The forex currencies of a country are influenced by a series of macro-economic conditions as well as the world’s economic situation. Macro indicators like Economic indicators (GDP growth, imports/exports), social factors (the unemployment rate, country infra-structure or real estate market conditions) and the country central bank’s (like RBI in india) policies are the key factors that determine the value of a currency on the foreign exchange market.
In this section, we will learn about the distinct features of six major currencies.
The US Dollar dominates the world foreign exchange market heavily. The US Dollar is the base or universal currency to evaluate any other currency traded on forex. Almost all currencies are generally quoted in US dollar terms.
The US dollar currently represents about 86% of all foreign exchange market transactions. Most commodities (metals, oil etc.) are traded with prices denominated in US Dollars; as a result, any fluctuations in supply and demand of these commodities have direct impact on the value of US Dollar. This happened in 2008 financial crisis when oil prices collapsed and the EUR/USD climbed to 1.60.
As US dollar is considered as the safe-haven currency. Therefore, investors move towards the dollar when economic conditions deteriorate.
The Euro is the second most dominating currency in the forex market. Like the US Dollar, the Euro also has a strong international acceptance streaming from the members of the European Monetary Union.
The Euro is used by 18 member countries of the European Union and is currently accounted for almost 37% of all forex transactions.
The main factors that influence the acceptance of Euro’s prices are often based on wellestablished economies (developed countries) that use the common currency, such as France and Germany. Euro prices depend on key countries (like Germany) Consumer Price Inflation (CPI), the European Central Bank, unemployment rate, and exports data.
The Euro is the common currency of all the European countries and there is a difference between these countries’ economies, as was highlighted during the 2011 debt crisis. This restricts the dominance of Euro in the global forex market. In the event of problems, EU leaders have a hard time finding common solutions that are beneficial to both the large and small economies.
The Japanese yen is the most traded and dominating currency in the Asian forex market. It is the third most popular or traded currency in the forex market and represents almost 20% of the world’s exchange. The natural demand to trade the Yen comes mostly from the Japanese Keiretsu, the economic and financial conglomerates. The Japanese stock market, .i.e., the Nikkei index and real estate market correlate with the volatility of the Japanese yen (JPY).
Because the Japanese economy is mostly an industrial exports economy, the Japanese currency (JPY) among traders and investors is considered as a safe-haven currency in periods when risk aversion hits the market. Low interest rates in Japan allows traders to borrow at low cost and invest in other countries.
The JPY’s currency risks are related to the constant devaluation of the currency and the interventions of the country’s central bank. Because japan is an export oriented economy, the central bank is constantly trying to weaken its currency.
The British Pound is the UK’s currency. Until the end of World War II, the pound continued to have the same dominance in forex market what is US dollar today and was the currency of reference. The currency (GBP) is heavily traded against the euro and the US dollar but has less presence against other currencies.
The British Pound (GBP) is the fourth most traded currency internationally and about 17% of all transaction is done through GBP in global forex market. Because London is considered as the forex market hub globally, 34% of all forex transaction pass through London City.
The fundamental factors that affect the pound are as complex and varied as the British economy and its influence on the world. Inflation, country GDP and the housing market influence the pound value.
Forex traders sometimes use the pound as an alternative to the euro especially when the European Union’s problems become too bad.
The Swiss Franc is the currency and legal tender of Switzerland. The currency code for Franc is CHF and the most popular Switzerland franc exchange rate is the CHF/EUR pair. It is also, the only currency of a major European country that neither belongs to the European Union nor to the G-7 countries. Though the size of the Swiss economy is relatively small, the Swiss franc is one of the four major currencies traded in the forex market, closely resembling the strength and quality of the Swiss economy and finance.
The CHF is also considered as the safe-haven currency and investors move towards it during periods of risk aversion: the Swiss economy and its foreign reserves mainly gold (7th largest reserve in the world) add to the currency’s credibility.
The CHF prices depend on the central bank policy. The CHF tends to be more volatile compared to other major currencies due to lack of liquidity.
The CAD is a commodity driven currency. This is because the Canadian economy is exportoriented and the main product of export is crude oil. Therefore, the Canadian Dollar prices are influenced by the price of crude oil.
Global economic growth and technological progress help to make the CAD attractive to investors.
There are different ways in which trading is done in the global forex market. The commonly followed trading systems in the forex market are described below −
The foreign exchange broker or the forex broker also known as the currency-trading broker unlike the equity or commodity brokers does not hold positions. The main role of these brokers is to serve banks. They act as intermediaries to buy and sell currencies at commissioned rates.
Before the dawn of Internet, a majority of the FX brokers executed orders via phone using an open box system. There was a microphone in the broker desk that continuously transmitted all that he communicated on the direct phone lines to the speaker’s boxes in the banks. This way, banks also received all the business orders.
In an open box system used by brokers, a trader is able to hear all the prices quoted; whether the bid was executed or the offer (ask) taken; and the price that followed. What is hidden from the trader is the amounts of particular bids and offers and the names of the banks showing the prices. The prices were confidential, and the buyers and sellers were anonymous.
In this age of Internet, many brokers have allowed clients to access their accounts and trade through electronic platform (mostly through their proprietary software) and computer applications.
Direct dealing is based on the economy of mutuality. All participants in the currency market – a bank, establishing a price, thinks that the other bank that has turned to it will reply with mutuality, establishing its own price, when they turn to the bank. Direct dealing provides freedom of actions than the dealing of the broker market. Sometimes traders take advantage of this characteristic.
Direct dealing previously took place over the phone. This gave way to mistakes which could not be identified and rectified. The mid-1980s witnessed a transition from direct dealing to dealing systems.
Dealing systems are computers that link the contributing banks around the world. Each computer is connected with a terminal. To connect to a bank through dealing system is much faster than connecting through a phone. The dealing systems are getting more secure by each day. The performance of dealing system is characterized by its speed, safety and reliability. The trader is in permanent visual contact with the information changing on its terminal/monitor. It is more comfortable with this information rather than to be heard during the switches, during the conversations.
Many banks use a combination of brokers and direct dealing systems. Both these methods can be used by the same bank but not in the same market.
Matching systems are quite different when compared with dealing systems. Matching systems are anonymous and individual traders deal against the rest of the market, similar to dealing in the broker’s market but unlike dealing systems where trading is not anonymous and is conducted on a one-to-one basis. Unlike the broker’s market, there are no individual to bring the prices to the market, and liquidity is limited at times.
The different characteristics of matching systems are – speed, safety and reliability like the dealing system we have. One advantage in matching system is that credit lines are automatically managed by the systems.
In the interbank market, traders deal directly with dealing systems, matching systems and brokers in a complementary fashion.