Understanding the factors that influence the trends of major currency pairs is very important for us to successfully trade in the forex market. We will focus on analyzing EURUSD, GBPUSD, USDCHF, USDJPY, USDCAD, and AUDUSD.
I. Factors Influencing the Trend of EUR/USD
1. Characteristics of the Euro
The euro accounts for 57.6% of the weight in the US Dollar Index. This means that the euro has the largest weight and is essentially considered the counter currency to the dollar, or the "anti-dollar". Forex traders can use the euro to gauge the strength of the dollar’s trend.
Speaking of the euro’s own currency characteristics and trend features, it is the most robust currency among the major non-USD currencies due to its large proportion and volume in international transactions, similar to blue-chip stocks in the stock market.
As a "leading stock", the euro often guides the trend of European currencies and other non-USD currencies. From this perspective, we suggest that beginners should choose the euro as their primary trading currency. There are several reasons for this suggestion.
Firstly, since the euro has only been in circulation for a few years, it has been traded during the period when technical analysis became networked and popularized, so its trend is quite consistent with the rules of technical analysis.
Secondly, because of its large trading volume, it is not easily manipulated, and fewer factors disrupt the technical trend. From a technical analysis standpoint, this makes the grasp of its longer trends more effective.
Lastly, except for some special market conditions and trading sessions, usually, the reliability of breaking through key levels, trend lines, and patterns is relatively strong and suitable for orthodox breakout trading principles.
2. Factors Influencing the Euro
The main fundamental factors that affect the euro include the following:
(1) Inflation Level
The sole objective of the monetary policy in the euro area is price stability, which differs from the Federal Reserve’s monetary policy objectives, as the US policy must consider both employment and price stability.
Price stability in the euro area is mainly measured by the Harmonized Index of Consumer Prices (HICP), with a policy requirement that its annual growth rate is below 2%. If it exceeds this level, interest rate hikes are likely.
(2) 3-Month Euro Deposits in Europe
This refers to euro deposits held in banks outside the euro area. The interest rate differential with other countries’ same-period rates is also used to assess exchange rate levels, as capital tends to chase high returns.
Therefore, when the interest rate for three-month euro deposits in Europe is higher than that for the same period of US dollar deposits, the EUR/USD exchange rate is boosted.
(3) German 10-Year Government Bonds
The interest rate differential between 10-year government bonds in the euro area and US 10-year Treasury bonds is another key factor affecting the EUR/USD trend.
Since Germany is the economic engine of the euro area, we use German 10-year government bonds as a benchmark for specific comparisons.
If the interest rate level of German 10-year government bonds is lower than that of US Treasury bonds, but the differential is gradually narrowing (i.e., the yield on German government bonds is rising or the yield on US Treasury bonds is falling), it will theoretically boost the EUR/USD trend.
Therefore, the trend and expectations of the differential are generally more indicative than their absolute values.
(4) 3-Month Euro Futures Contracts
The value of this contract shows the market’s expectation of the interest rate for three-month euro deposits in Europe (related to the contract’s expiration date).
For example, the interest spread between the three-month euro futures contract and the three-month US dollar futures contract will affect the basic changes in the future trend of EUR/USD.
(5) Important Economic Data from the Euro Area
The most important economic data comes from Germany, as it remains the largest and most influential economy in the euro area, and the prototype of the European Central Bank also comes from the German central bank. One important economic data point is the IFO survey, a widely used business sentiment index.
(6) Fiscal Deficits of EU Member States
The euro area has a unified monetary policy but lacks effective unity in fiscal policy, which threatens the stability of the euro.
To consolidate the euro’s position and maintain its stability, the euro area has established the Stability and Growth Pact, which stipulates that each country’s fiscal deficit must be controlled below 3% of GDP, and each country has the obligation and goal to further reduce the deficit.
3. The EU’s Main Trading Partners
The EU’s main export destinations are the United States, Switzerland, and Japan.
The EU’s main import sources are the United States, Japan, and China.
II. Factors Influencing the Trend of GBP/USD
1. Characteristics of the British Pound
London, as the most active financial center for currency trading, has greatly benefited the British pound. The pound was once the world’s currency and remains a favorite among speculators, as well as being one of the most valuable currencies due to its high exchange rate against the dollar.
