What Causes Volatility In Currency Rates?

The foreign exchange market is characterised by volatility and all movements in currency rates are susceptible to external influences.

The value of a currency is not constant and all currencies change their value against each other during their lifetime. There are stable currencies whose exchange rate does not fluctuate much in the short-term but most world currencies are susceptible to expected or unexpected changes in their value. In a free foreign exchange market, the currency rates reflect the value of a currency pair and the extent to which a particular currency fluctuates against another is called volatility.

There are fixed-rate foreign exchange regimes, which do not allow fluctuations of the currency as opposed to the free-floating exchange rate. There are also pegged currencies whose value is tied to the value of another currency or a basket of currencies and their value varies in conjunction with the value of the currency they are tied to. A freely floating currency, however, always tends to fluctuate over time.

The free-floating currencies change their value on the Forex market daily, currency exchange deals are conducted in seconds, while a particular currency can gain or lose as much as 5-10% of its value in a single trading session. Such drastic moves happen rarely but volatility is an intrinsic attribute of the Forex market so brokers are prepared for such currency rate movements.

In a complicated global world, the national and international currencies are no exception. The release of the quarterly data for the level of unemployment and new job openings in the United States can cause havoc and trigger the Forex brokers desire to sell U.S. dollars if the indicators are poor. Even unconfirmed rumours about upcoming release of poor economic results or a possible government reshuffle can serve as a signal for all market players to start selling a nations currency, which results in a drastic drop in their currency rates.

These unexpected fluctuations are very hard to predict although all reputable Forex dealers utilise sophisticated software tools to follow and forecast currency rate movements. In addition, the coincidental announcement of poor economic indicators by a couple of leading world economies, say, Japan and the European Union, can cause extreme volatility of several currency pairs while spreading unease among market players.

Most analysts and central bank governors agree that extreme volatility and unexpected movement in the exchange rate levels have negative impact on the global financial markets stability. The very nature of these markets is volatility, though. All dealers and brokers utilise similar tools to research and forecast fluctuations in the currency rates; all of them follow media coverage and listen to the statements of selected high-ranking officials. Therefore, they will act as a homogenous group most of the time and will follow similar directions in their behaviour, predestining the volatile nature of the Forex market.