MARKET DRIVERS
Market drivers are key factors influencing the financial markets, such as economic indicators, market sentiment, and geopolitical events. They affect supply and demand, investor behavior, and overall market direction. Understanding these drivers helps traders make informed decisions in a complex trading environment.
Monetary Policy & Interest Rates Decision
They are defined by Central Banks.
Higher interest rates attract investment, and therefore create demand for a certain currency. In context of higher interest rates, central banks tend to adopt a restrictive approach to monetary policy, tightening financial conditions, reducing consumption and business investments, and tackling inflation.
At the opposite, lower interest rates no longer attract investment and therefore reduce demand for a certain currency. In context of lower interest rates, central banks tend to ease their monetary policy, easing financial conditions, boosting consumption and business investment, and favouring inflation.
Inflation
Inflation is defined as the general increase in prices. Inflation that is too high is considered as bad for an economy as well as an inflation that is too low.
Higher Inflation leads central banks to hike interest rates. In general, it can create demand for the currency, depending on the bigger picture (context) and vice versa.
Example:
Imagine having one country A and a country B. Let's say that the country A displays signs of economic outperformance while country B is displaying the opposite. On the price front, both economies are facing high inflation which is out of central bank’s target.
Question: Which currency will outperform ?
Answer: It’s obvious that the currency of country A will outperform country B’s currency. The country A while facing higher inflation, is displaying economic outperformances. It will allow central bank A to hike its interest rate and to become more restrictive without hurting the economy. In this case, we could have a soft landing.
The country B while facing higher inflation, is displaying economic underperformance. Thus, It will become a constraint for central bank B to hike its interest rate because the economy is already paying prices with that high inflation.In this case, central banks are now facing bigger challenges between growth and inflation. It’s called stagflation.
Economic Performance
A country with stable and strong economic performance will attract investment and create demand for the currency. Economic performance can be measured through GDP and Unemployment.
GDP known as the Gross Domestic Product is the total of Goods and Services produced in a country. Strong economic growth (rising GDP) is often seen as a sign of stability and economic outperformance which can make the currency’s country stronger.
The unemployment rate indicates the proportion of people who are unemployed but actively looking for work. A low unemployment rate can indicate a healthy economy, while a high rate can signal economic difficulties and cause the currency to decline.
Political Stability
A stable and accommodating political regime is likely to attract investments leading to demand for the currency.
Trade balance
A positive trade balance for a country means higher exports than imports. There is then a greater buying demand for the currency as it generates FX reserves.
Public Debt
Governments finance public sector spending through debt. High debt levels can lead to inflation and, in a worst-case outcome, may trigger a default.
Economic anouncements
Of course, the items listed above don’t happen overnight, but market sentiment and investor confidence can swing and shift in a moment, triggering a rapid change in exchange rates.
An economic data release, such as an inflation report, gross domestic product (GDP) growth figures, unemployment rate, PMI datas or a central bank interest rate decision, can cause a currency to gain or lose value quickly as it builds a picture of future economic performance and therefore the currency’s value.