What is trading?
What moves currencies: rates, inflation and central banks
Learning objectives
Explain why currency analysis is always relative rather than absolute
Identify which data and which central bank matter for a given pair
Describe carry, risk sentiment and the commodity currency relationships
Everything here is relative
Start with the reframe, because it changes how every other question is asked.
A currency has no strength of its own. It only has strength against something else.
So you never ask "is the euro strong?" You ask "is the euro stronger than the dollar right now?" And that question has two halves, each of which can move independently.
The practical consequence is significant. Every pair is two economies and two central banks, and your position can be affected by news from either side. A trader long EUR/USD watching only European data is watching half their trade. A euro having a difficult year will still rise against a dollar having a worse one.
Rate differentials
The primary driver, and the one everything else feeds into.
Capital moves toward better returns, adjusted for risk. If markets expect one central bank to tighten while another eases, the gap between what the two currencies pay widens, and money tends to flow toward the higher-yielding one.
Note the word expect. As Central banks 101 set out, markets price an anticipated path of decisions, not today's rate. A currency can rally on a rate cut if the market had priced a deeper cutting cycle than the bank delivered.
So the question that actually moves a pair isn't "which currency pays more?" It's "which expected path is changing, and in which direction?"
Carry trades
The differential has a direct, daily consequence for your account.
Hold a higher-yielding currency against a lower-yielding one and you may be credited overnight financing rather than charged it. Hold it the other way round and you pay. This is the swap covered in the trading costs lesson, and in forex it comes directly from the rate gap between the two currencies.
Two honest points. Carry is small on any single night and meaningful over weeks, which matters for swing and position traders and not at all for day traders. And carry is never a reason to hold a losing position. A few dollars of nightly credit does not offset an adverse move, and treating it as compensation is how a trade gets held past its invalidation level.
Inflation
Inflation matters because central banks respond to it, not for its own sake.
Hotter inflation than expected raises the market's estimate of how tight policy will need to be, which lifts the expected path, which supports the currency. Softer inflation does the reverse.
Which is why CPI has, in some periods, moved currencies more than employment data or growth figures. When inflation is the dominant policy question, the inflation print is the policy signal.
Growth and risk sentiment
Two forces that sometimes reinforce the rate story and sometimes overwhelm it.
Growth feeds into rate expectations. A strengthening economy can bear tighter policy.
Risk sentiment operates separately, and this is where currencies behave in ways the rate story alone can't explain.
- Safe havens. The Japanese yen and Swiss franc tend to strengthen when markets are frightened, regardless of what their own economies are doing. Capital moves to perceived safety first and asks about yield later.
- Risk proxies. The Australian and New Zealand dollars tend to weaken in the same conditions, because they're associated with global growth and commodity demand.
- The US dollar is complicated, and behaves as a safe haven in genuine stress while responding to rate expectations the rest of the time.
This is why a rate rise can be followed by a currency falling. If the market reads the rise as damaging to growth, the risk channel can overwhelm the yield channel entirely.
Commodity currencies
Three currencies carry a strong association with a commodity, and it's stable enough to be worth knowing:
- CAD and oil. Canada is a major exporter, so higher crude tends to support the Canadian dollar.
- AUD, iron ore and China. Australia's export economy is heavily tied to Chinese industrial demand.
- NZD and dairy, along with the same broad China exposure.
Treat these as tendencies rather than mechanisms. They hold often enough to be useful context and break often enough that trading them as a rule will cost you.
Key data for each currency
Remember the pairing rule: anytime you trade a currency pair, both rows apply.
Currency
What to watch
USD
Fed policy, CPI, non-farm payrolls, retail sales
EUR
ECB policy, eurozone CPI, German data as the largest EU economy
GBP
Bank of England policy, UK CPI, wage growth
JPY
Bank of Japan policy, global risk sentiment as pivotal as domestic data
AUD / NZD
RBA and RBNZ policy, Chinese growth data, commodity prices
CAD
Bank of Canada policy, crude oil, US data
The honest limit
Every relationship on this page is a tendency, and every one of them breaks.
Higher rates usually strengthen a currency, until growth fears dominate and they don't. Oil usually supports the Canadian dollar, until broad dollar strength overwhelms it. Safe havens usually rally in stress, until a domestic policy shift cuts across it.
What is fundamental analysis? made this point and it's worth repeating where the relationships look most mechanical. These are useful for context and for knowing what to watch. They are not signals, and a position sized as though they were rules is sized wrongly.
Key takeaways
Currencies have no absolute strength. Every pair is two economies and two central banks, and either side can move your position
Rate differentials are the primary driver, but what moves price is a change in the expected path of policy rather than the current rate
Carry credits or charges you nightly from the rate gap. It matters over weeks and is never a reason to hold a losing position
Risk sentiment can overwhelm the rate story entirely, which is why safe havens rally in stress regardless of their own economic data