Although the foreign exchange market is often billed as a banker’s game, currencies can sometimes be a great way to diversify a portfolio that hit a bit of a rut. It’s a market that can also offer tremendous opportunities when other global forums enter the doldrums.
Knowing a little bit about forex and the fundamentals behind it can make significant additions to any trader, investor, or portfolio manager’s arsenal. Let’s take a look at eight currencies every trader or investor should know, along with the central banks of their respective nations.
Key Takeaways
- The U.S. dollar is the home denomination of the world’s largest economy, sometimes referred to as the greenback.
- The European Central Bank holds the right to issue euro banknotes as it sees fit, while policymakers can interject at times of bank or system failures.
- The Bank of Japan governs monetary policy as well as currency issuance, money market operations, and data/economic analysis.
- The Bank of England has a Court of Directors or governing body appointed by the Crown. It also has a Monetary Policy Committee headed by the governor of the bank.
- The Swiss franc, the Canadian dollar, the Australian and New Zealand dollars, and the South African rand round out the list of top tradable currencies.
1. U.S. Dollar (USD)
Established in 1913 by the Federal Reserve Act, the Fed is the central banking body of the U.S. The system is headed by a chair and board of governors, with most of the focus being placed on the branch known as the Federal Open Market Committee (FOMC), which supervises open market operations as well as monetary policy or interest rates.
The current committee is comprised of five of the 12 current Federal Reserve Bank presidents and seven members of the Federal Reserve Board, with the Federal Reserve Bank of New York president always serving on the committee. Even though there are 12 voting members, non-members are invited to share their views on the current economic situation when the committee meets every six weeks. This includes additional Fed Bank presidents.
The Almighty Dollar
Sometimes referred to as the greenback, the USD is the home denomination of the world’s largest economy, the United States. As with any currency, the dollar is supported by economic fundamentals, including gross domestic product (GDP), and manufacturing and employment reports.
But the dollar is also widely influenced by the central bank and any announcements about interest rate policy. The USD is a benchmark that trades against other major currencies, especially the euro, Japanese yen, and British pound.
2. Euro (EUR)
Headquartered in Frankfurt, Germany, the ECB is the central bank of the 19 member countries of the eurozone. Just like the FOMC, the ECB has a main body responsible for making monetary policy decisions, the Executive Board, which is composed of four members plus a president and vice-president.
The ECB policy heads are chosen with the consideration that four of the seats are reserved for four of the five largest economies in the system, which include Germany, France, Italy, Spain, and the Netherlands. This ensures that the largest economies are always represented in the case of a change in administration. The board meets almost every week.
In addition to having jurisdiction over monetary policy, the ECB also holds the right to issue banknotes as it sees fit. Similar to the Federal Reserve, policymakers can interject at times of bank or system failures.
But the ECB differs from the Fed in an important area: Instead of maximizing employment and maintaining the stability of long-term interest rates, the ECB works toward a prime principle of price stability, with secondary commitments to general economic policies. As a result, policymakers will turn their focus to consumer inflation in making key interest rate decisions.
The Dollar’s Nemesis
Although the monetary body is somewhat complex, the eurozone’s currency is not. The euro tends to be a slower currency against the USD compared to its colleagues like the British pound or Australian dollar. On an average day, the base currency can trade between 70 and 80 pips or percentages in point with more volatile swings averaging slightly more, at 100 pips wide per day.
Another trading consideration is time. Because the FX market is open 24/7, forex traders must strategically set FX trading schedules. Trading in the euro-based pairs can be seen during the overlap of London and U.S. sessions. This occurs from 8 a.m. through 12 p.m. EST.
3. Japanese Yen (JPY)
Established as far back as 1882, the BoJ serves as the central bank of the world’s third-largest economy. It governs monetary policy as well as currency issuance, money market operations, and data/economic analysis.
The main monetary Policy Board tends to work toward economic stability, constantly exchanging views with the reigning administration, while simultaneously working toward its own independence and transparency. Meeting about monetary policy eight times a year, the central bank governor leads a team of nine policy members, including two appointed deputy governors.
Technically Complex, Fundamentally Simple
The Japanese yen (JPY) tends to trade under the identity of a carry trade component. Offering a low-interest rate, the currency is pitted against higher-yielding currencies, especially the Australian dollar, New Zealand dollar, and British pound.
As a result, the underlying tends to be very erratic, pushing FX traders to take technical perspectives on a longer-term basis. Average daily ranges are in the region of 70 to 140 pips, with extremes well over 200 pips.
4. British Pound (GBP)
As the central bank of the United Kingdom, the BoE serves as the monetary equivalent of the Federal Reserve System. The Court of Directors is a governing body appointed by the Crown, made up of five executive members and as many as nine others, including the chair and deputy chair.
There is also a Monetary Policy Committee, headed by the governor of the bank and made up of nine members, four of whom are appointed by the Chancellor of Exchequer. Announcing policy at least eight times a year, the MPC decides on interest rates and broader monetary policy, with primary considerations of total price stability in the economy.
As such, the MPC also has a benchmark of consumer price inflation set at 2%. If this benchmark is compromised, the governor has the responsibility to notify the Chancellor of Exchequer through a letter, one of which came in 2007 as the U.K. Consumer Price Index (CPI) rose sharply to 3.1%. The release of this letter tends to be a harbinger to markets, as it increases the probability of contractionary monetary policy.
The Queen’s Currency
A little bit more volatile than the euro, the British pound, also sometimes referred to as pound sterling or cable, tends to trade a wider range through the day. With swings that can encompass 100 to 150 pips, it isn’t unusual to see the pound trade as narrowly as 20 pips.
