Forex: Who moves my rupee or dollar? Check out the movers & shakers – The Economic Times

Clipped from: https://economictimes.indiatimes.com/markets/forex/who-moves-my-rupee-or-dollar-check-out-the-movers-shakers/articleshow/82001364.cmsSynopsis

One key to capturing the forex moves lies in one basic principles – how growth differential drives inflation differential, which finally moves interest rate differential, which is the ultimate reason for exchange rate movement.

Forex movement always remains in the limelight in the financial markets, as it involves the relative performance of two economies. To drill down on forex movement, one has to understand the current macroeconomic theme and then further dissect the sub-elements at work in the market.

One key to capturing the forex moves lies in one basic principles – how growth differential drives inflation differential, which finally moves interest rate differential, which is the ultimate reason for exchange rate movement.

Growth Differential
We can assess growth differential in terms how the macro-outlook of two different economies is panning out. When pandemic started last year, the US economy was the worst hit compared with the euro zone. Accordingly, the growth differential favoured the euro over the dollar, and thus lifting thedollarNSE 0.15 % higher.

Inflation Differential
Higher inflation tends to favour currencies of developed economy in anticipation of more capital flows into that country. The recent surge in the US yields in the wake of higher inflation in that economy due to a bulky stimulus injected widened the yields differential between the US and the euro zone, which further widened the inflation differential. Now the US economy is on the verge of facing higher inflation than that of the euro zone, which is favouring the dollar over the euro.

Interest Rate Differential
This last pillar is influenced by both growth and inflation differential. Higher the interest rate, higher the currency in developed economies and vice-versa. However, it is completely opposite for emerging markets, as higher inflation reduces the cost of carrying equity, which is the prime reason for emerging currencies to rise during such periods.

Lastly, apart from the above three pillars, dollar-funded markets do influence exchange rates. The US dollar being the global reserve currency accounts for more than half of foreign trade. During the pandemic, businesses all over the world experienced difficulties in cash flow and supply chains most got halted.

Accordingly, the US Fed used its forex swap window to supply dollars outside the US, which supported the euro and the yen due to this central bank swap activity. It is always worth tracking the development in dollar-funded markets.

The highly liquid global forex market impacts and influences businesses and corporations across the world. Apart from the above factors, fluctuations and movements in forex pairs are also triggered by global earnings and balance of payments issues of different countries. Indeed, the flexibility offered by the forex market makes it what it is.

(DK Aggarwal is the CMD of SMC Investment and Advisors)

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