Nowadays, every news resource is talking about inflation, economic articles are yelling about it. More and more people are getting confused with all the published information.
Types of currencies: which to choose?
2022-07-12 • Updated
Depending on the economic situation, investors choose where to invest their money and which currency to buy.
Not everyone knows that there is a great number of currency pairs that can be traded. Many traders, especially novices, trade only the main Forex pairs such as EUR/USD, GBP/USD, USD/JPY. But have you ever thought about other opportunities that will allow you earning a bigger amount?
In this article, we will tell you about the main types of currencies. You will learn which of them to use in different situations to increase your income.
Do you know what a safe-haven is? Safe-haven is a place where you are protected from harm or danger.
There are currencies that can protect you from financial dangers as well. Safe-haven or refuge currencies are currencies that tend to strengthen during the periods of uncertainty and fear in the market when investors want to find a safe place for their savings.
What currencies are that? Safe-haven currencies belong to countries with political and economic stability, low inflation rate and balance of payments surplus. As time goes by, different currencies play the role of the refuge ones. For now, such currencies are the US dollar, the Japanese yen, and the Swiss franc.
Let us give you a short description.
The US dollar is the most famous and widely traded reserve currency. It played this role ever since the Bretton Woods conference in 1945. During the last decade, more than 60% of the world’s foreign exchange reserves were held in dollars. All things equal, investors see the USD as a reliable and safe currency. Positive news about American economic growth and labor market support the dollar’s exchange rate as well.
The Japanese yen is another currency that attracts a lot of investors. It is interesting that the yen can rise even when negative news from Japan come. It happens because Japanese investors return their money from abroad to the domestic market (a process known as repatriation). Cross-currency pairs as AUD/JPY, NZD/JPY, CAD/JPY are highly traded and negative news in the commodity market lead to the increase of the yen and, as a result, to decline of these pairs.
The Swiss franc became the refuge currency because of the political neutrality of Switzerland and its attractive banking sector. During the euro zone’s debt crisis of 2010-2012, the demand for the franc was high.
To sum up, we can say that the reserve currencies are used more during unstable economic situations when investors need to preserve their savings.
We are sure you know that a commodity is a basic good that is used in commerce. If you remember this definition, it won’t be difficult for you to determine countries with commodity currencies. Commodity currencies are the currencies of economies with the large share of production and export of natural resources like oil, gas, coal, precious metals, etc. The Canadian, the Australian and the New Zealand dollars, the Russian rubble and the Norwegian crone are among them.
However, most commodity currencies are regulated by governments and not traded on the market enough. That is why only three currencies are highly used in the international Forex market: the CAD, the AUD, and the NZD. They are liquid and freely floating.
The peculiar feature of these currencies is that their exchange rates are highly influenced by the market’s risk sentiment in general and the dynamics of exports in particular. These currencies tend to strengthen when the world economy is expanding and the demand for resources. It happens as these countries get higher income from selling the expensive commodities. This allows them to increase interest rates. Higher rates attract foreign investors to the country.
Such investors use a carry trade strategy: they borrow money in currencies with the low rate of return and invest them in high-yielding commodity currencies. The high rate of return correlates with high risks. Carry trade may support the rise of commodity currencies. However, if the situation turns around, and financial conditions get worse, it will lead to the capital outflow and the fall of a commodity currency. When the global economy falters, commodity currencies fall.
Let’s study an example of the carry trade. When Australian interest rates are higher than in Japan, investors sell the yen and purchase the Australian dollar. It will drive the AUD up. When market volatility increases or growth of Australian rates slows down, investors close their trades and the AUD depreciates. Such difference in rates between commodity and refuge currencies is often here.
Let’s look at the three main countries with the commodity currencies.
Canada is famous for its oil and gas resources. So the Canadian dollar highly depends on oil and gas prices. When the crude price rises, the Canadian dollar appreciates. At the same time, the Canadian economy is linked to the US economy. The USA is the main importer of Canadian commodities. So, the weak US economy can cause the decline of Canadian exports and the fall of the CAD.
Australia exports natural resources – copper and iron ore. China is the biggest buyer of Australian commodities, so Chinese economy has a huge influence on the Australian dollar. When Chinese economic figures are positive, the AUD appreciates against the USD and vice versa.
New Zealand exports are based on agricultural sector: dairy products, meat, wood, and wool. The currency is affected by figures of dairy auctions, for example, the Global Dairy Trade. Moreover, the New Zealand economy is correlated with the Australian economy.
To sum up, when traders want to trade commodity currencies, they should follow the trend in commodity prices.
Making a conclusion, we can say that Forex traders always should take into account the economic situation. When the world economy is stable and grows, traders can get a high profit by trading commodity currencies – AUD, NZD, and CAD. However, during the periods of economic instability, it’s better to choose refuge currencies – JPY and CHF.
There is a great number of currency pairs which include commodity and refuge currencies. These currency pairs have great profit potential.
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