The pound also experiences significant daily fluctuations, but its trading volume is much less than that of the euro. Not only does the GBP/USD pair show high volatility, but so do cross-currency pairs like GBP/JPY and GBP/CHF.
One of the main reasons for this is that London, as the earliest forex trading center, has top-notch currency traders whose skills and experience are well reflected in the movements of the pound.
Due to these reasons, the pound has a particularly high speculative component compared to the euro, which is especially evident in short-term fluctuations. London traders have a “tried and true” method of “deceiving” less experienced investors by intentionally triggering stop-losses at the opening of London trading, then moving in the actual direction of the trend.
For this reason, short-term trading of the pound is a "litmus test" for investors’ skills. However, we advise traders who are not yet mature in their experience and skills to stay away from the pound.
Geopolitically and economically, the pound belongs to the European currency group. The UK is closely related to the eurozone in terms of economy and politics, as can be seen from its main import and export partners.
Due to this close connection, economic and political changes in the EU have a significant impact on the pound. However, if the UK were to join the eurozone, then UK interest rates would have to be lowered to the euro level.
Therefore, any talk of the UK possibly joining the eurozone would depress the pound’s exchange rate. Additionally, since the UK has oil in the North Sea, rising oil prices are generally beneficial to the pound, all other conditions being equal.
2. Factors Influencing the British Pound
The main fundamental factors affecting the pound include:
(1) Benchmark Interest Rate
The Bank of England is the central bank of the UK. It is responsible for setting the main interest rate, which is the minimum lending rate (base rate).
In the first week of every month, the Bank of England sends a clear monetary policy signal to the market through interest rate adjustments. Since interest rate differentials are a major cause of international capital flows, changes in the benchmark rate usually have a significant impact on the pound.
(2) 10-Year Gilt Yield
The yield on UK gilts compared to other countries’ bonds or US Treasury bonds also greatly affects the exchange rate of the pound with other currencies.
(3) Important UK Economic Data
Key economic data from the UK includes initial unemployment claims, average earnings, retail price index, industrial production, gross domestic product, purchasing managers’ index, and manufacturing and services sector survey reports.
(4) 3-Month Sterling Deposit Futures
The price of this contract reflects the market’s expectations for the interest rate on sterling deposits in Europe three months later. The difference in price compared to other countries' futures contracts for the same period can also cause changes in the pound’s exchange rate.
3. The UK’s Main Trading Partners
The UK’s main export destinations are the United States and the eurozone.
The UK’s main import sources are the United States and the eurozone.
III. Factors Influencing the Trend of USD/CHF
1. Characteristics of the Swiss Franc
Due to historical tradition and international law, Switzerland is a traditional neutral country, and the Swiss franc is a traditional safe-haven currency.
During political turmoil in the US and outside the European continent, it can attract safe-haven capital inflows. Additionally, the Swiss constitution once stipulated that every Swiss franc must be backed by 40% gold reserves.
Although this regulation is no longer in effect, the Swiss franc still has a psychological connection to the price of gold. An increase in the price of gold can lead to a rise in the Swiss franc to some extent.
This psychological link to gold further strengthens its characteristics as a safe-haven currency. Switzerland is a country with an extremely developed financial industry, and its investors in Zurich are world-renowned.
Switzerland is a small country, so the exchange rate of the Swiss franc is more influenced by external factors. Also, as it belongs to the European currency group, it generally follows the trend of the euro, and its chart is a mirror image of the euro.
2. Factors Influencing the Swiss Franc
The main fundamental factors affecting the Swiss franc include:
(1) Benchmark Interest Rate
The Swiss National Bank is the central bank of Switzerland. It uses changes in the discount rate to announce changes in monetary policy. These policy changes have a significant impact on the currency. However, the discount rate is not often used by banks for discounting purposes.
(2) 3-Month Swiss Franc Deposits in Europe
Swiss franc deposits held in non-Swiss banks are known as European Swiss franc deposits. The interest differential with other countries’ European deposits is also an important factor influencing the trend of the Swiss franc.
