How Covid affects online forex trading

The forex market is the world’s largest and most liquid financial market. Given the different time zones around the world, the forex market is open 24 hours a day, five days a week. The widespread nature of the coronavirus outbreak and its varying impact on different nations have seen increased levels of volatility across global financial markets. It is essential to explore financial markets as a whole in order to accurately assess the impact on forex trading. Let's take a closer look.

How is the Covid
Outbreak Impacting
the Financial
Markets?

No one could have anticipated the impact of covid-19 when the first case was reported in December 2019 in the Chinese city of Wuhan. The virus spread like a wildfire. Hotspots quickly shifted throughout Asia from China to Japan and South Korea before stretch to Italy, France, Spain, Germany, the United Kingdom, and the United States. The virus had no borders and on March 11, the World Health Organization (WHO) declared the outbreak as a pandemic.

To curb the spread of the virus, governments of various countries closed their borders and announced lockdowns of businesses, schools, shopping centres, stadiums, and other places where large amounts of people would normally gather. As travel came to a grinding halt and factories were forced to remain closed, the global economy spiralled. As the death toll continued to rise, global markets plummeted.

Apart from the human tragedy, the pandemic had a severe impact on the global financial markets, including equities, commodities, and forex. As black swan events tend to do, the coronavirus crisis caused shock, panic and fear among investors around the world. Despite this initial reaction, forex and other financial markets exhibited great resilience even as confirmed cases continued to soar.

In fact, trading volumes actually increased during this crisis. Brokers around the world reported a rise in the number of client accounts as well as orders being placed. Experts believe this increase in trading may have been a result of people having more time on their hands amid work from home, travel restrictions and events being cancelled as well as the initial decline in the global financial markets making various asset classes more attractive to purchase.

Meanwhile, governments announced several moves, including stimulus packages and changes in the monetary policy, which had an impact on the financial markets. Global trade starting coming to a halt with countries quickly facing supply chain issues. The coronavirus pandemic quickly sank its teeth in - capital markets suffered with the Dow Jones suffering two of its five largest percentage losses in the span of a week. To understand the impact of such, let us first look at the various factors that influence the forex market.

What are the
Factors Impacting
the Forex Market?

The foreign exchange rate, or the rate at which the currency of a country is converted into that of another, is a key indicator of the country’s economic health and stability. The forex rate may fluctuate on a daily or even hourly basis, as the demand and supply of the currency changes.

The factors that impact forex rates can be divided into two broad categories: macroeconomic factors and other factors.

What are the
Macroeconomic
Factors Impacting
the Forex Market?

While trying to understand the relationship between key macroeconomic factors and currency exchange rates, let us also look at the exceptions to the rules. It is important to know them as they are among the key influences of the covid-19 era for the forex market.

The key macroeconomic factors influencing the forex market are:

Inflation Rate

Typically, when the inflation rate of a country increases, the value of its currency declines. This is logical because inflation is essentially a measure of a rise in the average price of a basket of goods and services of common use. This includes things like food, clothing, transportation, housing, and consumer staples. As prices rise, you need more money to buy the same basket of goods and services. In other words, the value of money declines. Therefore, a rise in inflation eats into the value of a currency and a decline in inflation results in the value of the currency appreciating. Even if the inflation rate of a country remains consistently low, its currency value rises.

Exception to the Rule: While this is the general rule, extremely low or near zero inflation is not a good sign for the economy either. Near zero inflation or deflation discourages consumers from spending (as they feel prices may remain the same or fall in the future). Low inflation rates also make it less attractive to borrow and invest. All these factors result in lower economic growth. A recovery from such a scenario is both slow and fragile.

Trade Balance

The trade balance is a statement of exports and imports of a country. Higher exports means there is higher demand for a country’s goods and services and, therefore, higher demand for its currency. So, when exports grow, the value of the currency appreciates. In the same vein, when imports rise, the currency depreciates. There is also a balancing factor at play here. As a country’s currency depreciates, its exports become more attractively priced in other currencies. This results in higher demand for its exports and, therefore, for its currency, which lifts its exchange rate.

Exception to the Rule: The US is a net importer and typically reports a trade deficit. This does not mean the US dollar depreciates every time the US announces a trade deficit. This is due to the greenback’s reserve currency status which keeps the demand for the US dollar high and maintains its exchange rate.

National Debt

This is also known as government debt since it refers to the debt of a country’s central government. The government is compelled to take a debt when it needs to spend more than it has collated in taxes. Higher government debt lowers the attractiveness of the country’s currency. On the other hand, a decline in government debt lifts the country’s currency exchange rate. Consistently low national debt indicates a more fiscally responsible government and a more stable economy. For instance, Australia’s national debt remains low relative to other developed countries like the US, UK and Japan, giving the impression of a more stable and resilient economy.

Exception to Every Rule: A government surplus means that the government spends less money than it collects as tax. Government spending is an important factor boosting a country’s GDP. So, if the government spends less, it can have a negative impact on the economy and, therefore, lower the value of its currency.

