The Effect of a Property Slump on a Currency
About $150 billion was wiped off home values in Sydney after property prices recorded the highest ever annual decline since 1990 on November 1, 2018. With around 60% of the wealth of Australian households invested in a family home, such fluctuations in property prices could have a serious impact on the economy of the nation.
Housing Price Index and the Currency Market
The Housing Price Index (HPI) is used to measure changes in family house prices across a particular market. It is not only important for real estate, but policymakers as well. HPI has been used by policy experts and economists to analyse long-term trends in customer behaviour and the financial condition of an economy.
HPI becomes important as fluctuating house prices also indicate the direction of probable change in a country’s economy. Along with the gross domestic product (GDP), the consumer price index (CPI) and unemployment statistics, HPI is a crucial indicator analysed by currency investors before making an investment decision.
HPI helps economists and policy experts to predict the range of inflation, with constantly rising HPI indicating inflation. Inflation is a key factor in the decision making of central banks. When inflation is low, interest rates are reduced by central banks and when inflation is high, interest rates are increased.
When interest rates are raised, people are bound to avoid taking loans, especially for property purchases, and keep their money in banks because the bank offers higher returns. With an increase in interest rates, the demand for that currency also increases in the foreign exchange market. This is because higher returns on investment are guaranteed on that particular currency.
So, the demand and value of a currency rises following an increase in the interest rates in the nation that the currency belongs to. With a dip in the HPI, inflation decreases and banks reduce their interest rates. This results in a decline in the value and demand for that currency in the foreign exchange market.
This is why investors keep an eye on a country’s inflation and HPI as key indicators of inflation, with each release of an HPI report being followed by a fluctuation in the demand for a currency.
Impact of a Property Slump on the Economy
Property prices serve as a barometer for the health of an economy. Any decline in property prices, or even prediction of a decline, is likely to impact the financial markets. It has serious consequences for consumer confidence on the market too. A prediction of falling prices tends to make people skeptical about investing in real estate, resulting in a further decline in prices.
Falling property prices will reduce consumer spending and aggregate demand in the economy. This may result in lower growth and may even lead to an economic recession.
Impact of a Property Slump on Currency
According to Daniel Blake, chief economist at Morgan Stanley, a slowing or slumping housing market can force a reevaluation of gearing and may lead to household balance sheet recession. This is likely to have a severe impact on the economy of a nation. A balance sheet recession takes place when high levels of debt in the private sector make individuals focus on saving money by paying down debt, instead of spending or investing. This leads to a slowdown or decline in the economic growth of the nation.
Recession will, of course, affect the exchange rate of the nation’s currency, by decreasing its value against other currencies. For example, you own Pound Sterling and you want to buy US dollars. If the UK market enters a recession, then the Pound Sterling’s value will depreciate against the US dollar, making it more expensive to buy USD.
If you wish to invest in property in USA or import machinery from USA, you will need more GBP to pay the total amount in US dollars.
This happens because when a market enters recession, it sends out negative signs about that economy to the global market. Interest rates are decreased, to make borrowing cheaper and promote more investment. Unemployment rises as businesses attempt to cut costs to survive in the market. Customers begin to focus more on saving then spending. In general, the economy becomes less prosperous.
All this makes it unattractive for foreign investors to invest in that economy because the potential of returns on investment decreases or is limited. This weakens the domestic currency, as demand for it decreases in the global market.
Recession doesn’t, however, guarantee that the value of the domestic currency will fall. For example, the UK is in recession while the Eurozone isn’t, although recently the value of the GBP has increased to a record high against the euro since 2008. This is because the political framework of the UK is more stable and rigid than that of the European Union. The UK economy is unlikely to collapse in the near future, while there is a possibility for European Union to disintegrate after the Brexit. This is due to major EU economies mulling an exit from the union, similar to the UK. This only goes to show how recession in an economy or slump in property prices doesn’t play a dominant role in the foreign exchange rate.
Benefits of Falling Property Prices
If property prices fall, it reduces consumer spending as well. It also reduces inflation in the economy. And, if the inflation rate falls below the targeted rate, the monetary policy committee or central bank will reduce interest rates. The decline in interest rates, in turn, will decrease the overall mortgage repayment amount. This will prove beneficial for entities with high mortgage interest repayments.
This could also slowdown the price decline in the property market and make investment in property lucrative once again. It could also make buying property achievable for first time buyers. In addition, it would decrease the need to save more for mortgage deposits, enabling consumers to invest more. Decreasing property prices might also increase the purchasing power of foreign investors in the property market.
