What factors affect your exchange rate?

2 minutes read

When you send money from the United States to your family in other countries, one of the factors to consider is the exchange rate between the two countries’ different currencies.

Let’s look at an example. In the case of the Mexican peso, if you sent $100 USD on December 29, 2019, the exchange rate was around 19MXN / USD, meaning your family members would receive 1,900 MXN. If you were to repeat that same transaction on March 23, 2020, when the exchange rate was 25 MXN / USD, your family members would have received 2,500 MXN. That is a difference of 600 MXN between the two transactions! This is due to the exchange rate factor. If you’re sending money internationally, you should be familiar with the factors that affect the exchange rate.

The most important factors that affect the exchange rate are the following:

  1. Interest rate: The interest rate of a country’s government bonds affects the value of its currency. A higher interest rate generally makes the local currency appreciate against the dollar, since by offering more attractive rates, it attracts more foreign investment into the country.
  1. Inflation: Changes in a country’s inflation rates have an impact on the exchange rate. A country that experiences high inflation will see that the prices of goods and services increase in local currency, which is why the currency is losing value compared to other currencies. The currency market will reflect this fact, with a depreciation of the local currency against the US dollar.
  1. Current account / Balance of payments: The current account balance refers to the balance between a country’s imports and exports. When a country exports more than it imports, it is said to have a surplus, and when it imports more than it exports, it is said to be in deficit. A current account surplus causes the currency to appreciate, while a deficit causes depreciation.
  1. Political stability and country risk: Foreign investors look for countries that present favorable conditions such as legal protections for private property and general political and economic stability. The more stable investors perceive a country to be, the more foreign investment the country will attract, leading the local currency to appreciate. On the other hand, an unstable country not only discourages new investors, but also leads current investors to take their money to countries with lower country risk, causing the local currency to depreciate.
  1. Appetite for global risk: Generally during periods of global risk such as the one experienced in 2020 due to COVID-19, investors seek safe havens in the financial instruments of developed countries in order to preserve their capital. Perhaps the most common example is the US government bond, which is seen as extremely safe and stable. These flows out of emerging countries cause the currencies of emerging countries to depreciate during these periods.
  1. Speculation: If people perceive that a country’s currency is going to appreciate, they seek to make a profit by buying the currency and then selling it once the price goes up. When there is high demand among speculators for a particular currency, it appreciates. In contrast, when speculators believe that a currency is going to devalue, they sell it, causing the currency to depreciate.

The factors mentioned above are some of the most important ones that affect the exchange rate of a currency. In the case of people who send remittances from the United States to Mexico and Latin America, the best time to send their remittances is when the currencies of emerging countries depreciate, since they will obtain a greater amount of local currency for each US dollar sent.

Category

Salvador Mendoza

See author's posts