Course Content
Synchronize Time and Place for Forex Trading
Forex Trading Course
    About Lesson

    Main FX Market Forces

    Interest rates:

    The Interest Rate is the market rate that the buyer (or borrower) has to pay the seller (or lender). Interest rates impact the local currency’s strength against other currencies. Interest rates in each country are determined by its central bank, as part of its monetary policy. The compatibility of interest rates to market conditions helps maintain stability. Central banks raise interest rates in order to decrease inflation if they believe it is too high. In other words, increasing the interest rate will cause inflation to slow down and even stop, which in turn leads to a drop in prices while strengthening the currency! Meaning, it moderates the pace at which the economy grows.

    Remember: In a healthy economy the interest rates usually vary between 3% and 5%.

    For those who are not quite sure what inflation is – it is the growth rate in prices. Inflation is the reason a chocolate bar that cost 5 cents twenty years ago costs 30 times more today. All in all, central banks are interested in market growth, but to control inflation (so it will not go too high), they raise interest from time to time and thereby restrain and control growth.

    Inflation higher than 2% is usually not healthy. The same goes for a market with no inflation at all.

    Impact of Inflation Rates: 

    Example: Assume that a month ago, inflation in your market was 2.6%. During that month inflation rose to 3%. We will definitely want to know what actions the central bank is going to take, and why. We can assure you that this move will affect the market. Why? Because the central bank will increase the interest rates to fight inflation. That means that the respective currency will be evaluated further.

    A high-interest rate has another impact: It attracts outside investors to enter and invest in the economy, and by doing so, it strengthens the currency. Imagine you have $1,000 under your floorboards. You wish to put it into savings and you are about to decide between one of two banks. The clerk in Bank A promises you 5% annual interest ($50 profit). The clerk in Bank B promises you 10% annual interest ($100 profit). Of course, you will choose Bank B.

    For this exact reason, if we look at market activity, high-interest rates will cause many players on the one hand to save more, and on the other hand, to reduce borrowings (it is less worthwhile for them due to higher repayments).

    Think of how exciting it would be if we discovered a world full of possibilities to invest our capital in accounts that are able to yield returns of tens and hundreds of percent annually.

    Well… such a world of possibilities actually exists – the Foreign Exchange Market or Forex! Fundamental understanding can produce tremendous profits, just by knowing market forces and its players. There are several currencies, like Brazilian Real, Russian Ruble, or Vietnamese Dong that have gained a lot of strength in just few months. Experienced traders have made fortunes forecasting and escorting those moves. We are talking about tens of thousands of dollars and more (without even mentioning leveraging profit potential, as you learned in the previous lesson).

    The interest rates also have a high impact on the indices. Normally, stocks would go up when the central bank raised the interest rates because it meant that the economy was improving (like the 2008 financial crisis). Nowadays, the indices go up when the interest rates are cut, because it means that more money will flow into stocks, despite a worsening economy.

    Interest rates across the globe have the biggest single influence on the Forex market!

    The market’s stability is the name of the game for the currency it represents.

    Remember: Announcements about interest rates deeply affect currency trading movements.

    Example: In the early 2000s, the interest rate in the U.S. decreased. This move had a huge influence on the US dollar for many years to come, in a process lasting almost a decade (till approximately 2007-2008). Reducing interest rates weakened the dollar against other currencies, thereby changing the face of U.S. real estate throughout the first half of that decade.

    Interest Rate Rises = Lower economic growth + Inflation slows

    Interest Rate Rises = Lower economic growth + Inflation slows

    Interest Rate Cut = Higher economic growth + inflation speeds up

    Interest Rate Cut = Higher economic growth + inflation speeds up

    The order of events is supposed to follow the order of the above examples, but it doesn’t always work that way. The purpose of the image above is to simply show how things are supposed to go in a perfect world. But we don’t live in a perfect world, and that’s why you must understand the fundamentals. We have written this course for just that – and you can also follow our live market updates to understand the forex market in real time.

    The most significant times in a given market are when interest rates are expected to change. If the interest rate has already moved in a certain direction a few times, it must be balanced back. That is what speculators build their trades on.

    Interest Differentials – a trading method based on two currencies’ rates: Many traders choose pairs by comparing the interest rates of two currencies. If the “interest rate differential” (the gap between the two interest rates) gets bigger, it will strengthen the stronger currency of the two (and vice versa). This strategy is called the “Carry Trade Strategy” (you will learn more about Carry Trading later on in the course).

    • While one interest rate is supposed to go up and at the same time, the other one will go down, this could cause serious changes in price.

    Central Banks and Major Commercial Banks:

    A Central Bank is a state bank whose job is to manage and run the country’s monetary policy while maintaining the currency’s strength and stability.

    The central bank’s monetary policy aims to ensure price stability and market growth. It also controls inflation, interest, money supply, and banks’ reserves.

