Foreign exchange rates impact the fundamental situation of other markets. In general they reflect the strength or weakness of a particular economy. There are certain factors that directly influence forex prices. These factors generally fall into three categories: economic factors, political conditions and market psychology. Economic factors include economic policy of that particular country circulated by government agencies and central banks, economic conditions prevailing in that country and other economic indicators. The market usually reacts negatively to expanding government budget deficits, and positively to reduction in the budget deficits. The trade flow between a set of countries illustrates the demand for goods and services that also indicates demand for a country's currency to conduct trade. Any currency loses value if there is a high level of inflation in the country. The gross domestic product (GDP), employment levels, retail sales, capacity utilization etc. denotes the level of a country's economic growth and health.
Internal, regional, and international political conditions and events of any particular country can have a substantial effect on the forex prices. Market psychology and trader perceptions impact the forex prices in different ways, unsettling international events can lead to a greater demand, thus a higher price, for contracts considered as stronger over their reliably weaker counterparts. Beside these there are some other factors also, that influence the forex prices.
Interest rates play a major role when the idea of evaluating one currency against another comes in to play. The interest rate determines the capacity of earning for a particular currency. Inflation influences the interest rates very much. If interest rates of country are rising because of a healthy economic growth that is a positive sign for the currency. It has to be kept always in mind that the value of a particular currency always reflects its buying power. The forex market came into the existence to facilitate trade only, and trade is a major factor in the determination of the value of a particular currency. More demand of the goods means higher values for that currency. This influence forces the forex dealers to keep a close watch on the international trade data. Capital flows indicate the investment of capital in that country. Investment also works on the same pattern as trade. If a country receives a lot of investment its currency would be in great demand. The forex dealers look at the capital flows in the same way as they look at the trade data.
The US Dollar is always rated as a reserve currency internationally; other countries keep a healthy supply of Dollars on hand as a precaution against any future adversity. This always propels the demand for the Dollar as all of the major global commodities like oil and gold are denominated in Dollars. Any country buying such commodities has to exchange their own currency for Dollars in the first place to make a purchase; this always increases the demand for the Dollar.
Looking at one country or currency is not enough for any dealer because a currency is always valued and traded against an array of other currencies having their own sets of considerations. Although exchange rates are affected by many factors, in the end, currency prices are a result of supply and demand forces. If the supply of any currency shows the shortage in the forex market then the prices for the same would rise on the other hand if the supply is in a very healthy condition and the demand is very low for that currency then the prices for that currency bound to fall. This is the major conclusion of all above and the forex dealers keep a cautious eye on this fact patiently.