Trading currencies on the foreign exchange, or forex, markets enables investors to balance their trades or to use the currencies as investment vehicles. Several factors influence the exchange rate between individual and baskets of currencies. Although the most important factor is supply and demand based on the need for a particular currency to settle a balance of payments, global political and economic affairs also affect foreign exchange markets. This is particularly true if military intervention is a possibility.
Recent examples of turmoil dominating headlines around the globe include the standoff between China and Japan as well as the civil unrest in Ukraine that pits Russian interests against those of the Western powers. Currency rates will increase or decrease based on the progress and results of diplomatic efforts. When events appear to be spiraling out of control, investors and currency traders seek the safety of stronger currencies, such as the U.S. dollar, euro and yen. These trades result in a strengthening of these perceived safe havens and a weakening of other currencies that have floating exchange rates. The opposite is also true. As events appear to be less precarious, forex traders may sell the stronger U.S. dollar. A case in point is the Ukrainian hryvnia. In early February, the currency slid to its lowest level in five years against the U.S. dollar as civil unrest grew inside the country. The hryvnia eventually regained some of its losses a month later as fears subsided due to the belief that the situation would not deteriorate further and full military intervention seemed less likely.
Just like political events, economic measures, such as trade agreements, currency swaps and financial bailouts can affect exchange rates. The steps that the IMF and European Central Bank are currently taking to support European countries and financial institutions often weaken the euro against the U.S. dollar as these policies are announced. Other economic news, such as GDP and unemployment rates, affects central bank monetary decisions. As a major-producing nation, such as China, reports a decline in economic activity, it not only affects the value of the yuan but also the Australian and Canadian dollars as well as the currency of other resource-exporting nations. This often leads to a strengthening of the U.S. dollar in comparison.
It is important for those involved in the forex market to stay abreast of global political and economic events and establish well-defined goals and strategies for their investment portfolios.