Determinants of FX rates.
The following theories explain the fluctuations in FX rates in a floating exchange rate are governed.
a) International parity conditions : Relative purchasing power parity,interest rate parity,Domestic fisher effect,International fisher effect.Though to some extent the above theories provide logical explanations for the fluctuations in exchange rates,yet these theories falter as they are based on challenegable assumptions[ex: free flow of goods,service and capital] which seldom hold true in the world.
b) Balance of payment model : This model however focuses largely on trad able goods and services,ignoring the increasing role of global capital flows.It failed to provide any explanation for continuous growth of Dollar during 1980s and most of 1990s in face of soaring US current account deficit.
c) Asset market model : Views currencies as an important asset class for constructing investment portfolios.Assets prices are influenced mostly by people's willingness to hold the existing quantities of assets,which in turn depend up on their expectations on the future worth of these assets.The asset market model of exchange rate determination states that "the exchange rate between two currencies represents the price that just balances the relative supplies of , and demand for,assets denominated in those currencies."
None of the models developed so far succeed to explain FX rates levels and volatility in the longer time frames.for shorter time frames (for few days) "Algorithm" can be devised to predict prices.Large and small institutions and professional individual traders have made consistent profits from it.It is understood from the above models that many macroeconomic factors effect the exchange rates and in the end currency prices are a result of dual forces of demand and supply.these two factors are consistently tilting ,and the price of one currency in relation to another shifts accordingly.No other market distills as much of what is going on in the world at any given time as foreign exchange does.
Economic Factors
a) economic policy,circularized by government agencies and central banks
b) economic conditions,generally revealed through economic reports,and other economic indicators such as
Internal,regional and the international political conditions and events can have a profound effect on currency markets.
All exchange rates are susceptible to political instability and anticipations about the new ruling party.political up heal and instability can have a negative impact on nations economy.
Market psychology
Market psychology and trader perceptions influence the foreign exchange market in a variety of ways.
Main factors influencing Foreign Exchange are.
Economic Factors
a) economic policy,circularized by government agencies and central banks
b) economic conditions,generally revealed through economic reports,and other economic indicators such as
- Economic policy includes government fiscal policy(Budget spending practices) and monetary policy(the means by which a government's central bank influences the supply and "cost" of money,which is reflected by the level of interest rates).
- Government budget deficits or surpluses.
- Balance of trade level and trends.
- Inflation levels.
- Economic growth and health.
- Productivity of an economy.
Internal,regional and the international political conditions and events can have a profound effect on currency markets.
All exchange rates are susceptible to political instability and anticipations about the new ruling party.political up heal and instability can have a negative impact on nations economy.
Market psychology
Market psychology and trader perceptions influence the foreign exchange market in a variety of ways.
- Flights to quality : Unsettling international events can lead to "flight to quality",with investors seeking a safe haven,there will be a greater demand,which will influence a huge cost for the currency when compared to the weaker counterparts.
- Long term trends : Currency markets often move on visible long term trends,analysis looks at longer-term price trends that may rise from economic or political trends.
- Economic numbers : In recent years,for example money supply,employment,trade balance figures and inflation numbers have all taken turnsin the spotlight.
- Technical trading considerations : As in the markets,the accumulated price movements in a currency pair such as EUR/USD can form apparent patterns that traders may attempt to use.Many traders study price charts in order to identify such patterns.
