensive with their money.  We will examine this in greater detail later.

    So to determine the current value of a pair we need to know all economic data pertinent to both currencies.  It is like having a snap shot of the current well being of the economy.  That, however, is not enough because the input to currency values are many, and the traders are always trying to peer down the road or around the corner in an effort to get an edge on the future value of a currency pair.

    Some economic reports are leading indicators, because they are the first to move higher or lower when a trend is changing.  An example of leading indicators would be durable goods orders, which are orders for items that take time to construct, like an airplane or an oil tanker, and will be needed for future use.

    Surveys are taken in most countries which attempt to determine the level of future economic activity.  These may be consumer spending surveys or surveys of purchasing agents for manufacturing companies, or perhaps a poll of consumer confidence.  The results of this data provides clues to all the participants in the forex market, what might be the level of future business activity.  Our current level of activity, and it’s trend is useful information, helping to determine where we might be headed.

    Reaction to the various reports will depend upon what had been anticipated,  where in the phase of the current business cycle the economy is, and the status of the other countries economy in the currency pair.  Should the data show a rapid expansion of activity, this might be a constructively received report, if the economy is in the early recovery stage.  Response might be just the opposite if expansionary activity is reported after a period of rapid expansion.  It there are reports in two different countries on the same day, this compound the hazards and the trading opportunities.

    With the ample leverage in forex trading, and the multiplicity of factors traders use to determine the price, there might be the right price, but for only a few minutes before there is more news, or traders want to get in, or out of the market. This moves the market to a different level.  You have to assimilate and react to the information available, trying to capture some of the move.  Yes a pair may, over time, move 500 pips, but the back and forth interim moves may be 2500 pips.  Good luck.  A moving target gives you lots of opportunities.

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