(3) Important Economic Data
The most important economic data for Switzerland includes money supply, consumer price index, unemployment rate, balance of payments, gross domestic product, and industrial production.
3. Switzerland’s Main Trading Partners
Switzerland’s main export destinations are the eurozone and the United States.
Switzerland’s main import sources are the eurozone and the United States.
IV. Factors Influencing the Trend of USD/JPY
1. Characteristics of the Japanese Yen
Japan’s domestic market is small, and the country has always maintained an export-oriented approach, establishing itself through education and science. Especially in the past decade or so, with economic recession, exports have become the only opportunity for domestic economic growth.
To suppress the strengthening of the yen, the Japanese Ministry of Finance frequently intervenes in the foreign exchange market to prevent the yen from becoming too strong. Maintaining the competitiveness of export products has become a customary foreign exchange policy for Japan. The means of intervention in the foreign exchange market in Japan mainly include verbal intervention and direct market entry.
Therefore, the frequent comments by officials from the Bank of Japan and the Ministry of Finance have a significant impact on the short-term fluctuations of the yen, which is a key focus for short-term investors and also a difficulty in short-term yen operations.
Because Japan’s economy is highly connected to the outside world and closely related to important trading partners such as the United States, China, and the Southeast Asian region, the yen exchange rate is very susceptible to external factors.
For example, China’s economic growth has become increasingly important for the recovery of Japan’s economy, so news of a slowdown in China’s economic growth has an increasingly negative impact on the yen exchange rate.
Although Japan is an economic powerhouse, it is politically small and has to be suppressed by the United States. Therefore, in terms of exchange rate policy, it needs to conform to the wishes and interests of the United States. The "Plaza Accord" of 1985 is a result of being politically weak and subject to others.
The rise in oil prices is negative for the yen, although Japan’s dependence on oil has been decreasing, and Japan has now invested heavily in oil fields and oil transportation facilities, so the impact of rising oil prices on Japan is not as great as before.
2. Factors Influencing the Japanese Yen
The main fundamental factors affecting the yen include:
(1) Intervention by the Japanese Ministry of Finance
The influence of the Japanese Ministry of Finance on exchange rates exceeds that of the United States, the United Kingdom, or Germany.
Officials from the Japanese Ministry of Finance often make comments about the economic situation, which generally affects the yen, such as when the yen appreciates or depreciates against the fundamentals, the officials will intervene verbally. Therefore, several officials from the Japanese Ministry of Finance have been called "Mr. Yen".
(2) Benchmark Interest Rate
The Bank of Japan is Japan’s central bank. The overnight call rate is the main short-term interbank interest rate, decided by the Bank of Japan. The Bank of Japan also uses this rate to express changes in monetary policy, which is one of the main factors affecting the yen exchange rate.
(3) Yield on Japanese Government Bonds
To enhance the liquidity of the monetary system, the Bank of Japan purchases 10-year or 20-year Japanese government bonds every month. The yield on 10-year Japanese government bonds is considered a benchmark indicator of long-term interest rates.
For example, the basis difference between 10-year Japanese government bonds and 10-year US Treasury bonds is considered one of the important factors driving the direction of the USD/JPY exchange rate. A fall in the price of Japanese government bonds, i.e., a rise in yield, usually benefits the yen.
(4) Important Economic Data
Important economic data from Japan includes gross domestic product, Tankan report, balance of payments, unemployment rate, industrial production, and money supply.
3. Japan’s Main Trading Partners
Japan’s main export destinations are the United States, China, and South Korea.
Japan’s main import sources are China, the United States, and South Korea.
V. Factors Influencing the Trend of USD/CAD
1. Characteristics of the Canadian Dollar
The Canadian dollar is a "commodity currency". Canada is the most export-dependent country among the G7, with exports accounting for forty percent of its GDP, and the main export products are primarily agricultural and seafood products.
Additionally, Canada is the only oil-exporting country among the G7, so the rise in oil prices is a significant boon for the Canadian dollar, allowing it to perform well against the yen in cross-exchange trading.
