From the April 01, 2011 issue of Futures Magazine • Subscribe!

Top five forex fundamentals

4. Geopolitical events/Acts of God: Forex markets are open 24 hours a day, five days a week. Consequently, they move fast when any news hits. "Exchange rates react much more quickly to geopolitical events than other forms of investing. Currencies are more volatile. It’s a 24-hour market that reacts very quickly to news and events," Boyd says.

These events include pretty much anything that couldn’t have been predicted such as war, civil unrest, weather situations or anything that causes uncertainty in an economy. "These are pretty broad-based [events]," Regan says. "Anything that is bad enough news on a geopolitical basis is going to have an impact on currencies."

Events in themselves do not move currencies; rather it is the underlying factors at play. The Libyan civil unrest is a good example of this. While the events are stark enough, the real fear in the market revolves around Libya’s oil production and, more importantly, regional oil production if it leads to contagion in the region, particularly to Saudi Arabia. If oil production is threatened, then oil prices must rise, which push gasoline prices. Consumers then must spend more on gas, leaving them less to spend elsewhere, which can lead to stagnation in the economy.

5. Commodity prices: Commodity prices affect currencies differently depending on the use of those commodities in each country. A lot of that depends on whether a country is an importer or exporter of a particular commodity (see "Follow the yellow brick road," below).

Crude oil prices typically are a good example of this. Canada is generally thought of as the currency to benefit most from rising oil prices because it exports so much oil. Alternatively, the United States often is hindered from rising oil prices because studies have shown that as gas prices rise, consumers cut spending on other discretionary items to make up the difference.

"[The Aussie and Canadian dollars] react most quickly to commodity changes. The impact that commodity prices have on other currencies is probably more from a demand side," Boyd says. "If demand is up, the Aussie and Canadian get that boost right away, but then it’s a matter of where that demand is coming from."


Big picture

Currencies move for numerous reasons, ranging from central bank actions to weather disasters. It is important to remember, though, that exchange rates are always expressed in pairs, so you are always measuring pros and cons of two currencies.

One more thing to consider is that while currencies are measured by their relative strength vs. other currencies, they also are measured by their stability. The U.S. dollar has long been the reserve currency of the world. For all its flaws, even today, it is seen as perhaps the most stable currency; so when the global credit crisis hit the dollar rallied sharply. The dollar rallied on bad news because it was viewed as a safe haven.

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