    In solid markets with continuously growing economies, central banks will respond to high inflation by increasing the interest rate. As we have already mentioned, this constant zapping navigates between the need to retain stability and the desire to attract foreign investors. We as traders can respond by trading according to the monetary policy, its targets, and purposes.

    Central banks can also print more banknotes in order to expand the supply of the currency. This might change its strength compared to other currencies. It would make the currency weaker because the more currency in the market the cheaper it gets.

    Important: This is the reason why it is so important to follow economic releases and events throughout the year, emanating from the central banks!

    Jerome Powell is the current head of the American central bank- the Fed (Federal Reserve Bank). It is recommended to follow the announcements he makes to the media. Remember, Fed policy has the biggest influence in the world on the Forex market.

    Other key players worth mentioning are the largest commercial banks (such as UBS, JPMorgan, Deutsche Bank, Barclays, or Citibank). They have enormous capital. Capital flowing in and out of these corporations suits their policies and market sentiment and can be used as evidence of existing and potential trends. Capital Flow is money movement in and out of the market. We often hear on the news that one of the major banks intends to invest in a particular economy for which it forecasts exceptional growth; this is one of the ways it has to influence the global Forex market.

    Example: During the past few years, Brazil has been a developing market with a fast-growing economy. Commercial banks and corporations from all over the world, and also speculators, commercial firms, and venture capitalists have decided to invest heavily in this track, transferring a high volume of capital into Brazil.

    Major Events, News, and Announcements:

    Several other significant economic events have a big impact on the Forex market. Imagine that all major economic journals and news sites including CNN, CNBC, and Bloomberg report that a certain well-known, major corporation is in real danger of bankruptcy. You can imagine what is going to happen to its share price over the following days.

    Now, take the corporation out of this story and replace it with a country’s economy instead. You can imagine what is going to happen to its currency. You do not have to imagine!

    It is happening all over the world with the economies of the U.S.A, Spain, Italy, Greece, Portugal, and others that are in danger. The effect is similar to stocks and shares. One essential difference between stocks and Forex is that prior information on stocks is illegal, while prior information on currencies isn’t, especially if it can help to predict trends.

    Some major fundamental events:

    NFP (Non-Farm Payrolls) – Released every month, on the first Friday of each month. Presents the change in the number of unemployed over the last month (remember that the number of workers on payroll changes between different periods, according to holidays, year’s end, and vacations). NFP plays a powerful role, in indicating the market’s general condition. The more positive the NFP, the better the condition of the market. It needs to be compared with both the previous month and the market’s expectations.

    GDP (Gross Domestic Product) – Total goods and services produced by a market’s labor (does not include imports). It measures the market’s standard of living and its health. If it rises (compared to the previous report), this indicates a healthy economy which will eventually lead to an interest rate increase. A GDP report can be lower than the previous report but remain positive. Negative GDP, especially if it shows negative numbers more than once consecutively, should turn on a big red light concerning the stability of its currency. GDP has a big influence on decisions made by central banks regarding monetary policy. Its advantage (in traders’ eyes) is that it provides a general, clear picture of a given market, without complicated analyses.

    CPI (Consumer Price Index) – A basket of goods and products, which is published once a month. The market rate that the buyer (or borrower) has to pay the seller (or lender). If it rises, it indicates rising inflation (which in turn will eventually lead to the central bank increasing the interest rate). It is therefore considered an inflation index. The prices included in this index come from retail. When CPI is up but at a lower level than in the previous period, this indicates deflation (prices are still rising, but at a lower rate than previously).

    Remember: There is a positive relation between CPI and interest rate. A CPI that is rising may cause an increase in the interest rate.

    PPI (Producer Price Index) – Index of changes in the consumer goods prices (to the retail networks). In this case, frequent changes indicate changes in prices later on in the chain – consumer prices. The Index includes both prices of products and prices of materials required for production.

    COT (Commitment Of Traders Report) – A slightly different type of report. It does not measure economic conditions, but rather it publishes banks’, companies’ and venture capital holdings in the market. It is released every Friday at 2:30 pm EST (i.e., New York). It helps us understand how different major forces in the market are going to invest their capital. It also helps us understand the general atmosphere and to predict in which direction the wind is going to blow in the future. This report is a great tool for long-term traders. It is also relevant for ‘swingers’.

    Tip: If the COT report includes data on “extreme net long/ short”, you can know that it indicates a change in trend in the next session!

    COT can be presented either as a report or a graph (below a currency chart). Unlike most of the technical indicators, COT measures volumes traded.

    Unemployment Rate – A report on the percentage of the unemployed seeking jobs, out of total the potential labor force. This is published once a month and helps to get a general market view. A strong, healthy economy is characterized by decreasing numbers of job seekers, and by relatively low unemployment rates. A decline in those numbers leads to a stronger currency, and eventually to a rise in interest rates.

