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All of us are familiar with international currency exchange rates to one degree or another, whether we’re forex traders or simply planning for a summer holiday abroad. However, you may not know that currency rates and monetary stability used to fluctuate wildly across the globe, thanks to a number of macroeconomic and geopolitical factors.
This is one of the reasons why the European Exchange Rate Mechanism (ERM) was introduced in 1979, as this provided a method through which exchange rate variability could be reduced and managed by members of the Common Market. The advent of the European Union and the single currency largely made this redundant, however, with 23 nations having adopted the Euro since it was launched in 1999.
But why do international exchange rates differ in the first place, and how does this impact on forex market traders? Let’s find out.
Macroeconomics and the Impact of Metrics on Currency Values
Whilst economics is essentially the study of how agents use finite resources to achieve unlimited objectives, macroeconomics focuses primarily on the market systems and metrics that operate on a national and global scale.
It, therefore, deals with the behavior and structure of an entire economy, and many of the factors that underpin an economy’s strengths and weaknesses are also known to have an impact on currency valuations across the globe. The reasons for this is simple; as nations must buy and sell each other’s currencies in order to conduct trade, with real-time exchange rates determined by a number of macroeconomic considerations.
Inflation rates are one of the most important factors, as this has a direct impact on currency exchange rates. More specifically, trading platforms like Oanda will observe the appreciation of a country’s currency value in the event of a lower inflation rate, whilst the reverse is true for nations that are struggling to control their inflation levels.
This means that the former’s currency can be used to buy more of the latter’s, creating a more favorable exchange rate that benefits associated businesses and consumers alike.
This leads us neatly onto interest rates, which affect both the currency value and the dollar exchange rate. Not only is this metric influenced by inflation, but it’s also true that higher levels of interest provide increased rates to lenders and cause a country’s currency value to appreciate.
These factors, along with a nation’s debt-to-GDP ratio, geopolitical stability, and trading terms, all have a direct impact on currency valuations and the underlying international exchange rates.
What do Exchange Rate Fluctuations Mean to Traders?
Significant and recurring currency fluctuations are thought to be problematic for a number of reasons, which is why systems such as the so-called “gold standard” (which pegs currencies to the value of gold) and the EMR have been utilized throughout history.
However, it’s minor fluctuations that enable forex traders to profit from the foreign exchange, as they can leverage price movements to achieve gains even in a depreciating market. More specifically, they can back or hedge against specific pairings depending on the underlying exchange rate, whilst factoring in future trends to inform their decision further.
However, it’s also possible for traders to influence exchange rates directly through sustained speculation, and this is always something to consider if you’re a novice forex trader who’s active online.