What moves currency prices: rates, inflation, jobs and risk mood

An exchange rate is the price of one currency in terms of another, and it moves when demand for one side changes relative to the other. Over months, the biggest driver is usually the expected path of interest rates, which in turn depends on inflation, jobs and growth. Over hours and days, surprises in economic data and shifts in global risk mood do most of the work. This article goes through each driver with an example of how it shows up in a currency pair.

Start with how a pair is quoted

In EUR/USD, the euro is the base currency and the US dollar is the quote currency. A rise from 1.0800 to 1.0900 means one euro buys more dollars: the euro has strengthened against the dollar, or the dollar has weakened against the euro. Every driver below works by making one side of the pair more or less attractive than the other. A strong US jobs report and a weak eurozone report can both push EUR/USD the same way: down.

Interest rates and central banks

Money tends to flow toward currencies that pay more, other things being equal. When a central bank raises its policy interest rate, deposits and bonds in that currency become more rewarding, which supports the currency.

What matters most is not the rate itself but the change in expectations. Markets price in expected decisions weeks in advance. If everyone expects a 0.25 percentage point hike and the central bank delivers exactly that, the currency may barely move, or even fall if the accompanying statement sounds cautious. If it holds rates when a hike was expected, the currency often drops sharply.

Example. The US Federal Reserve signals that it will keep rates higher for longer than markets had assumed. US yields rise relative to European yields, and EUR/USD tends to fall as investors prefer dollar assets.

The gap between two countries' rates also drives the carry trade: borrowing in a low-rate currency to hold a higher-rate one. When risk mood is calm, carry trades can support high-yielding currencies for long periods; when fear rises, they are often unwound quickly.

Inflation

Inflation affects currencies mainly through what it means for interest rates. Higher-than-expected inflation usually raises the odds that the central bank will tighten policy, which tends to support the currency in the short run. Persistently high inflation that the central bank fails to control erodes the currency's purchasing power and can weaken it over the long run.

Example. UK consumer prices come in well above forecast. Traders bring forward their expectations of a Bank of England hike, and GBP/USD jumps within minutes of the release.

Employment and growth

Strong employment and solid GDP growth point to an economy that can handle higher rates, so they tend to support the currency. Weak data do the opposite.

• Employment. The US non-farm payrolls report is one of the most watched releases in forex, together with the unemployment rate and wage growth.
• GDP. Gross domestic product measures total output. Because it is published with a lag and often anticipated by other data, its surprise effect is usually smaller than that of jobs or inflation figures.
• Business surveys. Purchasing managers' indices (PMIs) are early readings of activity and can move currencies on the day.

Example. US payrolls rise far more than forecast and wages grow faster than expected. The dollar strengthens broadly: USD/JPY rises, EUR/USD falls.

How to read these releases on a calendar is covered in economic calendar basics.

Risk sentiment

Sometimes the main story is not one country but the general appetite for risk. In "risk-on" periods, when investors feel confident, money flows toward growth-linked and higher-yielding currencies. In "risk-off" periods, during market stress, it flows toward perceived safety.

Safe havens: JPY and CHF

The Japanese yen and the Swiss franc have long tended to strengthen when markets are frightened, partly because Japan and Switzerland have large net foreign assets that their investors bring home in a crisis. The US dollar also often benefits from stress because of its role in global finance.

Example. A sudden sell-off in global stock markets: AUD/JPY falls as investors cut riskier positions and the yen is bought.

Safe-haven behaviour is a tendency, not a law. Central banks can intervene, too. In January 2015 the Swiss National Bank abandoned its minimum exchange rate against the euro, and EUR/CHF fell steeply within minutes, a reminder that policy decisions can override any pattern.

Commodity currencies: AUD, CAD and NOK

Some currencies are closely tied to what their countries export.

Example. Oil prices rally after supply disruptions. USD/CAD tends to fall as the Canadian dollar strengthens, and EUR/NOK may fall as the krone strengthens.

These links loosen and tighten over time; interest-rate expectations can easily overpower a commodity move.

Why fundamentals do not settle the direction

Three things make fundamentals hard to trade on short expiries:

1. Priced in. Expected news is already in the price. Only the surprise moves it, and you only know the surprise after the release.
2. Conflicting drivers. On any given day rates, data and risk mood can pull in different directions.
3. Noise. Over seconds and minutes, price movement is dominated by order flow, not fundamentals. The drivers above explain trends over days and weeks far better than the next 60 seconds.

These drivers do not apply to OTC prices

Everything above is about real markets. On Sky Trade, OTC instruments, including EUR/USD OTC and every crypto and index instrument, have prices generated by Sky Trade's server with a random-walk model. They do not track any real market, and rate decisions, inflation data or oil prices have no effect on them. Fundamental analysis applies only to market pairs. See OTC explained.