Swings in notable cross currencies tend to give this major a volatile nature, with traders focusing on pairs like the British pound/Japanese yen and the British pound/Swiss franc. As a result, the currency can be seen as most volatile through both London and U.S. sessions, with minimal movements during Asian hours between 8 p.m. and 4 a.m. EST.
5. Swiss Franc (CHF)
Different from all other major central banks, the SNB is viewed as a governing body with private and public ownership. This belief stems from the fact that the SNB is technically a corporation under special regulation. As a result, a little over half of the governing body is owned by the sovereign cantons or states of Switzerland and other public institutions.
It is this arrangement that emphasizes the economic and financial stability policies dictated by the governing board of the SNB. Smaller than most governing bodies, monetary policy decisions are created by three major bank heads who meet on a quarterly basis. The Governing Board creates the band (plus or minus 50 basis points) of where the interest rate will reside.
A Banker’s Currency
The euro and Swiss franc have an interesting relationship. Similar to the euro, the CHF hardly makes significant moves in any of the individual sessions. As a result, look for this particular currency to trade in the average daily range of 45 pips per day. High-frequency volume for this currency is usually pitted for the London session, which is 3 a.m. to noon EST.
Although the foreign exchange market is often billed as a banker’s game, currencies can sometimes be great diversification for a portfolio that might have hit a bit of a rut.
6. Canadian Dollar (CAD)
Established by the Bank of Canada Act of 1934, the BoC serves as the central bank called upon to focus on the goals of low and stable inflation, a safe and secure currency, financial stability, and the efficient management of government funds and public debt.
Acting independently, Canada’s central bank draws similarities with the Swiss National Bank because it is sometimes treated as a corporation, with the minister of finance directly holding shares.
Despite the proximity of the government’s interests, it is the governor’s responsibility to promote price stability at an arm’s length from the current administration while simultaneously considering the government’s concerns. With an inflationary benchmark of 2%, the BoC has tended to remain a shade more hawkish rather than accommodative when it comes to any deviations in prices.
The Loonie
Keeping in touch with major currencies, the Canadian dollar, also called the loonie, tends to trade in similar daily ranges of 50 to 100 pips. Many currency prices and commodities move together, and one unique aspect of the CAD is its relationship with crude oil.
The country remains a major exporter of the commodity, and as a result, plenty of traders and investors use this currency as either a hedge against current commodity positions or pure speculation, tracing signals from the oil market.
7. Australian/New Zealand Dollar (AUD/NZD)
Offering one of the higher interest rates in the major global markets, the RBA has always upheld price stability and economic strength as cornerstones of its long-term plan.
Headed by the governor, the bank’s board is made up of six members-at-large, in addition to a deputy governor and the Secretary to the Treasury. Together, they work toward targeting inflation between 2% and 3%, while meeting eleven times throughout the year.
The RBNZ looks to promote inflation targeting in a similar fashion. As such, it hopes to maintain a foundation for prices.
A Carry Favorite
Both currencies have been the focus of carry traders, as the AUD and NZD offer the highest yields of the seven major currencies available on most platforms. As a result, volatility can be experienced in these pairs if a deleveraging effect takes place.
The currencies tend to trade in similar averages of 70 to 80 pips. Both currencies also maintain relationships with commodities, most notably silver and gold.
8. South African Rand (ZAR)
Previously modeled on the United Kingdom’s BoE, the SARB stands as South Africa’s monetary authority. Taking on major responsibilities similar to those of other central banks, the SARB is also known as a creditor in certain situations, a clearing bank, and a major custodian of gold.
Above all else, the central bank is in charge of the achievement and maintenance of price stability. This also includes intervention in the foreign exchange markets when the situation arises.
The bank remains a wholly-owned private entity with more than 800 shareholders who are regulated by owning less than 1% of the total number of outstanding shares. This is to ensure that the interests of the economy precede those of any private individual.
To maintain this policy, the governor and 14-member board head the bank’s activities and work toward monetary goals. The board meets regularly during the year.
Emerging Opportunity
Seen as relatively volatile, the average daily range of the ZAR can be as high as several thousand pips. But don’t let the wide daily range fool you. When translated into dollar pips, the movements are equivalent to an average day in the GBP, making the currency a great pair to trade against the USD—especially when taking into consideration the carry potential.
Traders also consider the currency’s relationship to gold and platinum. With the economy being a world leader when it comes to exports of both metals, it is only natural to see a correlation similar to that between the CAD and crude oil. As a result, consider the commodities markets in creating opportunities when economic data is scant.
Why Is the U.S. Dollar the World’s Largest Currency?
There is no doubt that the U.S. dollar is the world’s largest and most powerful currency. In fact, it is a reserve currency, which means it is globally recognized, held by other countries, and used in international trade and transactions. The status of the dollar in the global markets is due to its strong value, the size and strength of the U.S. economy, and the country’s political power.
What Are the Major Currency Pairs?
The major currency pairs that are traded in the forex markets are EUR/USD, USD/JPY, GBP/USD, and USD/CHF. Other commonly traded pairs include the USD/CAD, AUD/USD, and NZD/USD.
What Are Some of the Most Popular Exotic Currencies?
Exotic currencies are those that are thinly traded in the forex market. These currencies aren’t widely used in the global markets. Some examples of exotic currencies include the Turkish new lira (TRY), the Iraqi dinar (IQD), and the Thai baht (THB).
The Bottom Line
As financial markets continue to evolve and grow globally, foreign exchange and currencies will play an increasingly large role in day-to-day transactions. Notional volumes for the market sector are already averaging over $6 trillion per day. As a result, whether a conversion for physical trade or a simple portfolio diversification play, currencies continue to offer more opportunities to both retail and institutional investors.
