Why Does Currency Fluctuate?
If you’ve ever been wondering how to prepare for currency fluctuations and how they affect international trade, then please keep reading.
The price of currencies fluctuates due to the ever-changing supply and demand in foreign exchange markets. There are people, companies, governments, and speculators making trades in the FX market every millisecond.
In addition to the daily trading, there is another important factor—the interest rate set by central banks. If the interest rate increases, the value of the currency will also increase.
This happens due to the international investors selling the domestic currency to buy foreign currency with higher interest rates. The investors are piling up the debt instruments that are going to offer a higher interest rate. This purchase of foreign currency increases demand, causing the currency's price to rise.
Another important factor is politics and the overall strength of a country. If international players assume that the political system of a certain country is stable and its economy is thriving, that might support the price of its currency.
How Can Currency Fluctuation Affect International Trade?
The currency fluctuation can impact international trade both ways. Usually, when interest rates go down, businesses can borrow cheaper. Moreover, the currency then depreciates, making the price of exported goods lower. So the economy is stimulated and activity increases. This is called monetary policy.
However, there is an opposite effect too. When currency prices appreciate, exported goods become more expensive, and thus economic activity slows down.
To sum up, it is important to watch the general trend in interest rates set by central banks. This is the main driver for currency fluctuations in the long term. It is also important to observe the political environment and interest rates set by central banks. Significant changes in politics often trigger currency fluctuations.
How To Prepare For Currency Fluctuations?
Have you ever wondered about the timing when making payments internationally or looking to exchange foreign currency for your base currency? The FX market is hard to predict, and some events can trigger significant currency fluctuations that can materially affect your business.
You should admit the fact of a volatile FX market and adjust accordingly, so it makes sense to transact globally or exchange domestically. Here are a few tips that might help you navigate those currency fluctuations:
Set your profile.
First of all, you should set your own profile in order to decide on an action plan.
Questions to answer for yourself:
· Are you time- or price-sensitive? Do you have a target date by which the money should be received or sent in foreign currency?
· What is your risk tolerance?
· How often do you transact in foreign currency?
· What is the worst rate your business is prepared to exchange at?
· What is more important, completing a transfer quickly or getting a better exchange rate?
These questions will help you understand yourself better and have a clear goal.
Set a goal.
Having a clear goal will help you identify the right action plan and increase your confidence.
You will be able to look up a currency chart on the internet and see where the rate is headed. If it is going up, you should act quickly; if it is going down, you should wait for a better rate.
It is also important to follow market updates to see what the upcoming market events are that could trigger greater volatility in the market. If you are waiting for a better rate, maybe it is worthwhile to eliminate the risk factor and act prior to the market news?
Make a plan.
The FX market is rapid and hardly predictable, so being prepared can give you some confidence. Having a plan might help you not miss anything and act right away.
· Create a price alert and be up-to-date with the price.
· Have the available funds for the international payment in your multi-currency account so you can act right away and make the payment.
· Plan for holidays and weekends so your cross-border payment does not get delayed.
· You can save money on larger amounts of transactions.
· Split the transfers if you are not sure about the current market rate.
· Have a currency specialist consult with you. Does your provider offer a relationship manager as part of its service?
You can also effectively mitigate FX risks by implementing hedging into your overall payments and FX strategy. There are a lot of benefits to hedging, but it isn’t a simple process.
We can help you by introducing you to the most frequently used hedging strategies, such as layered hedges, long puts, vanilla forwards, and others. Moreover, having a reliable banking partner is of key importance. Reach out to us to receive a list of the best banking solutions that fit your business or currency hedging needs.
All in all, currency fluctuations are an unavoidable part of free markets. The important steps are to set a goal according to your profile, have a plan, and hedge accordingly. We hope this guide will encourage you to manage your currency risks! If you would like to speak to us about bank account opening, payment, and FX optimisation, as well as other currency risk hedging topics, just drop us a message.