Lesson 5: Forex Market Participants 1: Central Banks
Lesson 5: Forex Market Participants 1: Central Banks
In our last lesson we looked at how the advent of online trading platforms has begun to level the playing field for individual traders, allowing a much greater access to favorable pricing than was previously available. In today’s lesson we are going to continue our discussion on the structure of the FX market, with a look at who the different players in the market are and how the motives of each affect us as individual traders.
While the 10 largest banks which make up the forex Interbank market account for over 75% of the over $3 Trillion in daily trading volume, there is actually a level of participants with even more clout in the market. While generally no where near as active as the banks just mentioned, the Central Banks of countries also participate in the forex market, and as they have such deep pockets, have huge clout when they decide to enter the market.
There are two main reasons why a central bank would participate in the forex market which are:
1. To fix the value of its currency to a particular level: Unlike the main currencies which we are going to be focusing on in this course, the currencies of many developing countries are fixed in value to the dollar or to some other currency or basket of currencies. This is done to try and promote international competitiveness in the market and a currency environment that is more conducive to economic stability.
Probably the most talked about example of a country that does this is China who up until recently maintained a fixed value of their currency against the US Dollar. A central bank normally accomplishes this by buying their own currency when the value gets too weak creating more demand for the currency and therefore driving the value up, and selling their own currency when it gets to strong creating a greater supply of that currency and therefore lowering its value back to the desired level.
2. To protect the value of a floating currency from extreme movements: Unlike China and many other developing economies in the world, the US, The Euro Zone, Japan and the other major economies of the world have what is known as a floating exchange rate. Very simply what this means is that instead of having the value of the currency pegged to something else which therefore determines its value, the value of the currency is determined by market forces.
Although the values of these currencies float freely in the market most of the time, as a currency’s strength or weakness in the market has such a dramatic affect on a country’s international competitiveness, there are rare instances where a central bank will intervene in the market even with the major currencies. Normally this is only seen after large one directional moves in the market over a long period of time, to the point where the country’s stability or competitiveness is being severely damaged. As Japan’s economy relies heavily on exports the most notorious central bank for interventions is the Bank of Japan, however both the European Central Bank and the Federal Reserve have intervened in the currency markets in the pasts.
While some interventions have limited affect on exchange rates others, as you can see from the chart here of a past Bank of Japan intervention, can have a dramatic affect on the market.
Because of this often times a central bank can do what is termed a verbal intervention, where simply the talk of intervention is enough to have the desired affect on the market.
That’s our lesson for today, In tomorrow’s lesson we will look at the next level of participants in the market and how they affect us as individual traders, so we hope to see you in that lesson.
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WEEKLY Forex Economic Calendar: 30 Mar Thu
12:30 US- Weekly Jobless
12:30 US- GDP
23:30 JP- CPI 31 Mar Fri
7:55 DE- Jobless
8:30 GB- GDP
9:00 EZ- flash HICP
12:30 US- Core PCE Deflator
14:00 US- final Univ of Mich 2 Apr Sun
00:00 AU/NZ- Clocks "Fall Back"
Forex Market: items driving the forex market:
Event Risk: Recent solid U.S. data have helped stabilize the USD today. It appears now that unless the Trump Administration can get its legislative act together that the Fed might be forced pursue a more cautious policy tightening posture than expected rather than an aggressive one.
Event Risk: Article 50 was signed late Tuesday UK hours by PM May. It was presented to the EU on Wednesday.
As expected, a request to the U.K. Parliament for a second Scotland Independence referendum was approved by the Scottish Parliament Tuesday. Odds are the request will not be considered immediately.
There is a growing perception that the ECB might start to consider stepping back from excessive policy ease. Watch flash HICP data Friday. The March German Ifo Survey (Monday) was considerably stronger than expected and will be noted by the ECB. A press report Wednesday suggested that the ECB will remain accomodative.
Lots to consider. Please comment...
John M. Bland, MBA co-founding Partner, Global-View.com
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