The real estate market is a significant contributor to the economy of a nation. Growth and decline in this sector have direct influence on the GDP and the domestic currency of that nation.
How to Get Profit Out Of Currency TradingForex is the acronym for Foreign Exchange, which is the direct trading of currencies of different countries. Earlier, this type of trading in foreign exchange was limited to institutional traders and large banks. With the advancements in technology, smaller traders are able to take advantage of the several benefits of currency trading, simply by taking up various trading platforms, mostly online.A floating exchange rate is used for the various currencies in the world. All currency trading is always done in pairs such as, Dollar/Yen, Euro/Dollar, etc. Trading of the major currencies takes up nearly 85% of the daily transactions all over. Trading forex involves mostly four major currency pairs. These are US dollar against Swiss franc, British pound versus US dollar, US dollar versus Japanese yen, and Euro versus US dollar. In the trading market, they will look like USD/CHF, GBP/USD, USD/JPY, and EUR/USD. However, it must be noted that in forex trading no one pays dividends.The basic pattern of making money out of currency trading works like this. If you think, one currency is going to appreciate over another, you exchange the second currency to obtain the first, and wait. Provided things go as per your estimate, you may eventually exchange this currency back to the first, collecting the profits in the transaction.Dealers at major banks or forex brokerage companies perform the transactions on the forex market. In the worldwide market, forex occupies a necessary activity, which is carried out at all times. When traders in the US are asleep, dealers in Japan are trading currency with their counterparts in Europe.This means, you are right in assuming the forex market is forever active the whole 24 hours, and dealers are working in three consecutive shifts. Clients can place stop-loss and take-profit orders with brokers for execution overnight.Compared to the stock market, where the variations are sudden, and large jumps are often the routine, the price movements are far smoother on the forex market. A new investor can enter or exit the market without any major upheaval, since the daily turnover in the forex market is of the order of $1.2 trillion.The Forex market is also known by many other different names like the FX market, or the foreign exchange market. The forex market, being one of the largest as well as the oldest financial markets of the world, never stops. It is also the biggest and the most liquid market known to the world, trading through the 24-hour day inter-bank currency markets.When you compare the various markets, you will observe the futures market is only one percent of the forex market. Moreover, the stock and futures market are centered on an exchange. This is not so for trading currency. Currency trading moves from major banks in the US to New Zealand and Australia, then to the Far East, next to Europe and finally back to the US, going like a full-circle game of trading.
The foreign exchange market, also known as the forex market, facilitates the buying and selling of currencies around the world. Like stocks, the end goal of forex trading is to yield a net profit by buying low and selling high. Forex traders have the advantage of choosing a handful of currencies over stock traders who must parse thousands of companies and sectors. In terms of trading volume, forex markets are the largest in the world. Due to high trading volume, forex assets are classified as highly liquid assets. The majority of foreign exchange trades consist of spot transactions, forwards, foreign exchange swaps, currency swaps and options. However as a leveraged product there is plenty of risk associated with forex trades that can result in substantial losses. Leverage Risks In forex trading, leverage requires a small initial investment, called a margin, to gain access to substantial trades in foreign currencies. Small price fluctuations can result in margin calls where the investor is required to pay an additional margin. During volatile market conditions, aggressive use of leverage will result in substantial losses in excess of initial investments. Interest Rate Risks In basic macroeconomics courses you learn that interest rates have an effect on countries’ exchange rates. If a country’s interest rates rise, its currency will strengthen due to an influx of investments in that country’s assets putatively because a stronger currency provides higher returns. Conversely, if interest rates fall, its currency will weaken as investors begin to withdraw their investments. Due to the nature of the interest rate and its circuitous effect on exchange rates, the differential between currency values can cause forex prices to dramatically change. Transaction Risks Transaction risks are an exchange rate risk associated with time differences between the beginning of a contract and when it settles. Forex trading occurs on a 24 hour basis which can result in exchange rates changing before trades have settled. Consequently, currencies may be traded at different prices at different times during trading hours. The greater the time differential between entering and settling a contract increases the transaction risk. Any time differences allow exchange risks to fluctuate, individuals and corporation dealing in currencies face increased, and perhaps onerous, transaction costs. Counterparty Risk The counterparty in a financial transaction is the company which provides the asset to the investor. Thus counterparty risk refers to the risk of default from the dealer or broker in a particular transaction. In forex trades, spot and forward contracts on currencies are not guaranteed by an exchange or clearing house. In spot currency trading, the counterparty risk comes from the solvency of the market maker. During volatile market conditions, the counterparty may be unable or refuse to adhere to contracts. Country Risk When weighing the options to invest in currencies, one must assess the structure and stability of their issuing country. In many developing and third world countries, exchange rates are fixed to a world leader such as the US dollar. In this circumstance, central banks must sustain adequate reserves to maintain a fixed exchange rate. A currency crisis can occur due to frequent balance of payment deficits and result in devaluation of the currency. This can have substantial effects on forex trading and prices. Due to the speculative nature of investing, if an investor believes a currency will decrease in value, they may begin to withdraw their assets, further devaluing the currency. Those investors who continue trading the currency will find their assets to be illiquid or incur insolvency from dealers. With respect to forex trading, currency crises exacerbate liquidity dangers and credit risks aside from decreasing the attractiveness of a country’s currency. This was particularly relevant in the Asian Financial Crisis and the Argentine Crisis where each country’s home currency ultimately collapsed.
