Economy and Currency -Overview:
The characteristics of individual currencies arise from the state of the economy of the country in question, and also from its major exports in relation to their demand. For example an oil-centric economy would suffer were the demand for oil to drop, and so, therefore, would its currency. Although technical analysis is largely used in Forex, knowledge of how the economy of individual countries is affected by demand for their exports will also offer extremely useful information that must be taking into account in your investment strategy.
You can often construct a Forex strategy round the exports of certain countries, and how the developing world provides a demand for these. You can also adapt your Forex investment strategy around any world or geographical events that affect the availability or demand for the resources of any particular country. Here is why:
The currencies of certain countries are referred to as 'commodity currencies' because their strength is dependent on the demand for their major commodity exports: exports such as minerals, precious metals and oil. Should the demand for any of these fall or increase, then it can be expected that an equivalent reduction or increase in the value of the currency of these countries would occur.
Thus, by keeping an eye on the demand for the exports of specific countries, you should be able to forecast an increase or reduction in the value of the economy of that country. Such countries tend to come in groups, because it is rare for one country's economy to rely on the demand for any specific commodity.
Commodity Currencies: Examples
The commodity currencies in mind at this moment are those of Australia, New Zealand and Canada. i.e. AUD (Australian dollar), NZD (New Zealand Dollar) and CAD (Canadian Dollar) Within each of these countries, the internal demand for their major products is less than the production of these products, so the GDP of each country relies upon exporting their natural resources. These countries rely on export for their wealth and the health of their currency rather than internal consumption.
For Canada, these exports involve agricultural products, crude oil, lumber, minerals, natural gas and petroleum. Should world demand drop for these, or should large resources of these be found elsewhere, then the Canadian Dollar would be under threat. The same is true for New Zealand with fishing, lumber and wool and other agricultural products such as lamb. Should demand drop then the New Zealand Dollar may also drop.
Finally we come to Australia, as our third example of a commodity country. The Australian economy relies largely upon exports of coal, iron ore and gold, with crude oil and other minerals such as opals coming up behind. Should any of these lose worldwide demand then the Australian Dollar might also lose value.
If these three countries were listed in terms of which relied upon these exports for their Gross Domestic Product (GDP), then Australia would be first, then New Zealand and then Canada. In order to determine the future of the currency of these three countries, we have to look at the market for their assets, and right now, with China and India on the up and using increasing amounts of oil, lumber, iron and other mineral assets, the economies of Australia, New Zealand and Canada appear secure.
Safe Haven Currencies
What Forex investors have to look at carefully is any situation whereby these commodities could decrease in value. When that day comes, the market values of these currencies will also drop. That is one of the reason why many investors seek what are known as 'Safe Haven' currencies, in which they can invest when times are volatile because they know that 'safe havens' will maintain value no matter what.
Examples of such currencies are the US Dollar and the Swiss Franc . Whenever there is what is known as a 'risk aversion', investors will tend to place their money into the safe haven currencies. The opposite to 'risk aversion' is 'risk appetite', describing those with an appetite for risk, and who invest in higher-risk currencies. In risk aversion, it is considered that the market may be too volatile, and that even relatively safe risks are no longer safe, so investments are made into to the safe heaven currencies. This can often have the effect of even further reducing the value of the higher risk currencies.
The US Dollar reserves held by a number of central banks in 2010 were above 61%, in comparison to the Euro where investments were at just over 26%. The interests of the many economies investing in the US Dollar are against devaluation in the value of the dollar, and so it is unlikely to happen. It is therefore a 'safe haven' currency whose value is expected to be maintained.
The Swiss Franc is regarded as a safe haven because of the rate of inflation in Switzerland of almost 0%, although while it is no longer required to back the Swiss Franc with a minimum 40% gold, the percentage of gold reserves against the currency is still at a high level of more than 27%, so the Swiss Franc is considered secure.
There is also evidence that the euro may be regarded as a safe haven in the future, particularly since the euro reserves increased by 8.4 percentage units from 1999 to 2010, a period when US Dollar reserves dropped. As it goes with powers, we tend to end up having two powers. It is to be see if the power of being the safe heaven status remains with EUR and USD or EUR and CHF or the long standing USD and CHF.
Some thoughts on Safe haven status and Euro and Dollar
Low Yield Currencies
The currencies regarded as offering a low yield include the Japanese Yen that has experienced low interest rates recently, largely due to the very low inflation rate in Japan, and another is the Swiss Franc, which while a safe haven, is otherwise of little interest to the Forex investor. However, such low-yielding currencies tend to rise in popularity during times of global turmoil when there is little confidence in the global economy, the main reason for this being the unwinding of carry trades rather than these currencies being considered safer.
When risk appetite is high, and they feel like taking a chance on the Forex markets, investors tend to risk their money in high yield risk and sell the lower yielding and lower-risk currencies to fund their stakes. However, when there is a downturn in global economies, they tend to pull out of the higher risk investments and currencies and go back the safe havens until something else of interest happens.