The US dollar (USD) is known as the world’s reserve currency. Large quantities of it are held by central banks to cover international debts, facilitate changes to domestic exchange rates, make transactions or prepare for future investments. Effectively, the dollar became the reserve currency because of the economic strength of the US, and the fact as a nation, they are best equipped to pay the world’s debts.
Some of the major currency pairs in the foreign exchange market involve the dollar, including:
- Euros – EUR/USD
- Japanese yen – USD/JPN
- Great British pound – GBP/USD
You can trade in some of the major currency pairs when forex trading online, and can speculate on price movements of the dollar.
If you’re considering trading in one of these pairs, it’s vital that you understand the factors that can drive the US dollar prices. So, in this article, we will uncover the five main factors that can influence the value of the dollar.
- Interest rates
Since interest rates can have a direct impact on inflation levels, their levels can affect the price of the dollar. The US’ interest rates are altered regularly by the US Federal Reserve during their Federal Open Market Committee (FOMC) meeting. This is a discussion of monetary policy and takes place eight times annually.
Since this is a periodic event, it is plotted in an economic calendar. If you’re considering opening a trade in the forex market, an economic calendar can help you plan for the future, informing you of the events that could affect market prices.
The US’ central bank will use interest rates to keep inflation under control. The two are directly linked, with higher interest rates attracting foreign capital, improving US currency rates. However, with increased rates comes the risk of inflation, so it’s important that the US Federal Reserve regularly make adjustments to interest rates.
High inflation rates indicate that the cost of goods within a specific country, is high. This can cause a currency to depreciate because — as we previously mentioned — it means that the Federal Reserve will have to increase inflation rates. As a general rule, countries with low inflation tend to boast a stronger currency.
3. Economic health
The disposition of the US’ economy is one of the key factors that can affect the value of the dollar. This can be determined by viewing employment rates, which are regularly released by the Bureau of Labour Statistics (BLS), on the first Friday of each month.
This report is known as the Employment Situation Summary and is data that is collected using the Current Employment Statistics Survey of employers and the Current Populations Survey of households. A higher employment rate directly correlates with a healthy economy, since the US citizens will have more money to spend, thus boosting the economy.
This will in turn, attract investment from foreign countries, keeping inflation rates low and improving the US currency exchange rate.
4. Market sentiment
Unfortunately, it’s not possible for traders to act objectively all of the time, and we’re often influenced by psychological factors when making decisions in the forex market. Market sentiment is a collection of beliefs and predictions based upon feeling and assumptions, that can completely change the landscape of the market. Effectively, if enough people believe that the price of the US dollar will fall, their actions may reflect this and subsequently cause the price of the currency to decline.
5. Political events/instability
The dollar’s price can be driven by political events in the US, such as elections. Such events evoke uncertainty among investors, as an election could cause economic policies to change and also trigger unrest in the country. A country that is politically stable promotes foreign investment, which will consequently aid their currency rate.
Many of the factors that can drive US dollar prices are unprecedented, such as the coronavirus pandemic, for example, which significantly weakened economies and currencies worldwide. Despite this, it’s best practice to employ an economic calendar to track periodic events that can affect the forex market, and also keep a close eye on the news, to keep up to date and aware of key changes.