Major currency pair

What Is a Major Currency Pair?

A major currency pair refers to the most frequently traded currency combinations in the global foreign exchange market. These pairs involve the U.S. dollar (USD) combined with other highly liquid and economically significant currencies. Because of their substantial trading volume, major currency pairs typically exhibit lower bid-ask spreads and higher liquidity compared to other currency groupings. The category of major currency pairs is a fundamental concept within the Foreign Exchange (Forex) Market that every participant in currency trading must understand.

History and Origin

The dominance of major currency pairs in the global financial system is rooted in the evolution of international trade and monetary policy. Historically, currencies were often pegged to precious metals like gold, as seen under the gold standard. A significant shift occurred with the establishment of the Bretton Woods system in 1944, which primarily pegged global currencies to the U.S. dollar, with the dollar itself convertible to gold. This system, conceived to promote international monetary cooperation and economic growth, laid the groundwork for the modern foreign exchange market.¹⁸,¹⁷,

The formal end of the Bretton Woods system in the early 1970s led to the adoption of floating exchange rates for many major currencies. This transition allowed market forces, rather than fixed parities, to determine currency values, significantly increasing the volume and complexity of currency trading. The U.S. dollar maintained its central role due to the size and influence of the U.S. economy, the depth of its financial markets, and its widespread use in international transactions and as a global reserve currency.

Key Takeaways

• A major currency pair always includes the U.S. dollar (USD).
• These pairs represent the highest trading volume in the foreign exchange market.
• High liquidity and tight bid-ask spreads are hallmarks of major currency pairs.
• The most common major currency pairs include EUR/USD, USD/JPY, GBP/USD, AUD/USD, USD/CAD, USD/CHF, and NZD/USD.
• Their movements are closely watched as indicators of global economic health and investor sentiment.

Interpreting the Major Currency Pair

Interpreting a major currency pair involves understanding the relative strengths and weaknesses of the two economies represented. The exchange rate of a major currency pair reflects a multitude of factors, including the economic indicators of both nations (such as GDP, inflation, and employment data), their respective interest rates, and geopolitical events. For instance, a rising EUR/USD rate suggests the euro is strengthening relative to the U.S. dollar, which could be driven by stronger economic data from the Eurozone or a more hawkish stance from the European Central Bank.¹⁶ Conversely, a weakening of the Japanese yen against the U.S. dollar (USD/JPY rising) might indicate a widening interest rate differential in favor of the U.S. or concerns about Japan's economic outlook.

Hypothetical Example

Consider a retail investor who believes the Eurozone economy will outperform the U.S. economy in the coming months. The investor decides to buy the EUR/USD major currency pair.

• Initial Action: The investor places an order to buy 10,000 units of EUR/USD at an exchange rate of 1.0850. This means for every 1 euro, they pay 1.0850 U.S. dollars. The total cost is $10,850.
• Market Movement: Over the next few weeks, positive economic news emerges from the Eurozone, and the EUR/USD rate rises to 1.0950.
• Closing Action: The investor decides to close the position by selling 10,000 units of EUR/USD at the new rate of 1.0950. They receive $10,950.
• Result: The profit from this trade is ( $10,950 - $10,850 = $100 ). This example illustrates how changes in the exchange rate of a major currency pair directly impact profitability in currency trading.

Practical Applications

Major currency pairs are central to various aspects of global finance. Their high liquidity makes them ideal for large-scale currency trading by institutional investors, hedge funds, and central banks. Businesses involved in international trade use major currency pairs for pricing goods and services, settling transactions, and hedging against currency fluctuations. The volume of trading in these pairs far surpasses that of other financial instruments, with global foreign exchange turnover reaching $7.5 trillion per day in April 2022.¹⁵,¹⁴ This substantial turnover highlights the critical role major currency pairs play in facilitating global commerce and investment. Furthermore, central banks actively participate in these markets to influence their domestic currency's value, manage foreign reserves, and implement monetary policy. The U.S. dollar remains the most traded currency globally, underscoring its pivotal position in international finance.¹³

Limitations and Criticisms

While major currency pairs offer high liquidity and transparency, they are not without limitations or criticisms. Their volatility can still be significant, driven by unexpected geopolitical events, sudden shifts in interest rates, or major economic announcements. This unpredictability presents risks, particularly for traders utilizing high leverage. Moreover, the vast size and decentralized nature of the foreign exchange market have, at times, made it susceptible to misconduct. For instance, in 2015, several major banking organizations faced enforcement actions and substantial fines for engaging in unsafe and unsound practices, including attempts to manipulate exchange rates in the FX markets.¹²,¹¹ Such instances highlight the importance of regulatory oversight and the inherent risks associated with market integrity, even within the most liquid segments of the financial system.¹⁰ The influence of central banks through intervention can also limit natural market movements, potentially creating artificial pricing or impacting trade strategies like arbitrage.

Major Currency Pair vs. Minor Currency Pair

The primary distinction between a major currency pair and a minor currency pair lies in the inclusion of the U.S. dollar and their respective trading volumes and liquidity.

Minor currency pairs, also known as crosses, are formed by combining two non-USD major currencies. For example, EUR/JPY is a minor currency pair because neither the euro nor the Japanese yen is the U.S. dollar. While still liquid, they do not match the depth and ease of execution found in major currency pairs.

FAQs

Which currency pairs are considered major?

The seven most commonly recognized major currency pairs are: EUR/USD (Euro/U.S. Dollar), USD/JPY (U.S. Dollar/Japanese Yen), GBP/USD (British Pound/U.S. Dollar), AUD/USD (Australian Dollar/U.S. Dollar), USD/CAD (U.S. Dollar/Canadian Dollar), USD/CHF (U.S. Dollar/Swiss Franc), and NZD/USD (New Zealand Dollar/U.S. Dollar). These pairs account for the vast majority of foreign exchange market activity.

Why are major currency pairs important in the forex market?

Major currency pairs are crucial because they represent the world's largest and most stable economies, offering unparalleled liquidity and tight bid-ask spreads. This makes them highly attractive for individual and institutional currency trading, facilitating efficient price discovery and execution. Their movements often reflect global economic sentiment and are closely tracked by analysts and retail investors alike.

How does economic data affect major currency pairs?

Economic data significantly impacts major currency pairs. Positive economic indicators, such as strong GDP growth, low unemployment, or rising interest rates in one country, can strengthen its currency relative to another, causing the corresponding major currency pair to move. Traders and investors closely monitor these releases to anticipate exchange rate fluctuations and inform their trading decisions in the spot market.^123456789