Explainer: The three factors moving foreign exchange markets, ranked

• Changing expectations about interest rates are the No. 1 mover of currencies. 
• The broader market mood has an impact on specific currencies – mostly the dollar and the yen.
• Flows related to imports and exports play a minor role in moving currencies. 

What moves the euro or any other currency? Every trader should be familiar with the basics. 

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The short answer is that currencies move when expectations for future interest rates change – that is the No. 1 factor. The second factor is the mood in markets, which affects only certain currencies such as the dollar and yen – when stocks rise, the dollar and yen tend to drop, and the other way around. The third factor is the flows of imports and exports, but it plays a minor role.

Interest rate speculation 

The longer answer is that every factor that has an impact on interest rates triggers speculation among investors. For example, if inflation figures come out stronger than estimates, speculation about higher interest rates emerges. To fight inflation, the central bank could raise interest rates faster than expected or refrain from cutting interest rates. In turn, the currency rises.

On the other hand, if unemployment jumps more than forecasts, it implies a weaker economy and lower interest rates than previously projected.

Perhaps the most significant market mover is when central bankers say what they intend to do – or in some cases just do not say what they previously said.

For example, European Central Bank President Christine Lagarde said in December 2021 that her institution would, most likely, not raise rates in 2022. That statement sent the euro down. However, in February 2022, she refrained from repeating that statement, thus allowing for speculation that interest rates will rise during the year. The common currency jumped in response. 

The US Federal Reserve publishes a forecast for future interest rates every three months: in March, June, September, and December. When this "dot-plot" is published, the dollar jumps if the Fed foresees more rate hikes and falls if the bank expects fewer in the next 12 months. 

Market mood

As mentioned earlier, the US dollar, Japanese yen, and to a lesser extent, the Swiss franc, are considered safe-haven or funding currencies. They move in the other direction to stock markets and the general mood. Such a "risk-off" mood can happen in response to other developments, such as strong earnings from companies, the announcement of a covid vaccine, etc. 

When fear grips the world – such as around the Russia-Ukraine standoff – these currencies are in demand and all the others drop. When the mood improves, the dollar and yen are sold off, as was seen when Russia said it would withdraw troops. Disappointing earnings reports from major firms, natural disasters, and other economic disappointments also cause that kind of reaction in markets. 

Flows

The basics of foreign exchange are about companies converting funds related to imports and exports. If a country has a deficit – such as the US – its currency falls. The eurozone usually has a surplus, and this supports the common currency. Such shifts in the exchange rate help currencies balance out.

However, it is essential to remember that such import and export flows play a minor role in currency trading. The vast majority of price action is related to speculation about interest rates and the broader market mood. Only when everything is eerily quiet, do currencies respond to flows. In the example above, it would take an extreme "slow news day" to push EUR/USD up. 

Conclusion

Speculation about interest rates, the market mood, and to a far lesser extent flows, move currencies. It is essential to remember these factors and their importance when trading forex.