As we have mentioned in other posts, when you think of the 'Foreign Exchange' (FX) markets, you should imagine an actual old fashioned market, with stalls, sellers, masses of stock and/or more niche and homegrown wears.
Whilst the financial markets exist only in the electronic sphere, each of their many iterations are the same in principle and are fuelled by supply of products and demand for them.
But, someone who doesn't visit a market and relies on others to buy produce for them (we're sticking with the 'market' analogy here) would be forgiven for not understanding some of the terms and concepts at play.
Furthermore, if a change in the price of something directly affects you and your pocket, but, a detailed understanding of why that price has changed is not openly and freely available outside of the world that determines the price, then, how can you be expected to choose wisely when it comes to where best to buy what you want?
Rates of exchange change all the time.
We have commented before that, in one sense, this is because of the speed and sophistication of software that matches what someone is willing to pay for a currency with what someone is prepared to sell the currency for...
The bigger question is really what determines those two figures/prices?
What determines the rate/price a bank might ask for one currency and the amount a bank is prepared to pay for another?
Well, short of going into a dissertation about the global capital markets, we thought we might venture an opinion on some of the theory behind this question and some of the things that influence whether a currency is bought or sold, or held for the longer term.
Generally speaking 'risk' is one of the biggest factors in determining whether anyone does anything, regardless of whether that 'anything' is to do with financial products, stocks and shares, investments, building a house, leaving one's job, moving abroad...
The risk of something changing to one's detriment and the likelihood or probability of the opposite occurring tends to be the overriding motivator in any action.
Risks come in many forms and can be expressed in many different ways.
Again, 'risks' aren't necessarily confined to talk about finance and returns or losses.
A currency is, generally speaking, a measure of worth or value.
Yes, currencies are typically a system of money in use in a particular country, but, given that more or less anyone can accumulate a currency, currencies are essentially the unitary measure of the worth of a series of abstract, tangible or intangible, expressions.
You and I think of currency as being hard money we might use to pay for something.
But, goodwill is a form of currency.
Payment in kind could be considered a type of currency too.
When it comes to what influences the worth someone, whether they are a country or an individual like you and I, places on something, one has to look at the uses that person might have for that 'currency'.
What can that measure, that good will, that gold, that bike, that bit of data, be used for?
In a globalised world, holding currencies serves as security.
Having a stock-pile of readily available and globally in demand currency means you can react quickly to changes in circumstance; both your own and someone else's.
You can offset the effects of certain things and you can mitigate the risk associated with a certain course of action or the effects of certain influences that might more broadly affect your circumstances.
When it comes to currencies, changes in the rate of exchange are generally fuelled, for good or ill, by the perceptions of those holding or seeking to hold, those currencies.
On the Prime Cap Data Centre we list a few of the publicly acknowledged influences that can have effects on the movements of rates of exchange.
Central Bank meetings, minutes & press conferences.
Interest rate changes + speculation, inflation reports & GDP figures.
National Indexes - mortgage approvals, employment count, public sector borrowing, consumer price index.
Natural disasters, terrorist acts, political uncertainty & civil unrest.
News media sentiment, innuendo & day-trading shifts and appetites.
We must emphasise that the factors listed above are really only anecdotally relevant 'sign posts' which we know to be looked at by those who make decisions about the currencies they hold.
Whether you or I (at a high-street level) or a Central Bank, institution or globalised business, if we are holding currencies for currencies sake then we might look at these sign posts to determine how we feel about our longer term dealings in currencies.
All of the information and data sources referenced above are, in fact, directly linked to actual rates of exchange in one way of another.
By this we mean that you can, to a greater or lesser extent, identify a relationship between the flow of capital into or out of a country which, when expressed as a value, might prompt someone to increase or decrease their holding in a particular currency, but, that increase and/or decrease could and can, in itself, determine the measure of other expressions of activity in other areas of an economy.
Look at the recent price corrections with regards to products being sold in UK super markets.
The government uses the Consumer Price Index (CPI) as a measure of inflation.
A higher or lower rate of exchange has a direct effect on the price at which something might be sold in a supermarket.
A higher price because of a change in the exchange rate is fed in to the CPI which in tern has an effect on how the Bank of England views inflation in the UK.
Now, the rate of exchange on it's own does not prompt the BoE to increase or decrease their intervention in the UK's monetary system per se, but, it is both a symptom and a cause depending on how you chose to value it's role and, when considered along with the myriad of other indicators, it may prompt a certain outcome or recommendation.
The reason why you will not find anyone with an understanding of the part rates of exchange play in economics predicting with any certainty as to where a rate will be and when, is because the influences, demand, supply and appetite for a currencies changes as often as the wind.
Yes, those working with currencies or those with some sort of an engagement with foreign exchange and currency activities, can interpret certain data and arrive and certain conclusions, but, the landscape and the framing of that interpretation can very well change without warning depending on the appetites of 'the market'.
Events that cannot be predicted have a very significant effect on exchange rates largely because those engaged with rates of exchange have to, when presented with something they had not anticipated, make decisions very quickly.
Some times these decisions themselves can have effects on rates of exchange, but, most governments, institutions and investors want to limit the detrimental effects of an event on them.