Trading Forex – Impact of National Foreign Reserves

Historically, central banks of just about every country, used to hold gold as national reserves, or some kind of last resort source of funding. That also was a storage of country’s wealth. To some degree it’s still true, but is not practical on a large scale. The role of gold has declined since the gold standard was abandoned 30 some years ago by most economies.

These days a lot of countries, apart from smaller gold positions, also hold Foreign currencies as part of national reserves. This mainly applies to currencies used in international trade. Mainly USD, EUR, JPY and to a smaller degree GBP, CAD and AUD. Strategic commodities are usually priced in one of these currencies and they are also most accepted form of payments and conversions in international banking.

There are two groups of countries that accumulate a surplus of foreign currencies. China, Japan and India, manufacture and export more finished goods than they import.
Second group comprises of producers of raw commodities like oil and metals. Russia and Saudi Arabia are the most prominent beneficiaries of those.

How much money are we talking about? Publicly available figures vary widely and are not necessarily precise, but both Japan and China hold in the neighborhood of 1 Trillion dollars of foreign currencies, while India and Russia’s hold about 500 Billions each. Other countries have smaller amounts.

Historically most of reserves have been held in US Dollars, or more correctly, US bonds and notes denominated in USD. As the amounts involved grow, it is only natural that the central banks responsible for their management diversify the funds. Every now and then there are announcements coming from official sources that a respective country plans to move certain percentage of the money involved into another currency.

That diversification process is not done overnight, but rather over a course of weeks and months. Perhaps even years. It is not in the interest of anybody involved to create wild swings in exchange rate by sudden conversions of huge amounts of money from one currency into another. Nonetheless, these moves definitely have an impact on Forex market.

Almost certainly current EUR-USD bull market is aided by steady and systematic diversification of “Foreign reserves” by central banks. EUR has proven, so far, to be a viable alternative to USD as a holding instrument. That said, USD is still, and by far,
the most prominent currency in those holdings and is likely to remain a first choice for the foreseeable future.

Official policy announcements from various central banks absolutely demand attention. Buying power behind the staggering amounts involved can not be overstated. What is, however, largely overlooked, is the staying power of these markets participants. They are not interested in quick trades, but rather remaining in a position for a long time. Months and years.

There is a new twist to this orderly, and somewhat predictable, market participation. China has just launched a 200 Billion dollars “super Forex fund”. That is a large chunk of their reserves. This fund is supposed to be more actively managed than a traditional central bank’s holdings. The exact trading formula of this fund is has not been disclosed, so it remains to be seen just how active it is going to be.

Should this new fund set a precedent for more entities of this kind, “Foreign reserves” will become even more important part of news to follow. More money available for active trading means more volatility and more short term movements. For traders of all stripes that is not bad news- more opportunities ahead.

What Does Forward Guidance Mean In Forex Trading?

After the latest round of monetary policy statements, the forex scene was abuzz with the term forward guidance and what it implies for forex trading. Simply put, this is all about the public announcement of what the central bank plans to do with monetary policy and interest rates for the foreseeable future.

In this week’s Bank of England monetary policy statement, new BOE Governor Mark Carney stated that the markets shouldn’t expect an interest rate hike until the middle of 2015. Meanwhile, European Central Bank Chairman Mario Draghi said that interest rates in the euro zone will remain low for an extended period.

This kind of communication strategy isn’t exactly a brand-new phenomenon among central bank leaders. In fact, the US Federal Reserve has been practicing this kind of announcement for a few years already. Recall that Fed Chairman Ben Bernanke was often quoted saying that interest rates will remain at record lows for an extended period of time back when the US economy was having difficulty recovering. Recently, Bernanke gave a timeline for the stimulus taper plan, as he announced that the Fed is looking to reduce bond purchases towards the last quarter of the year and possibly ending the easing program by the middle of next year.

For central bank officials, they are able to accomplish two objectives with forward guidance. First, they are able to keep a lid on bond market volatility by preventing interest rate expectations from causing sudden spikes in bond yields. In effect, they induce stability in borrowing costs, as these will no longer be driven by differing speculations but by actual forecasts from the central bank. Second, they are able to make the most of their current monetary policies by extending the effect of their rate cuts or asset purchases. Remember that several central banks already have record low interest rates and are running out of ideas when it comes to implementing more stimulus. By announcing that rates are likely to stay low for a number of years, they are able to influence lenders into keeping interest rates lower for longer-term loans without needing to slash rates lower or print more money.

Because of that, forex traders are now more conscious of which central banks are dovish and which ones are leaning towards tightening monetary policy. To be specific, the ECB and BOE are clearly more dovish compared to other major central banks while the US Fed is relatively more hawkish. As a result, GBP/USD and EUR/USD could be in for stronger and longer trends moving forward.

Forex – Other Folks Who Trade in and Out

It is very vital that most traders be aware about the currency markets as possible as this would comprise who else out there is trading on the market. Well, a few trader may experience gaining while others would be losing.

1. Banks

– The role players in the forex markets have always been and continue to be banks. Banks composition is more than 75% of currency trading. Banks can trader for their own profit or for their customer’s profit, but they are the ones who drives the most money roughly.
As a matter of fact, nearly ten banks composed the majority of all bank trading These banks are often located in Europe which elucidates why the London trading session usually has the majority volume.

2. Corporations

– Large businesses also have a very significant part in forex trading. Companies that do a lot of business globally are very engrossed in exploring their investments so that they won’t go totally bankrupt if the currency markets shift too far one way or another. GM, Coke, and even Yahoo are examples of companies that you are trading with.

3. Central banks / governments

– Most Central banks do fine in currency trading such that they call for currency in their reserves and also they tend to buy millions and billions of dollars over a line of weeks with no hassle at all. Central banks occasionally try to sway the currencies to move in a direction that is favorable to their economic well being. This simply means they want to make sure that it will be advantageous for them.