Interest Rates

Central banks around the world, like the Federal Reserve, Reserve Bank of Australia, European Central Bank, and Bank of England, set benchmark interest rates for their respective regions. This is an important part of their monetary policy, as interest rates are the most effective tool with respect to regulating the supply of money. Changes in the interest rate affect the value of the local currency. An increase in the interest rate results in currency appreciation. This is because higher interest rates provide higher incomes to lenders, which attracts more foreign capital, thereby resulting in a rise in exchange rates.

Exception to the Rule: In emerging economies, interest rates tend to be fairly high. When interest rates in these countries increase, it discourages businesses from taking loans. This cripples economic activity and, in turn, has a negative impact on the currency exchange rate.

Balance of Payments

Balance of payments is a statement of all financial transactions made between a country and the rest of the world. This includes the purchase and sale of goods and services, as well as loans taken from foreign entities and investments made in the country by foreign entities.

The balance of payments includes two accounts, namely, the current account and the capital account. The currency account shows all financial transactions related to the purchase and sale of goods and services, while the capital account includes financial transactions related loans and investments.

If a country imports more than it exports, this means it spends more than it earns, resulting in a deficit in the current account. A currency account deficit results in a decline in the value of its currency. Similarly, a capital account deficit also exerts pressure on the currency’s value.

Economic Releases

Any economic data suggesting a strengthening of the economy bodes well for the forex market. This could be GDP, initial jobless claims, unemployment rate, housing prices, consumer and business confidence, manufacturing and services PMIs, retail sales, and more.

What are the
Non-Macroeconomic
Factors Impacting
the Forex Market?

Apart from the macroeconomic factors, there are other important factors that influence the forex market. These are:

Geo-Political Environment

Political stability within a country and diplomatic relations with the rest of the world are favourable for its economy and currency exchange rate. A country that is witnessing a political turmoil becomes less attractive to foreign investors. A relatable example is the souring relationship between the United States and China following the sharp rise in Covid-19 cases and comments made by President Donald Trump. In fact, as the situations heat, foreign investors may liquidate their investments and take funds back to their home country. This decline in foreign capital lowers demand for the country’s currency and exerts pressure on its exchange rate.

Speculation

While currencies are exchanged for travel and business, a significant portion of forex is exchanged by retail and institutional traders looking to make a profit. As traders place orders, the demand for different currencies fluctuates, resulting in changes in the exchange rate.

Other Events

Some events influence the forex market simply by impacting trader sentiment. For instance, news of the pandemic hurt investor sentiment long before it caused economies to slump.

There is another important factor that impacts the forex market – the performance of the stock market.

How Does the Stock
Market Impact the
Forex Market?

Equities and forex have a direct relationship. This is because a rising stock market reflects a stronger economy, which supports the currency of the country. Moreover, a rising stock market attracts more foreign investments into domestic companies, which creates higher demand for the local currency. This rise in demand pushes the value of the currency higher.

The equity markets around the world have hundreds of thousands of stocks. It is impossible to keep track of all of them. The best way to stay in touch with the stock market is to look at the leading indices. For instance, if you wish to trade the Australian dollar, it is a good idea to keep an eye on the ASX 200. This is by far the most popular Australian index and tracks the performance of the top 200 Australian-listed companies. Some traders also track the S&P/ASX 200, which is a part of the main index that includes only technology stocks. Similarly, if you are interested in trading the USD/JPY, it is a good idea to keep an eye on the Dow, Nasdaq and S&P 500, which are the most popular indices that reflect the direction of the US stock market, as well as the Nikkei 225, which reflects how Japanese stocks are moving.

You may also wish to keep an eye on the commodities market, depending on the currencies in your portfolio. For instance, the Australian dollar is impacted by price movements in the commodity market, since Australia is a large exporter of commodities. Similarly, the Canadian dollar is influenced by changes in global oil prices, as crude oil constitutes Canada’s leading exports. The New Zealand dollar is also considered a commodity currency.

How is Covid-19
Affecting the Forex
Market?

In the first half of 2020, the global financial markets witnessed unprecedented socio-economic challenges. Given investor fear and panic, there were sharp declines in many asset classes. However, even amid this, there were periods of optimism, highlighted by the S&P 500, Nasdaq and Dow hitting record highs.

The scale of the virus outbreak and the speed at which it spread across the globe caused significant market volatility. This triggered a rise in trading volumes, as wide price swings offer more attractive trading opportunities than a stable market. Most new traders began with trading forex, which has been the trend since online trading gained popularity. This trend was even more pronounced during the pandemic, as liquidity became the most important criterion for new traders.

One of the main advantages of trading forex is that it offers equal opportunity in both bull and bear markets. This is because when one currency falls, it does so against another currency. This means the other currency appreciates. The forex market offered attractive trading opportunities even while other asset classes were on a downturn amid the covid-19 crisis.

