Introduction
The foreign exchange (forex) market is influenced by a complex interplay of economic, political, and financial factors. Unlike technical analysis, which focuses on historical price movements, fundamental analysis seeks to understand the underlying reasons for currency fluctuations. This approach is essential for long-term traders, investors, and policymakers who need to assess currency strength based on macroeconomic conditions.
In this article, we will explore three fundamental factors that significantly impact forex price movements: interest rate differentials, economic performance, and political stability. To illustrate these concepts, we will analyse the behaviour of the following currency pairs: USD/JPY for interest rate differentials, EUR/USD for economic performance, and USD/CAD for political issues. Additionally, we will examine how these factors have influenced major forex pairs since 2022.
Interest Rate Differentials: The Case of USD/JPY
Interest rates are one of the most significant drivers of forex prices. When a country offers higher interest rates compared to another, its currency typically appreciates because investors are drawn to higher returns on their investments. This principle, known as the interest rate differential, plays a crucial role in determining exchange rate movements. Traders often monitor central bank policies to anticipate changes in interest rates, as these shifts directly influence currency demand.
A prime example of how interest rate differentials affect forex is the USD/JPY pair. The United States and Japan have historically maintained different monetary policies. The US Federal Reserve (Fed) adjusts interest rates to control inflation and manage economic growth, while the Bank of Japan (BOJ) has kept rates near or below zero to stimulate economic activity and combat deflation.
Since 2022, the Fed has been raising interest rates to combat inflation. The federal funds rate increased from 0.25% in early 2022 to 5.50% by mid-2023 1. In contrast, the BOJ has maintained its negative interest rate policy at -0.10% as part of its ongoing stimulus measures 2. This growing interest rate differential has made the US dollar more attractive to investors, driving the USD/JPY exchange rate higher from around 115 in early 2022 to approximately 158 by January 2025 3.
Chart: USD/JPY
Source: POEMS
This widening interest rate gap is further bolstered by carry trades, where investors borrow in yen at low interest rates and invest in US assets offering higher returns. However, should the Fed signal a shift towards rate cuts, the interest rate differential may narrow, potentially leading to a reversal in the USD/JPY trend.
Economic Performance and its Impact on EUR/USD
Another critical driver of forex prices is a country’s economic performance. A strong economy typically supports a stronger currency, as it fosters confidence among investors. Key economic indicators—such as GDP growth, inflation rates, employment figures, and trade balances—play significant roles in forex market movements. When a country’s economy is performing well, its central bank may tighten monetary policy by raising interest rates, further strengthening its currency.
The EUR/USD pair offers a prime example of how economic performance affects exchange rates. The eurozone, composed of multiple European nations, faces diverse economic conditions, making the euro vulnerable to fluctuations based on the region’s economic health. In contrast, the US has a more unified economy, allowing the Fed to make policy decisions with greater consistency.
Since 2022, the eurozone has encountered numerous challenges, including high energy costs, slowing GDP growth, and rising unemployment. Conversely, the US economy has remained resilient, driven by strong job creation, consumer spending, and economic growth. As a result, the European Central Bank (ECB) lowered interest rates to 2.65% in March 2025 to stimulate growth, while the Federal Reserve maintained its higher rate environment 4.
Chart: EUR/USD
Source: POEMS
Consequently, the EUR/USD exchange rate has fallen from 1.15 in 2022 to around 1.03 in January 2025, reflecting the stronger US economy compared to the eurozone [5]. As investors continue to favour the US dollar for its stability and higher returns, the euro remains under pressure. However, should economic conditions in Europe improve or if the Fed signals potential rate cuts, this trend could reverse.
Political Stability and Trade Relations: USD/CAD in Focus
U.S. President Donald Trump hosts his first cabinet meeting with Elon Musk in attendance, Washington, D.C., U.S., 26 February 2025.
Political events and trade policies also significantly influence forex markets. A country’s political stability, government policies, and international trade relations can lead to substantial fluctuations in currency values. Traders closely monitor elections, trade agreements, sanctions, and diplomatic relations to anticipate potential movements in currency pairs.
