Exchange Rate Movements and FOREX Market Strategies - Essay Example

Exchange Rate Movements and FOREX Market Strategies Name: Institution: Exchange Rate Movements and FOREX Market Strategies Introduction The foreign exchange market remains the most traded financial market, with exchange rate movements involved being determined by the fundamentals of economy. These economic fundamentals are the factors that influence foreign exchange rate movements. Exchange rate is the rate at which a particular currency can be changed for another. These rates are impacted by international trade, without which these rates would be of not much importance. International exports react to real exchange rate movements differently relative to the economic nature of the destination country. The behaviour and patterns of exchange rate movements are therefore important to the global economy in relations to international trades. For this reason, this paper seeks to outline and evaluate the essential factors that influence foreign exchange rate movements. The discussion takes into account the fact that some factors are not viable to put basis on when using empirical models to determine or even predict these exchange rate movements. A review of the fundamental factors that affect exchange rate movements helps to establish the relationship between the latter and the real economy. This relationship has become a vital macroeconomic point of focus as indicated by researches and policy discussions in international nations like New Zealand (Ferguson, 2013). The causes of exchange rate movements relative to a given currency extensively reflect on the macroeconomics of the country. The fundamentals that drive these causes draw from the partners of trade that a country gets into business with. Undesirable exchange rate movements and depreciation or appreciation of the real economy trigger necessities for policy responses. Such responses take into consideration the models and concepts of exchange rate equilibrium and alignment of a currency to primary determinants of exchange rate movements. Fundamentals Influencing Exchange Rate Movements The importance of evaluating fundamentals that impact FOREX rate movements is justified by the vital role that exchange rates play in a country’s level of trade and economic health and wealth. Evidently, this exchange rate factor matters a lot to the economy of the world in a general perspective and this makes it one of the most monitored, analyzed and influenced global issues. Notwithstanding this, in the same measure, it is also manipulated and intentionally shaped by economically powerful entities and nations. This shows that not all factors that influence exchange rate movements are necessarily economic; some of them are interest-based (Arthur, & Sheffrin, 2003). Most of the basic and principal determinants of FOREX rate movements also determine the business relationship between two countries. Government intervention This is a government initiative in a country to influence the value of its currency relative to another. This policy response is intended to make the country’s exports more competitive in the international market. Such an objective is mostly achieved by making the country’s currency to have lesser value. The modes of intervention depend on the goals and objectives that a country wants to achieve on the field of economy. King (2003) points out that different government intervention objectives call for different tactics and methods of intervention. To this level, it is evident that government intervention is an intentional and well organized undertaking to achieve particular economic objectives benefiting the country. Intervention, therefore, has direct impact on the exchange rate movement of one country relative to the rest of the economies. Nevertheless, foreign exchange market intervention by governments involves an economic pursuit that tries to change the value that market participants and international business operators put on a particular currency yet the methods and strategies for doing this are not yet immediately clear. The most probable channels of influence under intervention are home and abroad interest rates and portfolio balance. Inflation A relationship between exchange rates and inflation can only be established by conducting an empirical study on both developed and emerging countries with influential economies. Inflation affects various sectors of the nation’s economy including Information and Technology. Researches and studies on this factor indicate that the IT sector has advanced appreciably and is a common aspect in all the other sectors. It is therefore a probably suitable item to use in comparing the exchange rate movements between two countries. A general law of business postulates that a country with a consistently lower rate of inflation equally exhibits a consistent rise in currency value. Subsequently, the purchasing power of its citizens and organizational entities increase relative to other currencies. Most countries in Europe achieved low levels of inflations earlier that the united states of America. According to Sek, Ooi and Ismail (2012), country economies with higher levels of inflation characteristically experience a fall in their currency level. The currency value is determined in relation to the currencies of trading country partners. This is also usually accompanied by higher interest rates, hence monetary policy. Interest rates This is a subset of monetary policy and a potentially important influence of exchange rate movements. However, it is worthy to note that it is the monetary policy actions that cause interest rates differential between business at home country and abroad. Effectively, this moves the exchange rates. Interest rates highly correlate to exchange rates considering that a manipulation of interest rates uncontrollably imposes influence over exchange rates. As a matter of fact, manipulating these interest rates impacts inflation and affects the level of currency values as well. It is advantageous to lenders in an economy and leading business stakeholders when there are high interest rates since they gain higher return relative to other countries. Higher interest rates, therefore, do not only cause the exchange rate to rise but also attract foreign capital. With adoption of such a monetary policy, trading and business care have to be put into consideration so as not to cause the inflation of the country to rise much higher than in others, or drive the currency much more down the scale (Berthou, 2008). Public debt This is actually government debt that it woes to other countries of businesswise, big international financial institutions. Public debt greatly affects exchange rate movements especially when the market shareholders foresee a default of debts by the government. The result is that investors give up on the investments in the country and opt to sell their shares and bond. This causes the country’s exchange rate value to fall. On a brighter side, the government may initiate a large-scale financing of deficits these debts, which sets basis for and stimulates development and growth of the domestic economy. Nevertheless, a business fact remains that investors are less attracted to nations with large public deficits