Currency arbitrage is a technique traders use to take advantage of price discrepancies between two or more markets in forex trading. In Singapore, this refers to the difference in exchange rates between the Singapore dollar and other currencies.
It means that a trader could purchase GBP at a lower price in the UK market and sell it for a higher price in the Singapore market, resulting in a profit.
Here are reasons why exchange rates may vary between markets. Some of these include interest rates, economic stability, and political conditions.
Interest rates
Higher interest rates usually attract foreign investors, leading to an appreciation of the home country’s currency. For example, after the US Federal Reserve raised interest rates in December 2016, the US dollar strengthened against most major currencies.
Economic stability
Investors tend to flock to countries with stable economies and political conditions. It increases demand for the country’s currency, causing its value to appreciate. For instance, the Swiss franc is considered a safe-haven currency due to Switzerland’s stability and low inflation rate. As a result, the franc tends to strengthen during periods of market turmoil.
Political conditions
Uncertainty or instability in a country can lead to capital flight and currency depreciation. For example, fears over Brexit caused the British pound to fall sharply against other currencies in the lead-up to the referendum.
Capital controls
Capital controls are measures that a government takes to restrict the flow of capital into or out of the country. For example, China has implemented capital controls to prevent its currency from depreciating further. It has led to a discrepancy between the offshore and onshore yuan exchange rates.
Geopolitical tensions
Tensions between countries can also lead to fluctuations in exchange rates. For example, the Korean won has been trading at a record high against the US dollar in recent months due to rising geopolitical tensions between South Korea and North Korea.
Inflation
When prices rise, the value of a currency falls. People will need more currency to purchase the same amount of goods and services. For example, if inflation rates in the US were to rise, the US dollar would likely depreciate against other currencies.
Economic growth
A country’s rate of economic growth can also impact its currency. When a country’s economy is growing, investors are more likely to invest in it, which leads to an appreciation of the currency. Conversely, when a country’s economy contracts, its currency tends to depreciate.
Trade balance
A country’s trade balance (i.e. the difference between its exports and imports) can also impact its currency. A country with a positive trade balance (i.e., exports more than imports) will appreciate its currency. In contrast, a country with a negative trade balance (i.e. it imports more than it exports) will see its currency depreciate.
Country risk
Country risk is the perceived risk of investing in a particular country. It includes political and economic instability, corruption, and war. Investors often demand a higher return on investments in countries with high levels of country risk, which leads to a depreciation of the currency.
Debt levels
A country’s level of debt can also impact its currency exchange rates. When a country’s debt levels are high, investors are less likely to invest in it, which leads to a depreciation of the currency. For example, the Argentine peso has been depreciating rapidly against other currencies in recent years as the country’s debt levels have risen.
Purchasing power parity (PPP)
Purchasing power parity (PPP) is a theory that measures the exchange rate between two currencies by comparing the cost of identical goods and services in different countries. When PPP holds, it means that the purchasing power of each currency is equal. It means that a currency unit will buy the same amount of goods and services in every country.
Currency speculation
Currency speculation is when investors buy and sell currencies to make a profit from price movements. Speculation can lead to significant and sudden fluctuations in exchange rates. For example, the Japanese yen fell sharply against other currencies in 2015 after the Bank of Japan introduced negative interest rates, which led investors to speculate that the yen would depreciate further.
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