What Moves the Forex Market?
Currency prices are in constant flux, influenced by a combination of economic, political, and market-sentiment factors. Understanding these drivers is essential for making informed trading decisions.
Don't worry if some concepts feel overwhelming right now. This is just an introduction to familiarize you with what moves currency prices. We'll cover all of these topics in much greater detail—with real examples and practical application—in the Fundamental Analysis Basics module.
Central Banks
Decisions on interest rates by central banks (like the US Federal Reserve or the European Central Bank) are the most significant driver. But understanding why this matters requires looking at the actual mechanism at work.
When a central bank raises interest rates, it increases the return that investors can earn on deposits and bonds in that currency. This creates a chain reaction: International investors notice they can earn higher returns by holding assets in that currency, so they sell their current holdings in other currencies and buy the high-yielding currency to invest. This increased demand for the currency pushes its price up. Conversely, when rates are cut, the currency becomes less attractive—investors move their money elsewhere, reducing demand and weakening the currency. This is why interest rate announcements can cause immediate, dramatic moves in the forex market.
Economic Data
Reports on a country's economic health, such as GDP (Gross Domestic Product, which measures total economic output), inflation rates (measured by the Consumer Price Index or CPI), and employment figures (like the US Non-Farm Payrolls), can cause significant volatility. But why does strong data strengthen a currency?
The mechanism works like this: Strong economic data signals a healthy, growing economy. This attracts businesses looking to expand operations and investors seeking profitable opportunities. To do business or invest in that country, they need to purchase the local currency—increasing demand. Additionally, strong economic data often leads central banks to consider raising interest rates to prevent the economy from overheating, which further boosts the currency (as explained in the Central Banks section above). Weak data has the opposite effect—it suggests fewer opportunities and potential rate cuts, reducing currency demand.
Trade Balance
When a country exports goods or services, foreign buyers must purchase that country's currency to pay for them—this creates natural demand that strengthens the currency. For example, when Japan exports cars to Europe, European buyers must convert Euros into Japanese Yen to complete the transaction. This continuous buying pressure from export activity supports the Yen. Conversely, when a country imports more than it exports (a trade deficit), its citizens and businesses must sell their own currency to buy foreign currency for imports—this selling pressure weakens the domestic currency. This is why countries with large trade surpluses (like Germany or Japan) often have persistently strong currencies.
Geopolitical Events
Elections, political instability, trade disputes, and international relations can create uncertainty. Here's what happens: When uncertainty rises, investors cannot reliably predict future economic policies or stability. Since investment decisions depend on predictable returns, this uncertainty makes investors nervous about keeping their money in that country. They sell assets denominated in the affected currency and move funds to more stable economies with predictable policies—typically the US Dollar, Japanese Yen, or Swiss Franc (called "safe-haven" currencies). This mass exit reduces demand for the uncertain currency, weakening it, while simultaneously strengthening the safe havens.
Market Sentiment
Sometimes, the market moves based on its general feeling or "risk appetite." In times of fear ("risk-off"), traders flock to safe-haven currencies like USD, JPY, or CHF. In times of optimism ("risk-on"), they may sell those safe havens and buy riskier currencies with higher growth prospects.