Key Factor 2. Economic Growth.
The next factor you need to consider when predicting a country's currency movements is its economic growth. The stronger the economy, the greater the possibility that the central bank will raise its interest rates to tame the growth of inflation. And the higher a country's interest rates, the bigger the likelihood that foreign investors will invest in a country's financial markets. More foreign investors means a greater demand for the country's currency. A greater demand results in an increase in a currency's value. Hence, a ripple effect: economic growth inspires higher interest rates inspires more foreign investment inspires greater currency demand which inspires an increase in the currency's value.
How Anemic Economic Growth Crashed EUR/USD 2,000 Points
For a good example of the impact of economic growth on the direction of currency rates, let’s look at the EUR/USD from 2005 to 2006. Economic growth is best measured by a country's Gross Domestic Product, or GDP. The United States and Eurozone represent two of the most prosperous regions in the world with GDPs running at $13 trillion and $11 trillion respectively.
In 2005 and 2006, the difference in growth rates between the two major economic powers was clearly reflected in currency movements. In 2005, the Eurozone lagged significantly behind the United States in economic growth, averaging an anemic 1.5% rate throughout the year while the US expanded at a healthy 3% rate. Consequently, investment capital flowed from Europe to the US and the EUR/USD dropped by nearly 2,000 basis points by the end of 2005. In 2006, however, Eurozone growth perked up while US growth began to slow. At the end of 2006, Eurozone GDP actually overtook US growth rates, causing the EUR/USD to rally.
In 2005, The EUR/USD plummeted as Eurozone showed little economic growth compared to the US GDP. In 2006, as the EZ GDP rallied, so did the EUR/USD.
We've used GDP's to forecast trends on several more Forex trades in the last months. One great example is our November 14, 2006, United States dollar/ Japanese yen trade (USD/JPY).
67 Points in Four Hours
In the middle of November 2006, hurt by the contraction in its housing sector, the US economic data began to deteriorate. Rumor had it that the US might lower interest rates in the first quarter of 2007, which would encourage foreign investors to look elsewhere.
Meanwhile, the Japanese economy was buoyed by the weak yen that made Japanese products affordable internationally and helped spur double digit growth in exports. On November 14, 2006, the Japanese GDP printed at much better than expected -- 2% versus the 1% forecast. We decided to take advantage of the strength of the Japanese economic growth vs. the relatively weak economic outlook in the US, so we went short USD/JPY at 117.82. As we hoped, that morning, in sharp contrast to Japan, US retail sales produced very weak numbers and the USD/JPY pair collapsed. We were able to collect 67 points on the trade in less than four hours.
United States dollar vs. Japanese yen, November 14, 2006. The strong economic growth in Japan made the USD/JPY trade a success for us in November.
Five Key Factors that Move the Forex Markets..
..and How to Profit from Them!
1.Interest Rates 2.Economic Growth 3.Geo-Politics
4.Trade and Capital Flows 5.Mergers and Acquisitions
..and How to Profit from Them!
1.Interest Rates 2.Economic Growth 3.Geo-Politics
4.Trade and Capital Flows 5.Mergers and Acquisitions