Flight to Safe-Havens

Unlike stocks, all currencies cannot simultaneously decline. However, some currencies did fare much better than others during the pandemic. The main reason was that these currencies have a safe-haven appeal. The demand for such currencies remained high due to the pandemic-induced uncertainty and a decline in investor risk appetite. The three main safe-haven currencies are:

The Japanese yen: This has always been a leading safe-haven asset mainly due to Japan’s status as the world’s largest creditor. This became even starker during the coronavirus crisis, as countries took on massive government debt to inject funds in a bid to revive their economy following months of lockdown.

The US dollar: This enjoys the status of the default safe-haven currency, as it is the world's reserve currency. As various international trade, cross-border business deals and financial assets are denominated in this currency, the US dollar is the world’s most liquid currency. This supported the greenback during the covid-19 era.

The US dollar was also supported by businesses and traders exiting emerging market currencies. In the first half of 2020, capital outflows from emerging markets were larger and faster than during any previous crisis. As businesses and traders converted these currencies, the demand for the US dollar rose to three-year highs in March.

The Swiss franc: This is considered a safe-haven currency as Switzerland has a relatively stable economy and is seen as a neutral country that stays away from global conflict. The currency steadily rose, even against the US dollar which competes with the Swiss franc for hedging risks in investor portfolios.

Despite their safe-haven appeal, the major currencies came under pressure as the pandemic progressed. This is because of government initiatives to support their economies, including quantitative easing measures and interest rate cuts.

Interest rates

Most central banks lowered interest rates in an effort to encourage businesses to borrow funds to tide them through the covid-19 crisis. Declining interest rates are negative for the local currency. For instance, on March 11, the Bank of England slashed its base interest rate to 0.25%. This led to a sharp decline in the GBP/USD.

Of course, the selloff was also caused by disappointing economic data from the UK and Brexit uncertainties. On March 18, the GBP/USD crashed as low as $1.1757, reaching its weakest level since 1985.

Government Stimulus Package

Governments globally announced stimulus packages of more than $10 trillion to combat the economic impact of the coronavirus. While relief packages are meant to boost the economy, which should support the local currency, these packages increased government debt, a major negative for the currency. For instance, on March 12, the European Central Bank expanded its asset purchase program by €120 billion (approximately $136 billion). The EUR/USD plummeted following this announcement.

On the other hand, any uncertainty around government stimulus also adversely impacts the local currency. This was evident by the steady decline in the US dollar against its major rivals including the Euro, Swiss franc, and British pound, caused by the stalemate between the Congress and the White House regarding additional relief to help cope with the pandemic.

Despite its safe-haven appeal, the US dollar traded close to two-year lows in late July. This pressure on the US dollar resulted from high unemployment rates (which had surged past levels recorded at the peak of the 2008 financial crisis) and a more than 30% GDP contraction in the second quarter. Rising daily infections and disappointing economic data resulted in a steady decline in the US Dollar Index, which measures of the value of the greenback against a basket of currencies.

Impact of Other Markets

Commodity prices, oil prices and disappointing news related to other economies also caused volatility in the forex market amid the pandemic. For instance, the AUD/USD slipped to 17-year lows in March and April, with a decline in commodity prices as well as China (Australia’s largest trading partner) reporting a 6.8% GDP contraction for the first quarter of 2020.

In fact, any news of rising infections exerts pressure on the Australian dollar, as it is considered as a “risk currency”. On the other hand, hopes of a covid-19 vaccine lend support to the Aussie.

Similarly, the CAD/USD came under significant pressure with plummeting crude oil prices. Oil prices suffered a historic collapse on March 9, due to a severe contraction in demand and Saudi Arabia’s efforts to increase its market share by lowering prices. The Canadian dollar nosedived in tandem with oil prices. The currency recovered after the OPEC reached a deal for member nations to simultaneously reduce production to support prices.

The Canadian dollar is a risk-sensitive currency and any upbeat economic data suggesting a recovery of the global economic will support the Loonie.

How Will Covid-19
Continue to Impact
the Forex Market?

The impact of covid-19 is likely to be long lasting. Economic data from various countries around the world will continue to impact the forex market. Investor focus is likely to remain on the health and progress of the Chinese economy. This is not only because China is the world’s second largest economy, but also because it is the main driver of manufacturing trends. Moreover, China was the first to experience the impact of covid-19, deal with it and emerge from it, which is why investors view its progress as a blueprint for other countries.

Towards the end of the year, the US Presidential elections, the outcome of Brexit negotiations and diplomatic relations between the US and China will likely be among the biggest factors influencing the direction of the major currencies.

While the forex market is likely to remain volatile as the impact of the pandemic plays out, the US dollar and the Japanese yen could regain their strength, as investors and traders continue to hold safe-haven assets. As the global economy stabilises, undervalued currencies such as the Singapore dollar, Mexican peso, Turkish lira, and South African rand could deliver more sustained gains.

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Source - database | Page ID - 20862

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