Impact Of Trade Agreements On Forex Trading
The Forex market is one of the most liquid and actively traded financial markets. There are a lot of reasons behind its popularity, but it's impossible to argue that the volatility of currency exchange rates is one of them. As commonly known, the value of currencies can be easily affected by a number of different factors: geopolitical events, economic instabilities, social media trends, etc.
What often goes unnoticed, however, is how commerce and international trade agreements can influence the exchange rate of currencies and, in turn, Forex trading. In this article, you will learn about the nature of global trade agreements, their functions, and how they affect the value of national currencies.
International trade: how does it work?
If you look at the contents of your fridge, you won't find anything surprising or worth noting. But if your ancestors could peek at your food supplies, they would be shocked to find foreign goods they'd never seen in their lives. But now, thanks to highly-developed trade relations with countries worldwide, you can buy things that your fellow citizens from a hundred years ago never knew existed.
International trade refers to the purchase (import) and sale (export) of various goods where the buyer and the seller come from different countries. These goods can include food, materials, and devices.
The import and export of goods plays an essential role in the economic growth of a country. If it has an abundance of resources, selling them would bring additional income to the state budget. At the same time, importing may make up for a shortage of a product and encourage economic growth in new industries.
Benefits of international trade
- International trade can provide the citizens of a country with products that would otherwise be unavailable to them.
- While imported goods may also include products already present in the domestic market, it can urge domestic producers to up the quality of their products and keep the prices reasonably low if they want to stand up to their overseas competitors.
- Domestic businesses get the chance to expand their customer base and increase their revenues, which positively impacts the economy.
- If a company has a presence in several countries, it won't be severely affected should one of the countries suffer from economic downturns and other risk factors.
- Expanding businesses need more employees and create new job opportunities, helping to curb local unemployment rates.
What are international trade agreements?
Global trade agreements are treaties outlining terms and conditions for importing and exporting goods between two or more countries.
These agreements are overseen by international commerce organizations, including the World Trade Organization, the International Chamber of Commerce, the United Nations Conference on Trade, and other institutions. These organizations ensure that international trade agreements comply with International Commercial Law.
Global trade agreements differ from contracts for the sale of goods made between businesses. The former establishes trade relations between countries, setting out provisions about taxes, tariffs, quotas, trade restrictions, investment guarantees, etc. They provide the framework of rules for the purchase and sale of goods that all the parties to the agreement must adhere to.
Examples of international trade agreements are the North American Free Trade Agreement (between the US, Canada, and Mexico), the Association of Southeast Asian Nations (Indonesia, Malaysia, the Philippines, Singapore, and Thailand), and even the European Union, though it's much more complex.
How do global trade agreements affect the Forex market?
Now that you know more about international trade, it's time to learn the answer to the main question: how do global trade agreements influence currency rates?
When two or more countries enter a trade agreement, not only do they establish commercial relations, but they also alter their socio-economic system. The pricing of goods, new job opportunities, the levels of supply and demand for a particular currency, export profits, and import costs directly affect the economy of a country and the lives of its population, which naturally impacts the strength of a national currency.
Moreover, countries have different interests depending on their role in global trade relations.
Countries interested in exporting their products will try to keep the exchange rates of their currencies low so that export companies from these countries get more profits.
On the other hand, import-oriented countries are interested in the gradual appreciation of their national currencies, which they strive to achieve by buying goods and services at lower prices.
The main issue in these trading relations is finding the right balance for both parties to the agreement. Without it, there is a high risk of excessive exchange rate volatility, which isn't good for commercial transactions. (Besides, not all traders are able to find trading opportunities in highly-volatile markets.)
Thankfully, international trade agreements allow countries to find an optimal balance between their goals and reduce the risk of uncontrollable exchange rate volatility.
Types of global trade agreements and their functions
There are many classifications of international trade agreements, but we will focus on the number of parties included.
Unilateral trade agreements
The primary function of unilateral trade agreements is granting specific preferences for importing a trade product to a particular country. An example of these agreements is the Generalized System of Preferences 1976 between the US and 119 developing countries.
As a rule, when a unilateral agreement is signed, the beneficiary country increases its exports, which leads to more rapid development and, eventually, the growth of the national currency rate.
Bilateral trade agreements
These agreements are signed between two countries. Bilateral trade agreements mainly focus on the special concessions the importing party gives the exporting country. This includes decreased taxes, removal of tariffs, more market presence, etc.
The trade agreement between the EU and Japan in 2019 is a prime example of these agreements. As per the agreement, Japan was to remove "tariffs and other trade barriers" and "prevent obstacles to trade," as well as "reject protectionism."
Bilateral trade agreements have a positive impact on the currencies of the beneficiary countries.
Multilateral trade agreements
This type of trade agreement is similar to bilateral agreements, though it involves several countries.
One of the most well-known examples of multilateral agreements is the USMCA, a treaty between the US, Mexico, and Canada that replaced the North American Free Trade Agreement. However, unlike the examples mentioned above, the goal of the USMCA was to limit the countries' involvement in each other's markets.
The USMCA was the result of President Trump's aggressive protectionist policy. The negotiation and subsequent ratification of the agreement created the most severe macroeconomic noise affecting the key currencies of the participants - USD, CAD, and MXN.
Disagreement over the replacement of NAFTA was within the US political system and on the external circuit. For example, Mexico was pushing in every way to ratify the treaty, while Canada was in no hurry to reach an agreement. The coordination was accompanied by the scandal connected with increased tariffs on steel and aluminum imports from Canada. Consequently, acting aggressively, the US even threatened Canada with raising automobile import tariffs if the agreement was not ratified.
All this time, the currency market has been quite feverish.
As a result, USDCAD failed by almost 5% in 2019 (negotiations on the agreement) and a 1.7% slump in 2020.
As you see, international trade agreements can leave a lasting negative effect on the national currencies of the participating countries.
Global trade agreements bring a lot of changes to the economic state of the countries involved. The impact they leave on each country's trade and balance of payments affects the rate of national currencies and their position in the Forex market. Following the news about the latest international trade agreements can help you prepare for potential changes in currency rates and find lucrative trading opportunities.