One of the most politically affected currency pairs in recent years is USD/CAD. The economic relationship between the United States and Canada is strong, making the Canadian dollar (CAD) particularly sensitive to political changes and trade relations. Following the re-election of Donald Trump in late 2024, tensions between the two countries increased due to new trade policies and tariffs.
In January 2025, speculation around potential new U.S. trade policies, including tariffs on Canadian goods, increased uncertainty for the CAD [6]. Investors are closely watching for official announcements, as any new restrictions could weaken the Canadian dollar further. Analysts have expressed concerns that tighter trade policies could slow Canadian economic growth, potentially impacting GDP and leading to further depreciation of the CAD 7.
Chart: USD/CAD
Source: Poems
Historically, political uncertainty tends to weaken the Canadian dollar, as investors seek safer assets in times of instability. If trade tensions between the US. and Canada escalate further, the CAD could continue to weaken. However, if diplomatic negotiations lead to a resolution and the US eases its tariffs, the Canadian dollar may recover, potentially reversing the upward trend in USD/CAD.
Conclusion
Fundamental analysis remains an indispensable tool for understanding the intricate dynamics of forex markets, offering traders and investors a macro-level perspective on the forces shaping currency valuations. Since 2022, the trajectories of major currency pairs have vividly illustrated these principles: USD/JPY has soared from 115 to 158, propelled by stark interest rate differentials; EUR/USD has weakened from 1.15 to 1.03, mirroring the eurozone’s economic struggles against US resilience; and USD/CAD has climbed from 1.25 to 1.44, rattled by political and trade uncertainties following the 2024 US election. These shifts underscore how central bank policies, economic vitality, and geopolitical developments converge to dictate currency valuations.
Looking ahead, the forex landscape promises continued volatility as global conditions evolve. Traders who adeptly interpret interest rate signals, economic data releases, and political headlines will be best positioned to anticipate trends and refine their strategies. Whether it is the Fed pivoting to rate cuts, Europe staging an economic recovery, or US.-Canada trade tensions easing, adaptability grounded in fundamental insights will separate the successful from the sidelined. In an ever-shifting financial world, mastering these drivers is not just an advantage —it is a necessity for thriving in the currency markets.
Trade Forex with Phillip CFD
Explore over 30 currency pairs with competitive spreads and no commissions. Enjoy up to 20x leverage, allowing you to maximize opportunities with a small capital requirement. While leverage can enhance potential returns, it’s important to manage risk wisely. Start trading with confidence today!
How to get started with POEMS
POEMS’ award-winning suite of trading platforms offers investors and traders more than40,000 financial products across global exchanges.
Take this opportunity to expand your trading portfolio with our wide range of products including Stocks, CFDs, ETFs, Unit Trusts and more across 15 global exchanges available for you anytime and anywhere to elevate you as a better trader using our POEMS Mobile 3 App!
For enquiries, please email us at cfd@phillip.com.sg.
References:
- [1] Federal Reserve Interest Rateshttps://en.wikipedia.org/wiki/Federal_funds_rate
- [2] Bank of Japan Monetary Policyhttps://www.boj.or.jp/en/mopo/mpmdeci/index.htm
- [3] Japanese Yen Historical Rates https://www.xe.com/currencytables/?from=JPY&date=2025-03-12/
- [4] European Central Bank Interest Rates https://www.ecb.europa.eu/stats/policy_and_exchange_rates/key_ecb_interest_rates/html/index.en.html
- [5] EUR/USD Market Data https://www.investing.com/currencies/eur-usd-historical-data
- [6] U.S. Trade Policy News https://www.cnbc.com/2025/02/27/what-trumps-tariffs-on-canada-and-mexico-mean-for-your-money.html?&qsearchterm=us%20tarrif%20to%20canada
- [7] Canadian Dollar Forecast https://www.reuters.com/markets/currencies/canadian-dollar-dips-volatile-trading-tariff-implementation-uncertainty-2025-01-31/
Disclaimer
These commentaries are intended for general circulation and do not have regard to the specific investment objectives, financial situation and particular needs of any person. Accordingly, no warranty whatsoever is given and no liability whatsoever is accepted for any loss arising whether directly or indirectly as a result of any person acting based on this information. You should seek advice from a financial adviser regarding the suitability of any investment product(s) mentioned herein, taking into account your specific investment objectives, financial situation or particular needs, before making a commitment to invest in such products.
