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Fundamental Factors Behind Major Currencies

Every Forex-traded currency is influenced by a range of internal macroeconomic conditions in its country of origin, as well as by and the global market situation. Economic indicators (GDP growth, import/export trade accounts), social factors (unemployment rate, real estate market conditions) and the country’s central bank policy are the factors that determine the currency value in the foreign exchange market. Each one of the eight major currencies has its particularities, and we are going to analyze the fundamentals that drive the currencies individually.

US dollar (USD)

The US dollar is the most traded currency in the Forex market. It is also used as a measure to evaluate many other currencies and commodities. The USD dominates the foreign reserves held by all nations – it composes about 60% of the world reserves.

Globally speaking, there are several fundamentals that drive the US dollar. Since the largest amount of metallic commodities and the oil are mostly traded with prices denominated in USD, significant supply/demand fluctuations in these markets will have an immediate impact on the currency value, as it  has happened in 2008 and in 2014 when, largely due to the oil prices collapse, the EUR/USD declined dramatically. The dollar also benefits from its status as a safe haven, as investors run to it when economic conditions deteriorate. As a result of a reserve currency status sometimes, USD sometimes profits from problems inside the USA itself.

As for domestic factors, the Federal Reserve and its main interest rate has a tremendous influence on the currency. Decisions of the Fed about the benchmark rate are influenced by inflation, employment, and GDP, thus the dollar is also influenced by these factors.

Other important factors for USD are the trade balance and the national debt of the United States. Usually, a higher trade balance deficit and a growing national debt reduce attractiveness of the US currency. Yet sometimes, the opposite can happen as high trade deficit and debt may drive investors to the perceived safety of the dollar.

Euro (EUR)

The euro is by far the newest currency traded among the major pairs on Forex markets. It is used by 19 members of the European Union. The fundamental factors that move the euro are often based on the strongest economies using the new common currency, such as: France, Italy and, mainly, Germany.

The main factors for performance of EUR are inflation of consumer prices and the target lending rate set by the European Central Bank. The countries' indicators of the export trade and the unemployment rate also tend to have a high impact performance of the shared currency, considering that countries such as Germany are large exporters of manufacturing goods and technology.

Europe still remains an energy dependent from the Russian gas and the Middle Eastern oil, making higher demands for these commodities to have a negative reflect on the EU currency.

Another problem for the euro is the difference between its economies, made apparent by the debt crisis in 2011 and coronacrisis relief fund in 2020. It is hard for the EU leaders in times of troubles to find solutions that are equally benefiting to the major economies and the weaker ones.

EUR is considered as an alternative reserve currency to USD but still remains well behind the greenback in its utilization by in global foreign reserves with just about 21%.

Pound sterling (GBP)

The Great Britain pound is the national currency of the United Kingdom, and the fundamental factors that move it are as complex and variable as the British economy itself and its global influence.

London can still be considered as a world's financial capital and its commodity market plays a fundamental role in GBP trends.

Inflation and GPD tend to influence the pound by the biggest degree, while the housing market is also important for Britain’s currency.

Recently, especially post-Brexit, the UK economy was constantly showing signs of weakness, reducing appeal of GDP. Despite that fact, traders sometimes use the sterling as an alternative for the euro in times when problems in the European Union become too severe. GBP also tends to be influence by political event, including elections. Usually, the currency reacts negatively to events that cause uncertainty, like the parliamentary elections in 2010 that resulted in hung parliament and Brexit referendum vote of 2016.

Japanese yen (JPY)

The Japanese yen is the strongest and by far the most traded currency in the Asian market. Japan’s economy is mainly geared towards industrial exports. JPY is greatly valued by traders as a safer currency in periods when risk aversion sentiment hits markets, but also used by carry traders in times of risk appetite. Low interest rates in Japan allow such traders to borrow the currency and invest in countries with higher rates.

Japan's close proximity and tensions with China sometimes has a great impact on the yen. The problems for JPY are constant devaluation in Japan and interventions of the nation's central bank. The Bank of Japan is concerned that excessive appreciation of the yen (and Japan's currency tends to gain a lot at present because of economical uncertainty) may hurt nation's export-oriented economy and, as a result, constantly attempts to weaken the Japanese currency.

Deflation has hit Japan in early 1990s, following the burst of the real estate bubble in 1980s, and remains one of the greatest threats to Japan's future.

Growing number of old people compared to youths as well as increasing worries about the future makes it hard for the government to deal with the deflation.

Swiss franc (CHF)

Switzerland is a small country located in the European Alps, yet, its strong international trade and money influx, made the swiss franc , one of the main currencies traded on Forex. CHF is another currency that is preferred during risk aversion as Switzerland's robust economy and huge gold reserves (the country's reserves is seventh biggest in the world, despite Switzerland's small size) add to credibility of the currency. Similarly to JPY, CHF suffers from constant interventions of the central bank. The Swiss National Bank has gone as far as pegging CHF to EUR from September 6, 2011, to January 15, 2015, thus creating constant downward pressure for the currency.

Canadian dollar (CAD)

The Canadian dollar is considered a "commodity currency" as Canada's economy is export-driven. Most of its exports Canada sells to the USA, making the Canada’s economy and the currency dependent on the nation’s southern neighbor. The main export commodity is crude oil and CAD depends on the price moves of crude as well.

The global economic growth and resulting advance of commodities tend to make CAD attractive to investors. On the other hand, problems with the global and the domestic economy can hurt CAD.

Australian dollar (AUD)

The Australian dollar is much similar to the Canadian currency in that it is also largely export-driven. However, unlike CAD, AUD depends mainly on the exports of iron, coal, oil, and gold to China. Thus, positive news from China usually help the Aussie, while bad ones make it fall. Also, most commodity-related news tend to influence the Australian currency, which rises in value when commodities go up and declines in value when commodities go down.

In the past, when the Australian Reserve Bank used to set relatively high interest rates, the Australian dollar was a popular part of JPY-based carry trades. Nowadays, during the time of globally low interest rates, this role is nonexistent. Yet the Australian dollar still benefits from the flexible monetary policy of its central bank and it is useful to keep an eye on its decisions.

New Zealand dollar (NZD)

The New Zealand dollar is the third "commodity currency" in the list of majors and it depends significantly on its main trading partners — China and Australia. A major export category for New Zealand are dairy products. To track the prices on such products, there is the Global Dairy Trade marketplace, which also produces the GDT Price Index, which acts as a benchmark for dairy prices in New Zealand.

The exchange rate of the New Zealand dollar is affected by both interest rate decisions of the Reserve Bank of New Zealand and by changes in the GDT Price Index reading. During the last few years, the short-term trend is basically an outcome of interest rate decisions, while the medium-term trend is decided by the dairy prices which ultimately shape the economy of New Zealand.