The United States of America is comprised of 50 states and a federal district.
The majority of the country can be found in North America, but the United States also has some territories in the Pacific.
Since its independence from the U.K. on the Fourth of July back in 1776, the U.S. has become an economic superpower not just in the West but also in the whole world.
Being the world’s largest economy, the U.S. plays a serious role in the global market.
Just about any economic development in the U.S., such as a rise or fall in consumer spending or an affair by its President, that is made public, could create quite a hefty impact on economies all over the world!
The U.S. is widely considered to be the richest country in the world, producing about $16.24 trillion in output in 2012. It ranked 13th in 2012 in terms of per capita income – that’s just the country’s total income divided by its population – of about $51,700 in a year.
The U.S.’s main industries are aircraft, automobiles, transistors, telecom equipment, and other industrial materials. Although it might seem that the US economy is heavily oriented towards the manufacturing of physical goods, 70% of its output actually comes from the services sector!
Speaking of trade, one key element of the U.S. economy is that the country is notorious for running huge trade deficits (i.e., the total value of goods flowing into the country is more than the total value of those going out).
The U.S. is also home to the New York Stock Exchange, which is the largest stock exchange in the world. It is also home to the world’s largest bond market, with a market capitalization of over $31 trillion and over $822 billion in bonds traded daily on average.
Being the top economy in the world in today’s globalized market, any domestic event affecting the U.S. also has the potential to affect markets around the world… Yes, even the foreign exchange market!
The Federal Reserve Board, more commonly called the Fed, is the U.S.’s main governing body when it comes to setting and implementing monetary policy.
Monetary policy is just the way the Fed controls the availability and supply of money in the economy and what makes the Fed special from other central banks is that its objectives are based on longer-term effects of its monetary policy.
The Fed has two main objectives. The first one is keeping the prices of consumer goods and services stable and the second one is making sure that there is sustainable economic growth.
In other words, the Fed just wants to make sure that yo Benjies doesn’t lose value and yo momma and poppa have jobs!
Within the Fed is the Federal Open Market Committee (FOMC). Currently led by Fed Governor, Jerome Powell, the FOMC is tasked to make sound and rational decisions on monetary policy.
The FOMC has two main weapons to use in its battle against inflation and achieve its long-term objectives: open market operations and the Fed’s Funds Rate.
The Fed’s first line of defense, its open market operations, is the buying or selling of government financial instruments like securities, notes and bonds.
The Feds Funds Rate is the interest rate that banks charge each other for overnight loans.
Banks use these loans to make sure they have enough to meet the Fed’s reserve requirement. These reserves are kept at their local Federal Reserve bank or as cash in their vaults.
Now, the one accountable for fiscal policy decisions is the U.S. Treasury. Fiscal policy is the use of government spending or tax collection to influence the direction of the economy.
To encourage business activity, the U.S. Treasury, for instance, could choose to lower taxes and to allot more budget on capital infrastructures like highways, schools, broadband, secret military ninja bases, etc.
On the other hand, if inflation starts to get out of hand, it could increase tax rates and cut spending.
Did you know that the nickname “Buck” for the U.S. dollar originated from buckskin, which was a common medium of exchange when the early American settlers traded with the Indians?
Even after paper currency replaced buckskin in the barter system, people still refer to the medium of exchange as bucks! Check out these forex-related properties of the buck:
A ginormous amount of currency transactions every day involves the USD. Commodities like gold and crude oil are also denominated in dollars. During the Asian session alone, the dollar takes up around 93% of all the currency transactions!
To put this in perspective, take the New York Stock Exchange and the U.S. bond market for example. The value of the companies listed in the NYSE amounts to $28.5 trillion, about 78% of the size of the world’s $36.6 trillion stock market.
Similarly, of the $82.2 trillion value of the global bond market, the U.S. takes up $31.2 trillion. Every single transaction there, in some way, involves the USD. How’s THAT for liquidity?
Over the past few decades, the Fed and the U.S. Treasury have kept a “strong dollar” policy.
They believe that monetary and fiscal policy should be geared towards a strong exchange rate of the USD, as it would benefit the U.S. and the rest of the world.
How often have you heard the phrase, the dollar is the world’s reserve currency? Well, the reason behind this is that some countries actually peg their currencies against the dollar!
When a country does this, the government agrees to buy or sell their currency at a fixed priced versus the dollar.
While the government can increase and decrease the supply of money, they are still subject to having the equivalent amount of dollars in reserve.
This process magnifies the importance of the dollar around the world, because this means that some economies are entirely dependent on the dollar!
If the dollar’s value were to stage a massive fall, it would produce a wide-reaching negative effect in all the other countries that are pegged their currency on the dollar.
Non-farm employment change (NFP) – The NFP employment report measures the change in the number of employed people in the prior month.
GDP – The Gross Domestic Product (GDP) report is the measure of the country’s total value of all final goods and services.
Retail Sales – The headline retail sales report measures the monthly change in the total value of sales at a retail level. The core version of the report, on the other hand, excludes vehicle sales.