and debts. Continued public debts encourage inflation which reduces the value of the currency and hence exchange rate movements. A point of equilibrium needs to be investigated and maintained (Rodrik, 2008). Political Stability and Economic Performance It is evident in any business industry that foreign investors prefer to invest in politically stable countries with strong economic performance. A competitive market has beneficial potentials that stimulate innovative economic efficiency, greater productivity and almost exponential economic growth. The economic system is the driving tool that determines what to produce and the kind of products that a country accepts into its market from within or without. Market economies are under the impacts of supply and demand. The laws of supply and demand suggest that producers must find an equilibrium point at which the consumers are willing to pay the asking price and the company still makes profits as the consumers get services satisfactorily. A company’s involvement in the international marketing system from local positions can only mean economic growth (Goddard and Ajami, 2006). This growth is enhanced by the global economic systems which increase economic stability and brings confidence, not only to interdependent nations but also to the firms involved. On the other hand, other than beneficial, political economy mostly acts as an obstacle to reforms that ensure healthy competitions. It is vital to look at the current and future political system to ensure that the business environment is attractive for investors. Ellis and Singh (2010) mention that it is also important for a country seeking consistent exchange rates to analyze all the kinds and types of political risks that foreign investors may be subjected to so as to predict their possibility and probability. A country with desirable political and economic attributes will draw investment funds away from other countries into its own business industries since the investors will perceive the other economies to be having more political and economic risks. Strategies by the Reserve Bank of Australia As mentioned earlier in the discussion, exchange rate movements remain the most monitored and manipulated aspect of international trade. This is because of the much influence that it has on the growth and development of a country’s economy as well as financial empowerment of the people. Respectively, the Australian government, through the Reserve Bank of Australia, established a survey to deal in foreign exchange. The survey was done with corporation of respondents from the Australian Treasury, Commonwealth Bank of Australia, National Bank Australia Ltd and the Westpac Banking Corporation. The survey was conducted largely through international countries in Asia as well. Collection of information by questionnaire survey may be criticized on the basis of difficulty to ascertain whether respondents provide honest responses but the initiative gave a general feedback of close to 70 percent (Hutcheson, 2000). The Australian government adopted a monetary policy as a way of government intervention, which implies that it responded with the intention of making its exports more competitive in the international market. Such an objective is mostly achieved by making the country’s currency to have lesser value, though at safe and equilibrium trading levels. The Australian government decided to trade the Reserve Bank of Australia rate. The decision was such that as the Reserve Bank of Australia kept their benchmark interest at 3%, other financial institutions in the international scale kept their interest prices at approximately 17% (Song, 2013). The policy behind the rate decision continues to reduce demand for their currency yet there is still room for lower interest rates of borrowing. Changes in interest rates affect exchange rates as well and cause it to move dynamically especially when unanticipated. The Australian currency in high-yielding and therefore, there is a relative balance between domestic and foreign currency. The country has seen economic developments resulting from the intervention of the Reserve Bank of Australia. The tables show the upside and downside values of this development. Source: http://www.dailyfx.com The central government makes decisions through its national departments to make interventions for various reasons. Generally, intervention is warranted to stabilize exchange rates and bring necessary liquidity to domestic market. International and foreign intervention, however is triggered by the need to minimize overshooting effect when economic conditions are changing or have been misread by market stakeholders. Other reasons include reduction of exchange rate volatility, correcting a disorderly market and correcting exchange rate misalignment amongst others (Doole & Lowe, 2008). Conclusion The essay paper followed a methodology of introducing exchange rate, a review of the factors that influence exchange rate movements and a detailed evaluation of the fundamental factors. The paper also includes a section that reviews the strategies adopted by the Reserve Bank of Australia in relation to these exchange rate movements. The discussion achieves the objective of evaluating these fundamental factors and establishing how they influence exchange rate movements. The importance of this paper is validated by the fact that a declining exchange rate leads to a decrease in the purchasing power and income of the country as a whole. It also establishes that in as much as the influential economic factor affect exchange rates, a manipulated exchange rate also influences these factors which include interest rates, inflation, capital gains and foreign investments. References Ferguson, N. (2013). Exchange rate valuation and its impact on the real economy. New Zealand: New Zealand Treasury. Arthur, S. and Sheffrin, S. M. (2003). Economics: Principles in action. New Jersey: Pearson Prentice Hall. King, M. R. (2003). Effective foreign exchange intervention: matching strategies with objectives, Journal of International Finance, 6(2). Sek, S. K., Ooi, C. P. and Ismail, M. T. (2012). Investigating the Relationship between Exchange Rate and Inflation Targeting, Applied Mathematical Sciences, 6(32). Berthou, A. (2008). An Investigation on the Effect of Real Exchange Rate Movements on Oecd Bilateral Exports. European Central Bank. Rodrik, D (2008). The Real Exchange Rate and Economic Growth, Brookings Papers on Economic Activity, Fall, 365-412. Goddard, G. J., and Ajami, R. A. (2006). International Business: Theory and Practice, New York: M.E. Sharpe. Ellis, K. and Singh, R. (2010). Political economy factors affecting efficient functioning of markets. Trade Hot topics, 1(73). Hutcheson, T. (2000). Trading in the Australian foreign Exchange Market. Broadsway: University Of Technology. Song, D. (2013, March 4). AUD/USD- Trading the Reserve Bank of Australia Rate Decision. Retrieved from http://www.dailyfx.com/forex/fundamentals.html Doole, I. and Lowe, R. (2008). International Marketing Strategy: Analysis, Development and Implementation, Fifth Edition, Stamford: Cengage. Sanderson, L (2009) Exchange rates and export performance: evidence from micro-data, Bulletin, Reserve Bank of New Zealand, 72(2). Read More