Opinions expressed in these commentaries are subject to change without notice. Investments are subject to investment risks including the possible loss of the principal amount invested. The value of units in any fund and the income from them may fall as well as rise. Past performance figures as well as any projection or forecast used in these commentaries are not necessarily indicative of future or likely performance.
Phillip Securities Pte Ltd (PSPL), its directors, connected persons or employees may from time to time have an interest in the financial instruments mentioned in these commentaries.
The information contained in these commentaries has been obtained from public sources which PSPL has no reason to believe are unreliable and any analysis, forecasts, projections, expectations and opinions (collectively the “Research”) contained in these commentaries are based on such information and are expressions of belief only. PSPL has not verified this information and no representation or warranty, express or implied, is made that such information or Research is accurate, complete or verified or should be relied upon as such. Any such information or Research contained in these commentaries are subject to change, and PSPL shall not have any responsibility to maintain the information or Research made available or to supply any corrections, updates or releases in connection therewith. In no event will PSPL be liable for any special, indirect, incidental or consequential damages which may be incurred from the use of the information or Research made available, even if it has been advised of the possibility of such damages. The companies and their employees mentioned in these commentaries cannot be held liable for any errors, inaccuracies and/or omissions howsoever caused. Any opinion or advice herein is made on a general basis and is subject to change without notice. The information provided in these commentaries may contain optimistic statements regarding future events or future financial performance of countries, markets or companies. You must make your own financial assessment of the relevance, accuracy and adequacy of the information provided in these commentaries.
Views and any strategies described in these commentaries may not be suitable for all investors. Opinions expressed herein may differ from the opinions expressed by other units of PSPL or its connected persons and associates. Any reference to or discussion of investment products or commodities in these commentaries is purely for illustrative purposes only and must not be construed as a recommendation, an offer or solicitation for the subscription, purchase or sale of the investment products or commodities mentioned.
This advertisement has not been reviewed by the Monetary Authority of Singapore.
CFD Disclaimer
This promotion is provided to you for general information only and does not constitute a recommendation, an offer or solicitation to buy or sell the investment product mentioned. It does not have any regard to your specific investment objectives, financial situation or any of your particular needs. Accordingly, no warranty whatsoever is given and no liability whatsoever is accepted for any loss arising whether directly or indirectly as a result of your acting based on this information.
Investments are subject to investment risks. The risk of loss in leveraged trading can be substantial. You may sustain losses in excess of your initial funds and may be called upon to deposit additional margin funds at short notice. If the required funds are not provided within the prescribed time, your positions may be liquidated. The resulting deficits in your account are subject to penalty charges. The value of investments denominated in foreign currencies may diminish or increase due to changes in the rates of exchange. You should also be aware of the commissions and finance costs involved in trading leveraged products. This product may not be suitable for clients whose investment objective is preservation of capital and/or whose risk tolerance is low. Clients are advised to understand the nature and risks involved in margin trading.
You may wish to obtain advice from a qualified financial adviser, pursuant to a separate engagement, before making a commitment to purchase any of the investment products mentioned herein. In the event that you choose not to obtain advice from a qualified financial adviser, you should assess and consider whether the investment product is suitable for you before proceeding to invest and we do not offer any advice in this regard unless mandated to do so by way of a separate engagement. You are advised to read the trading account Terms & Conditions and Risk Disclosure Statement (available online at https://www.poems.com.sg/) before trading in this product.