Consumer Price Index (CPI) – The CPI measures the change in the prices of a fixed basket of goods and services. The core account excludes food and energy prices because of their volatile nature.
Personal Consumption Expenditure – This is very similar to the CPI report as it measures the price changes of US consumer goods. The reason why you should look at this report is because this is the one that the Fed looks at when making decisions regarding monetary policy. And we all want to be in cahoots with the experts right?
University of Michigan Consumer Sentiment – Every month, the University of Michigan releases its consumer sentiment report.
This index measures the attitude consumers have towards the economy. The more confident consumers are about economic conditions, the more likely they are to spend.
Whenever the dollar is at risk of losing its value due to inflation, investors turn to gold for safety. Unlike most financial assets, gold maintains its intrinsic value.
Gold is gold is gold – it’s the same everywhere! So when gold prices are rising, it could be a sign that the dollar is losing its appeal.
Fundamentally, positive economic developments in the U.S. attract more participants to invest in the U.S.
An investor would, of course, need to have some dollars to be able to transact in the U.S.
So as the demand for U.S. investments increases, the demand for the greenback rises as well.
With respect to Japan and London, the U.S. probably has the deepest and most advanced financial markets.
This provides the many kings, sultans, billionaires, and heirs around the world many types of investments which they can choose from.
In order to invest in these American assets, investors would first need to convert whatever currency they are holding into U.S. dollars.
The capital inflows and outflows from the U.S. financial markets can have a significant effect on the value of the dollar.
Since the USD takes up about majority daily currency transactions, just about any major development in the world (i.e. strong GDP growth in Australia, a stock market crash in Beijing, or a Godzilla attack in Tokyo) affects its short-term valuation.
With investors always looking for the best deal for their money, it is important to keep track of the differences in the yields of bonds of the U.S. and other foreign countries.
If investors see that bond yields are rising in foreign countries while yields in the U.S. are staying steady or going lower, investors will move their funds out of U.S. bonds (selling their dollars in the process) and begin purchasing foreign bonds.
Market participants pay attention to interest rates trends, and you should too.
If the Fed is expected to raise interest rates, this means that demand for dollar-denominated financial assets (like Treasuries) could rise, which would be bullish for the dollar.
If the Fed is expected to cut interest rates, it could lessen demand for these assets and we could see investors move their funds away from the dollar.
Since Fed officials usually drop hints about the central bank’s future interest rate moves, traders are all ears during policymakers’ speeches.
USD/XXX is traded in amounts denominated in USD. Standard lot sizes are 100,000 USD and mini lot sizes are 10,000 USD.
The pip value, which is denominated in XXX, is calculated by dividing 1 pip of the USD/XXX, which would be 0.0001 or 0.01 depending on the pair being talked about, by the USD/XXX current rate.
Profit and loss are denominated in XXX. For one standard lot position size, each pip movement is worth 10 XXX. For one mini lot position size, each pip movement is worth 1 XXX.
For example, if one pip is equal to 0.0001 and the current exchange rate of USD/XXX is 1.4000, one pip of one standard lot would equate to 14 USD.
Margin calculations are based in US dollars. With a leverage of 100:1, 1,000 USD is needed to trade 100,000 USD/CAD.
XXX/USD is traded in amounts denominated in XXX. Standard lot sizes are 100,000 XXX and mini lot sizes are 10,000 XXX.
The pip value, which is denominated in US dollars, is calculated by dividing 1 pip of the XXX/USD (0.0001 or 0.01 depending on the pair) by the XXX/USD’s current rate.
Profit and loss are denominated in U.S. dollars.
For one standard lot position size, each pip movement is worth 10 USD.
For one mini lot position size, each pip movement is worth 1 USD.
Margin calculations are based in US dollars. For example, if the current XXX/USD rate is 0.8900 and the leverage is 100:1, 890 USD is needed in available margin to be able to trade on standard lot of 100,000 XXX.
However, the as the XXX/USD rate increases, a larger available margin in USD is required. Conversely, the lower the XXX/USD rate is, the less required available margin is needed.
Now let’s put all these things we just learned and come up with some trade tactics for the USD.
Looking at differences in U.S. economic developments and economic data from other major economic is a good way to start off trading the USD.
For example, a jump in the US retail sales and ugly results on UK’s employment situation report would give you a reason to sell the GBP/USD.
The U.S. dollar index or USDX, which tracks the performance of the USD versus a fixed basket of currencies, is also a great barometer of the strength of the USD. By regularly looking at the U.S. dollar index, you can find some clues on where the USD is headed.
A USDX that is trending upwards could provide you the additional confirmation you need to take a short position on the EUR/USD.
Talks of a Fed funds rate hike, which signals the possibility of higher returns on US assets, encourage traders to buy up the USD. Well, don’t get left behind!
Taking note of the Fed’s monetary policy outlook, which is usually part of Fed officials’ speeches, could yield some clues about the direction of the USD.
Hawkish remarks could serve as signals to go long on the USD/JPY while dovish comments could serve as reasons to short the USD/JPY.