    Consumer Sentiment – Issued once a month. It expresses consumers’ attitudes towards the economy.

    Tip: If using this report, compare its elements to those in a Consumer Sentiment Report from another economy. It will help you to make a decision on a good trading partner for the U.S. dollar (or any other major currency).

    Capital Flow – The ratio of capital entering and exiting a market. The data can be either positive or negative. If positive, more investors will enter the market, and bolster its currency, in the same way as the supply/demand ratio. Increasing demand causes a stronger currency.

    Trade Balance – This report shows the ratio of imports to exports. If exports are higher, the ratio is positive! A positive ratio, especially if it is higher than the previous reports, strengthens a currency, making this currency more “desirable”.

    Retail Sales – An excellent index of an economy’s strength. Released once a month, around the 12th of the month, it shows changes in market trends regarding consumer purchases.

    Bank of Canada Rate Decision-After raising their main rate by 100-bps in July – the largest such increase since August 1998 – questions lingered about whether or not the BOC would continue with an aggressive rate hike path. Those questions may have been answered last month, when the July Canada inflation report (CPI) showed signs of decelerating price pressures. Ultimately, more monetary policy tightening is anticipated, but at a slower cadence than anticipated in July. Rates markets have a 75-bps rate hike discounted. Considering the BOC has suggested it is front-loading rate hikes, soft forward guidance may ultimately weigh on the Canadian Dollar.

    ISM Non-Manufacturing PMI (AUG)-While the US economy experienced a slowdown in the first half of 2022, data for Q3 2022 thus far has led the Atlanta Fed GDP Now growth tracker to sit at +2.6% annualized. The upcoming US ISM non-manufacturing PMI for August is expected to come in at 55.1 from 56.7, suggesting that growth is decelerating but remains in modestly positive territory. The forecast is strong enough to keep intact the ‘good news is good news’ paradigm for the US Dollar, but ‘good news is bad news’ for US stocks and gold prices.

    Employment Change & Unemployment Rate (AUG) –According to a Bloomberg News survey, the Canadian economy added +15K jobs in August after losing -30.6K jobs in July. Job gains may not be sufficient to keep up with workers entering the labor market, however, as the unemployment rate is anticipated to rise to 5% from 4.9%. Coming days after the September BOC rate decision, the data may have a muted impact on the Canadian Dollar. Nevertheless, a weak Canada jobs report could prove troublesome for the Canadian Dollar, given the BOC’s stance of softer forward guidance relative to other major central banks.

    FOMC – Federal Open Market Committee is a board that determines the future direction of the United States’ monetary policy. The FOMC includes twelve members (reserve bank presidents, the chairman of the Fed, and governors), who meet eight times per year and make decisions regarding money supply, government securities, interest rates, and the banking system. FOMC meetings are secret; therefore they are the subject of market speculations and large movements of currencies, mostly USD.

    Housing Stats – This says a great deal about recoveries in markets’ growth. Since the 2007-2008 global crisis, this report has played an important role. A rise in times of crisis has considerable influence on a currency’s strength. During the last few years, Housing Starts has been under a magnifying glass, affecting the U.S. dollar as well as the American market in general. (Since the 2007 collapse, the American and also global real estate markets have typically received pessimistic reports).

    Services/Industrial/Manufacturing PMI – This indicator shows the shape of the sectors of the economy which are crucial for any country. Some economies rely more on the service sector while others rely more on the manufacturing and industrial sectors. The US and UK economies are more dependent on the service sector so this economic indicator is more important in these two countries while the manufacturing sector is more important in Germany, China, Japan, France, Italy, etc.

    Beige Book – Published 8 times a year. This detailed report summarizes a market’s economy and offers an inclusive general point of view on the market. It examines:

    • Amount of new manufacturing orders for consumer goods
    • Speed of delivery of new merchandise from suppliers to vendors
    • The average number of initial applications for unemployment insurance
    • Average weekly hours worked by workers in manufacturing
    • Amount of new orders for capital goods (excluding defense)
    • New building permits for residential buildings
    • Consumer sentiment
    • Inflation-adjusted monetary supply
    • S&P 500 stock index
    • Spread between short and long interest rates

    See what affected the Forex market the most in the past 3 years:

    Most volatile reports

    What affects the forex market the most

    Where Can We Find This Information?

    In order for you traders to make important trading decisions, you must glean all the information required. Where can you find those reports? Good questions! The media provides endless news sources, whether in the print press, economic TV, or the Internet. Here are some great live sources:

    Chweya is one of the most popular sites in its field. You will be able to find live market updates, forex trading strategies as well as advice on how to choose the right forex broker to suit your trading needs.

    Recommended news sites that are updated 24/7 include: