Risks, Opportunities And Threats In The Age Of Sustained Inflation Across Forex Markets

Throughout financial markets, inflation emerged as one of the biggest challenges for investors to contend with in 2022, and is continuing to persist amidst reactionary measures from federal reserves to hike interest rates as a calming measure. For many forex traders, this will present unique risks and opportunities largely unlike the strong economic headwinds of the 21st Century’s earlier downturns. 

Although high inflation has wreaked havoc among major currency pairs against the US dollar, the future is likely to hinge on the recovery of USD. However, fresh concerns have emerged regarding how the currency can resist new headwinds and the prospect of global nations seeking to decouple from the dollar. 

Date - Inflation Value

April 30, 2023 - 4.93%

March 31, 2023 - 4.98%

February 28, 2023 - 6.04%

January 31, 2023 - 6.41%

December 31, 2022 - 6.45%

November 30, 2022 - 7.11%

October 31, 2022 - 7.75%

September 30, 2022 - 8.20%

August 31, 2022 - 8.26%

July 31, 2022 - 8.52%

June 30, 2022 - 9.06%

May 31, 2022 - 8.58%

April 30, 2022 - 8.26%

March 31, 2022 - 8.54%

February 28, 2022 - 7.87%

(Above data illustrating US inflation rate. Data source: https://ycharts.com/indicators/us_inflation_rate)

While data shows a slowdown in US inflation in 2023, tracing back from peaks of over 9%, May 2023 saw the Federal Reserve continue in its approach to ease concerns by hiking its base rate to 5.25% in a move that represents its 10th consecutive increase in 14 months. 

These metrics bring significant meaning to FX markets, whereby traders have the potential to balance risk and volatility, or by intelligently trading this widespread battle to control the damage caused by inflation on a global scale. 

Finding Opportunities In Post-Pandemic Forex

The post-pandemic forex landscape has been anything but calm. Factors like the Covid-19 pandemic, consumer demand driven by government stimulus packages, and Russia’s invasion of Ukraine have all impacted global currencies in different ways. 

With the prices of goods and services rising globally, federal interest rate hikes have been a natural contractionary monetary policy. This approach to introducing economic calming measures for nations around the world has altered the way that FX traders can make the most from their positions. 

With increased action in adjusting base rates, traders can achieve significant results by anticipating fed actions and taking the positions proactively before decisions are confirmed. 

Although changes in monetary policy can carry different effects for forex traders, the emergence of record-breaking inflation rates forms an ideal starting point to predict future movements. 

Based on the data that indicators show, it’s possible for forex traders to manage their trades. For instance: 

• Trading Outlook A
• Trading Outlook B
• Trading Outlook C

Indication:

• Continuation of high inflation
• Continuation of high inflation
• Short term inflation

Potential Central Bank Response:

• Moderate base rate hike
• Aggressive base rate hike
• No change in interest rates

Possible Economic Impact of Response:

• Small declines in price of goods but no major economic downturn
• Significant economic slowdown with a recession possible
• Inflation continues

Investor Strategy:

• Invest in currency
• Add a currency hedge by seeking exposure to commodities like gold
• Explore variables impacting exchange rates and the strengths or currency pairs

Crucially, many major forex trading platforms include fundamental indicators that can inform preemptive decisions. MQL5 indicators, for instance, can access entire databases of historical data for selected financial instruments that can be applied to price charts–making the process of discovering actionable insight more straightforward. 

The great thing about the MQL5 high-level programming language is that it offers an object-oriented architecture, bringing with it rapid calculation speeds and syntax akin to C++. This means that it’s not only easy to use industry-leading indicators that stretch even to the works of Bill Williams’ own trading systems as described in his books, but the MQL5 Development Environment has even paved the way for a vibrant marketplace of tailor-made trading bots that can be utilized to create effect during high-inflation scenarios by traders. 

These insights come as part of the MetaTrader 5 trading terminal, which boasts fundamental analysis metrics that can be used to forecast the price dynamics of financial instruments. Furthermore, the platform features a valuable news reports portal stemming from international agencies that are broadcast directly into the platform. 

This can offer essential financial information in real-time and perfectly complements MT5’s economic calendar feature, which incorporates the key macroeconomic indicators of different countries for a holistic view of economic health. 

Taking Up Long Positions

Although we’re already seeing a trend reversal take shape for nations experiencing high inflation rates like the US, historical trends show that it takes around one year for these reversals to fully take effect. For FX traders, this means that there are still plenty of opportunities to be found as different nations come to terms with inflation. 

As we can see from WiseVoter data, different global currencies can provide fresh opportunities for trading forex while other nations are further along in their economic recovery. 

Seeking Support Levels

The key opportunity for FX traders stems from national currencies performing in unconventional ways. This can help assets to reach support levels that haven’t been seen for decades, providing a rare opportunity for investors to buy trend reversals once support has been reached. 

(Image Source: MetaTrader 5)

These instances of trading support levels can be exemplified by the recent pullback experienced by the USD/JPY pair, which saw a growing trend encounter a key supply level from 1997, which sparked a pullback from the area and a fresh opportunity for FX investors to join the trend at a lower entry cost. 

Utilizing Actionable Data to Inform Investment Decisions

Because a core facet of forex trading during high inflation periods will be centered around anticipating fed decisions on interest rates, it’s essential that investors have access to all the right tools to provide a holistic view of the overall health of a currency. 

Inflation directly influences a range of economic parameters which invariably carries an influence on forex markets, these metrics can include: 

Gross Domestic Product (GDP)

One of the most popular metrics for forex traders but certainly worth reiterating, gross domestic product is a means of understanding the overall health of a country’s economy throughout a calendar year. 

Capable of monitoring a nation’s economic growth or decline, GDP is an excellent tool for examining how a country is recovering from periods of high inflation. 

However, during periods of high inflation, the monetary value of goods can grow, causing GDP to rise artificially, and it’s for this reason that the best results can often come from inflation-adjusted GDP charts, otherwise known as real GDP. 

Although a nation’s GDP can be seen to grow, there’s a danger that a currency could depreciate even despite GDP growth. This happens when inflation outpaces the rate of GDP growth. 

The formula to measure a nation’s Gross Domestic Product is: GDP = private consumption + gross private investment + government investment + government spending + (exports – imports). However, real GDP adds an economic deflator into the equation. With this in mind, if a nation’s GDP was $1 million but its inflation had stood at an average of 1%, the calculation would be: $1,000,000 / 1.01 = $990,099.

Because the US GDP shows sustained growth, reaching a value of $23.32 trillion to date, it’s important for investors to weigh this weight of growth with current inflation rates to determine the overall state of the economy. Should the growth of GDP outpace that of inflation, this can be taken as a generally positive indicator of the nation’s economic health. 

Gross National Product (GNP)

Gross national product represents the total value of goods and services produced within a country yearly. Unlike GDP, GNP includes the value of the products created by a nation’s residents overseas. 

GNP is a great asset for FX traders because it can help to indicate whether a national currency is losing value. For instance, if inflation is growing faster than the production of products from a nation’s citizens, its currency will theoretically be devalued. 

The formula to calculate Gross National Product is a little more complex than GDP and looks like this: GNP = Consumption + Investment + Government + net exports + net income earned by domestic residents from overseas investments - net income earned by foreign residents from domestic investments.

When comparing the gross national product with other listed nations, we can see little difference in the US GNP, while China’s features an increase of almost $10 trillion. This illustrates the strength of GNP as a consideration among forex traders when assessing the potential of a currency trading pair. 

Consumer Price Index (CPI)

Another essential metric comes in the form of the Consumer Price Index, which can directly indicate inflation growth or decline. 

Many investors will already be aware of CPI as a major analytical tool for understanding the strength of a currency. 

When CPI data fails to fall in line with market expectations, the currency could become prone to significant volatility across the forex market. This can occur if a high CPI figure shows that inflation is rising, while markets anticipate that higher interest base rates will cause currency appreciation. 

The formula for calculating the Consumer Price Index is as follows: CPI = cost of products/services in the current period ÷ cost of products or services in a previous time period x 100.

Crucially, the US Consumer Price Index reached an all-time high of 303.36 points in April 2023, underlining the unprecedented impact of today’s inflation rates. Considering the average US CPI between 1950 and 2023 is around 120.23 points, it’s clear that traders must factor in the rising cost of goods and services domestically. 

Producer Price Index (PPI)

Finally, the Producer Price Index can measure the average change over time in selling prices of goods and services. Once again, this is an excellent measure of inflation, and the increasing price of goods can indicate growing inflation, which would reduce a currency’s strength within global markets. 

However, rising PPI figures could also indicate that a central bank may raise interest rates in the coming weeks, thus raising the short-term value of its currency. 

The formula to calculate the Producer Price Index is as follows: PPI = current price of basket ÷ base price of basket. In this particular calculation, the term ‘basket’ refers to the relative weight of goods and services within both the current and base period specified. 

The US Producer Price Index has shown a 0.2% and 0.3% increase in goods and services pricing respectively in April 2023 in comparison to March 2023 figures, which details an indication of inflation continuing to impact consumer goods and services. This also shows traders that although a slowdown appears underway, prices will continue to influence consumer spending power–carrying a wider knock-on effect for the US economy. 

Learning From the Dangers of Currency as an Inflation Hedge

Of course, now would be an ideal time to caveat the opportunities presented by FX trading in the age of inflation with the risks posed within the industry. 

Inflation invariably brings with it periods of market volatility that can lead to currency depreciation and losses for forex investors. 

It’s also essential to note that we’re living in a time of heightened geopolitical tensions that come with their own risks. The conflict in Ukraine adds an extra level of unpredictability regarding currencies in the Eurozone and the US, which has been committed to aiding the defences of Ukraine. 

Furthermore, recent volatility has prompted some emerging markets to consider uncoupling from the US Dollar, turning instead to China’s Yuan and the possibility of the USD’s position as the world standard in currency being challenged. 

With this in mind, FX traders must consider that periods of high inflation can lead to significant instability across economies that can prompt decisive action from central banks. This means that any investment decision must be researched to a sufficient extent in order to avoid the threat of losing value in your open positions.