In the world of currencies, there are short-term trends and there are long-term trends.
In the distant past, data such as a surplus in the balance of payments, the foreign exchange reserves of the central bank and the growth rate of the economy, were key factors in the strength or weakness of a currency.
But for years now, capital movements have become the most important element that determines and influences exchange rate trends.
Capital movements can cause strong and sudden fluctuations, when unlike the flows that make up the balance of trade, capital movements can change directions at short notice. Capital movements are both short and long-term trends.
One of the main drivers of capital flows are interest rate gaps between currencies.
Capital movements tend to go to a currency that offers a higher interest rate. The phenomenon is very well-known in relation to changes in the relative strength between the dollar and the euro. When investors think that interest rates in the US will rise faster than in Europe, they will strengthen the dollar and weaken the euro – and vice versa.
Additional reasons for short-term fluctuations can be estimates distributed by market evaluation factors, who base their analyzes on Technical Analysis. What is a Technical Analysis?
Technical Analysis is the study of historical price movements in order to identify patterns and determine probabilities of future movements in the market through the use of technical studies, indicators, and other analysis tools
For example, when investors who believe in technical analysis see what might be called a “ceiling” to a FX rate, they will tend to sell the currency when it gets to that rate. These obviously are not objective economic factors but rather psychological, but still they do affect FX fluctuations when they are used by many investors.
Political and psychological factors determine and dictate the short-term volatility. The main effect of the short-term factors on the exchange rate is utilized through the effect of the aforementioned factors on capital movements, in a way that drives capital flows from weak currencies to currencies that are considered safer.
Just as in stock prices, changing the CEO of a company can give optimism or pessimism that will raise or lower the price of the stock, so in currencies, changing the prime minister/president of a country can weaken or strengthen its currency.
Of course, in situations of war, the currency weakens. See the case of the Russia-Ukraine war. Both currencies of both countries weakened.
There are rare situations in which a global fear of an extraordinary danger arises. In such situations, investors prefer to run to the safe heaven called the US dollar.
This happened when the outbreak of the corona virus began. Investors preferred to buy dollars. This happened even in the September 11th attack, even though the USA was the one that was attacked, the huge uncertainty that prevailed in the markets at the time caused a panicked run to the dollar.
USD gets stronger every time there is a major global crisis. Investors love having dollars when there are tough times geopolitically or locally in a specific country.
Flight from risky assets – when an economy has a poor performance for a long period of time, money pours out of that economy and its currency gets weaker.
This happens in situations where the country has high inflation over a long period of time and the country is unable to control it. This happens when a country whose main export is raw materials of a certain type experiences a drop in prices that causes a decrease in that country’s income.
Many third world countries base their economies on tourism. When the corona epidemic broke out, global tourism was greatly affected. This resulted in the weakening of the currencies of almost every third world country that was based on tourism.