Correlation Between Foreign Exchange Market and Stock Market Movement

Correlation Between Foreign Exchange Market and Stock Market Movement

04 Sep 2019 04:58 PM
 

The stock exchange and interest rate are crucial factors of economic growth of any nation. The impact of interest rate on stock exchange offer valuable implications to monetary policy, risk management practices, financial securities valuation and government policy towards financial markets. Further, the share market and the foreign exchange market are vital elements of a financial system. This is because, forex and stocks are two of the most traded financial markets in the world and is common for traders to look for a correlations between the two markets that might help them to predict future price movements.

It is the stock market where shares are issued and traded either through exchange or over the counter markets. The forex market influences the stock market in many ways and the stock market too influences the forex market. In fact, if one observes it carefully, one will find that all the markets in the economy move in different directions depending on the movement of money. It is therefore difficult to determine the extent to which each market influences the other.

Positive correlations between Sensex & INR

If one conducts a research on the market, one fact which will be clearly evident is- the sensex and the rupee movement share a strong and positive movement between them. Say when the market goes up, rupee appreciation is direct result you will witness and when it is the contrary, rupee level depreciates. Going a little beyond, you will find that sensex and rupee is directly and indirectly affected by several similar factors-that includes the outlook for the Indian economy, governance, trade deficit/ surplus, foreign institutional investors (FII) inflows and outflows Forex Reserves, monetary policies undertaken by Governments across the globe.

Among the various factors that experts say are positive correlation between rupee and the Sensex is FII flows. As a direct consequence of FIIs pouring in money, the market rises. Since FIIs need the Indian currency to invest in the Indian market, the demand for the rupee goes up, in turn, boosting the currency. A stronger market leads to a better outlook for the rupee leading to further inflows thereby leading to rupee appreciation.

This is a mutually beneficial positive cycle and the reverse too is a possibility. For instance in years when there are FII outflows, the markets go down and rupee depreciates. The noteworthy thing here is that in either of the cycles, the rupee and the market move in a similar direction.

Given below is a chart depicting the correlation between Sensex and INR (2017 to present). This should help you understand the negative as well as the positive correlation better.

How Does It Affect the Global Trade?

The connected ecosystem of the global market plays a decisive role in how the stock market influences the Foreign Exchange market. Most of the multinational companies that are publicly owned are especially instrumental in changing market dynamics. MNCs have a worldwide reach and are thus directly involved in the foreign exchange market in one way or another. Similarly, the MSMEs also contribute a sizeable gain to the nations GDP growth level through import and export of goods and services.

Large companies which operate globally like Coca- Cola have a direct impact on currency exchange. The economy can decline due to various reasons but the most likely reason is due to a decline in stocks value. Any kind of major news related to the economy can also affect the stock market and the companies in it before any other markets. Big corporate can also initiate the process of a poor performance in the stocks market when they make bad investment decisions. Say for any reason, if companies stop making profit, the reduction in spending by that company will definitely reflect in the economy. This thereby affects the value of the currency in the forex market.

The stock market has a huge bearing on the economy, it is often the first source of information for investors, consumers and other stakeholders of the economy who want to understand the direction the currencies might take. The indicators also show how the economy is performing and ultimately determine the price and general inflation in the economy. The general inflation rates affect the interest rates and this too in turn affects the level of investments. Investments are ultimately the main factor that determines the value of a currency at the forex market.

Bottom Line

Market value of any firm can be significantly affected by the health and national currency. Again, even the investors’ attention to the market can also affect the forex market in a big way. The stocks market performance is based on how much confidence the investors have on the assets being traded.  If for any reason investors start losing confidence in particular stocks, the investments will start to fall. This leads to a larger perception that the economy might not be faring well. When the investors pull out, they take their money with them and this has direct effects on the currency exchange markets.

When the economy loses units of foreign currency, it ends up seeing a devaluation of its currency. This, in turn has a direct effect on forex trading since the value of the asset of trade changes in such circumstances. The market sentiment is therefore a key factor in the stock market which has a direct effect on the forex market.

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