The Forex market can be a formidable opponent. The daily transaction volume is approximately $5 trillion, and the Forex market is regarded as the most liquid market in the world. In most respects, undercapitalized retail traders appear to be outmatched as they take on global central banks, investment banks, hedge funds, market makers and everyone in between. The odds against becoming a profitable Forex trader are high, but many small investors still try to tame this beast. The experience can be Sisyphusean, as individual mental mistakes, greed, and market-conditional outliers send investors back to square one with emotional and financial scars as a parting gift.Investors and traders love it, hate it, don’t understand it, or fall somewhere in between. How many times have we heard the saying "Cut your losses quickly and let your profits run?" It may be the most abused cliché in the trading world, but it still rings true. Trading requires a considerable amount of perseverance and grit to overcome the statistically guaranteed adversity. This is especially true in the Forex markets, which handsomely rewards winners while ruthlessly exposes a trader's flaws and weaknesses.Forex for BeginnersSo is trading in forex markets really as simple as as cutting your losses off quickly and letting your profits run? Ask any profitable trader and the answer may surprise you. (See also: Can Forex Trading Make You Rich?)One portion of the proverb may hold true - cut your losses off quickly. But letting your profits run may be easier said than done, as it relies on the trader’s ability to make profitable moves in the first place. In my opinion, the right side of the chart may be the hardest section to predict with any precision. The fundamental and technical pundits battle for supremacy on what school of thought will win the trade, while actual traders are in the trenches grasping at profits or getting slaughtered as the next wave unfolds. Traders who are positioned correctly have the ability to manage profits, while traders who are fighting the flow are either pressing their eject buttons or experiencing margin calls. Letting your profits run requires a disciplined indifference to P/L fluctuation, and that is certainly an adjustment for the traders who are identifying opportunities to manage winning trades.The Forex market is a rather technically pure market with global transactions occurring around the clock. The market’s structure generates an intricate puzzle of support, resistance, trends, ranges, channels, patterns, highs and lows, and they are all interconnected and explanatory in real-time, and certainly in hindsight. If a trader ever asks why in the Forex market, there is most likely a headline, news announcement, or technical reason for the movement - making it great for after-the-fact explanations. But live trading perplexes and fakes out traders with nasty unanticipated volatility. This simply means that managing risk and trade size is important to reduce the noise and capitalize on the actual movement or direction the market has to offer. (See also: The Pros & Cons Of A Forex Trading Career.)Limit the DownsideA solid education can provide an application-based foundation. Aupport and encouragement are also necessary to stay positive as a trader. I am a big believer in having a support network to tap into when you find yourself struggling. Rather than throwing everything out and starting over, traders can keep the core principles (market structure, support, resistance, trends) and surgically remove the flaws that are costly to the P/L curve. Lean on a support network of traders who are performing well and adopt some survival skills during the tough times.It is very important to identify what is and has been repeatable in the market. There are a variety of ways to apply winning strategies and consistent trades to the market’s predictability and structure. Most successful traders are far more conscious of the downside than the upside. The upside where unexpected profits are acquired is often little more than the market being overly generous. The market is full of surprises, but unfortunately most of those surprises are to the detriment of the trader. Consider the upside as generosity, and keep the downside in the forefront in your strategies.The Bottom LineThe most important part is to remember to cut your losses quickly. Losing is the worst part of trading, but when the losses are manageable, small and seemingly insignificant relative to your total equity, you’ll be fine. If you find a way to let your profits run, congratulations on doing something that most traders don’t. But most importantly, find a way to cut your losses quickly and you have a chance to survive the chaos the market throws your way. Then, aim to take advantage when it’s behaving to your liking.