News reports today are full of articles rising concern over the increasing volatility of the forex market. However, the majority of people do not understand the real-life implications of this. It’s a big mistake, especially for those who speculate on sharp changes in FX rates. Understanding the impact of these changes can help one navigate financial markets and protect their businesses. Once you know what to look for, you’ll be able to make a more-or-less accurate forex prognosis simply by studying current events reports. Therefore, you’ll be able to choose the best directions for your investments. Moreover, you’ll know when and how to hedge to protect and increase your fortune.
How Do Shifts in FX Rates Affect Everyday Lives of People and Businesses?
It doesn’t matter if you are an expat, a business owner, or an investor, FX rates affect you. Even people who don’t need to make or receive payments from abroad feel this impact. That’s because foreign currency exchange rates affect every meaningful aspect of one’s financial life through their influence on:
- The rate of inflation.
The COVID-19 pandemic has already triggered global economic recession, which might lead to a global inflation. FX rates affect the prices of imported goods within a country. Therefore, they influence the inflation of prices. As such, the purchasing power of people and businesses is directly tied to the value of their country’s currency.
- Interest rates.
The value of the country’s currency in relation to other currencies affects lending greatly. With a weak currency, lenders face greater risks and therefore increase interest rates. Moreover, this results in a reduction of lending, which also forces a further increase in interest.
- Depending on the inflation and interest rates business owners in countries with weak currencies might be forced to reduce wages. In times of economic crises, like the one we are living through now, they might also need to reduce their staff. This means that forex rates indirectly affect the level of unemployment and consumers’ purchasing power. Therefore, they impact the health of the country’s economy as a whole.
- The rate of unemployment grows as the currency weakens because of the forex impact on wages. But a currency that’s growing stronger is also bad for jobs. When this happens, the export prices increase. Therefore, export volumes decrease. It’s just too expensive for other countries to buy goods from yours if your currency is expensive. Therefore, the number of jobs in production and transportation decreases as well.
- Travel and life for expats.
The level of wealth for both travelers and expats depends directly on currency exchange rates. Depending on those, the total amount of money you have will either increase or decrease.
Benefits of Understanding the Impact of FX Rates Movements
As you can see, any changes in FX rates affect the country’s (and by extension global) economy greatly. However, for all that every aspect of the economy is connected, changes there don’t happen overnight. This means that if you learn to read forex rates trends, you’ll be able to predict economic changes they will trigger.
If you know how to use this little bit of foresight, you’ll be able to benefit greatly from it.
First of all, business owners and investors will be able to tell if they need to read detailed forex forwards guide and start hedging. In case the general economic and forex situation indicates currency weakening, securing the rates with a forward contract is an immediate and effective protection. When you are using it, even if the currency crashes, you’ll still be in a good position.
Expats and international investors also might need to use hedging tools. By tracking changes in forex rates, they will see whether these rates work for or against them. These people need to make or receive international payments regularly. Therefore, they are highly exposed to FX risks. Securing a highly favorable position that you have now will ensure that you retain it for up to a year. It won’t matter how the global economic situation changes during this time. You’ll be protected from FX volatility.
People who plan to travel or make purchases abroad also need to watch forex rates. They can use them to catch a good time to exchange their funds to maximize the amount they will receive.
And everyday people who just go about their lives can watch forex to predict inflation. If nothing else, it will show you when to stock up on imported goods.
How Businesses and Expats Can Protect Themselves from FX Volatility
While FX volatility is extremely risky, there are ways to protect oneself or one’s business from it. You can use a variety of tools to do this, ranging from forward contracts to CFDs (contracts for differences). However, it’s important to understand that these tools aren’t equal. You need to know which of them to use in what situation to achieve maximum benefits.
CFDs, for example, are valuable tools for traders who want to profit from price movements without actually buying assets. But they come with large premiums, so overall, your gain isn’t all that high. Therefore, they aren’t a particularly good security tool against the forex market volatility.
Forward contracts, on the other hand, were literally made for it. This type of hedging tool allows you to secure the FX rate at a specific level. Therefore, you become invulnerable to volatility for the duration of the contract. Of course, you’ll need to pay about 10% of the contract’s value upfront. Also, you must fulfill the whole payment at the end of it. Usually, these contracts last for a year.
Futures contracts are similar to forwards but allow for more flexibility in the negotiation of the terms and dates. These are the tools most often used by currency speculators. The cost of the contract in this case is outweighed by the benefits a clever speculator can reap from it.
There are also currency options. Like forward contracts, they allow you to buy currency at a rate set today but in the future. However, this tool doesn’t make that future purchase an obligation. Therefore, if the rate is better at the time, you can complete a spot exchange instead.
Using hedging tools against forex volatility is a skill that anyone involved with foreign currencies must develop. And your understanding of the forex changes impact will help you use hedging more effectively.