The Canadian dollar is a very typical "American currency" with 80% of its exports going to the United States, and Canada’s economic dependence on the United States is extremely high. This is reflected in the exchange rate as the Canadian dollar’s trend against major currencies is consistent with the US dollar’s trend against major currencies.
For example, the euro against the Canadian dollar and the euro against the US dollar maintain good synchronicity in the chart, although this connection has gradually weakened in recent years with the general decline of the US dollar. Often, we can infer US economic data from Canada’s economic data.
2. Factors Influencing the Canadian Dollar
The main fundamental factors affecting the Canadian dollar include:
(1) Commodity Prices
The Canadian dollar exchange rate is more affected by non-energy commodity price changes. The rise in oil prices puts pressure on the Canadian dollar because it weakens the purchasing power of the Canadian dollar.
(2) Benchmark Interest Rate
The central bank of Canada is the Bank of Canada, whose main goal is to maintain price stability. As a commodity-exporting country, its economy is always prone to overheating, so Canada’s interest rates are relatively high to ensure inflation remains within controllable limits.
Additionally, higher interest rates make the Canadian dollar a target for carry trades, which undoubtedly exacerbates the strength of the Canadian dollar.
(3) Mergers and Acquisitions Activity
Because Canada and the United States belong to the North American Free Trade Area, economic ties are highly close, so corporate mergers and acquisitions are frequent.
These activities will lead to cross-border capital flows and currency conversions, which have a significant short-term impact on the trend of the US dollar against the Canadian dollar.
(4) Important Economic Data
Important economic data from Canada includes unemployment data, consumer price index, gross domestic product, international trade balance, and producer price index.
3. Canada’s Main Trading Partners
Canada’s main export destinations are the United States, the eurozone, and Japan.
Canada’s main import sources are the United States, China, and Mexico.
VI. Factors Influencing the Trend of AUD/USD
1. Characteristics of the Australian Dollar
The Australian dollar is also a typical "commodity currency", "American currency" and "Asian currency".
Australia has an absolute advantage in the international trade of industrial raw materials such as coal, iron ore, copper, aluminum, wool, and cotton textiles, so the rise in prices of these commodities greatly promotes the rise of the Australian dollar.
Additionally, although Australia is not an important producer and exporter of gold, the Australian dollar has a clear positive correlation with gold prices. The same is true for oil prices.
For example, in recent years, the international commodity futures price index, which represents the world’s major commodity prices, has been climbing, especially after the second half of 2001, when the sharp rise in gold and oil prices boosted the strength of the Australian dollar.
However, after 2010, with China’s soft landing and economic transformation, the trend of the Australian dollar has been less favorable, coupled with US interest rate hikes, leading to its decline.
2. Factors Influencing the Australian Dollar
The main fundamental factors affecting the Australian dollar include:
(1) Commodity Prices
The Australian dollar, known as a "commodity currency", has a close relationship with the prices of commodities, such as gold, copper, nickel, coal, and wool, which account for nearly two-thirds of Australia’s total exports.
Therefore, the trend of the Australian dollar is usually influenced by the trends of these commodity prices. The Australian dollar often receives support in an inflationary economic environment, which is precisely when commodity prices are rising.
(2) Japanese Economy
The Australian economy is closely linked to the Japanese economy, after all, Japan absorbs 20% of Australia’s exports, which explains why the Australian dollar follows the trend of the yen.
For example, the negative correlation between the exchange rate of the Australian dollar against the US dollar and the exchange rate of the US dollar against the yen in the foreign exchange market is relatively easy to identify.
(3) Benchmark Interest Rate
The Central Bank of Australia is the Reserve Bank of Australia. The most important monetary policy tool of the Reserve Bank of Australia is the overnight money market rate or the cash rate target. The cash rate is the overnight lending rate between two financial institutions.
3. Australia’s Main Trading Partners
Australia’s main export destinations are Japan, the United States, and China.
Australia’s main import sources are the United States, Japan, and China.
The above are the main factors influencing the trend of major currency pairs in forex trading. We find that the price of each currency is related to its own country’s politics, economy, trade, and other factors. These factors are the fundamental drivers of currency trends. In forex trading, we should pay attention to these fundamental factors.