Trading Fundamentals

Trading Forex and Fundamental Analysis

The fundamental analysis aims to predict the future market conditions based on the study of current economic indicators and other fundamental data.

The Important Role of Central Banks

Central Banks play a key role in the Foreign Exchange Market, more specifically:

• They are applying the monetary policy by modifying interest rates

• They help governments to implement their fiscal policy objectives

• They are responsible for controlling the domestic banking sector

Central banks have the ability to adjust the level of interest rates at any given time. Therefore, they can control the demand for the domestic currency and the exchange rate of the domestic currency against foreign currencies.

“Trading against the Central Bank policies is madness unless your name is George Soros.” 

8 Major Categories of Fundamental Data

These are the eight (8) categories of fundamental data that are highly affecting the Forex markets.

  

1. INTEREST RATES

The level of interest rates may define in a high extend the attractiveness of any Forex currency. The interest rate decisions are in the core of every monetary policy which is implemented by the country’s central bank. Any unexpected change in the level of interest rates can turn the Forex exchange rates upside down. Even rumors of an upcoming interest rate change may lead to substantial movements in the Forex market.

THE ROLE OF CARRY TRADING

The differential in the level of interest rates between two currencies defines the effectiveness of carry trading. Carry traders buy the currencies offering the higher interest rates and at the same time they sell currencies offering the lower interest rates. This practice is very important for the global Forex rates and creates the so-called “Dynamics of the carry trade”. More about Carry Trade here: 

» Carry Trade Strategy

INTEREST RATE DECISIONS

Mainly, there are two different interest rate policies:

(a) Central Banks increase interest rates during extended periods of high growth in order to limit inflation. As interest rates increase, the real demand decreases and inflation is limited to a more manageable level.

(b) Central Banks decrease interest rates during extended periods of high unemployment. During extended deflation periods a potential decrease in the level of interest rates may boost investment and consumer spending. The outcome is more growth and less unemployment.

■ World Bank, World’s Real Interest Rates: http://data.worldbank.org/indicator/FR.INR.RINR

 

2. EMPLOYMENT REPORTS

Employment data is affecting the Forex market in multiple ways:

(a) It highly affects the interest rate decisions of central banks

(b) It affects future consumer spending and future inflation

(c) It is a clear sign that an economy is doing good or bad

If employment figures are improving for an extended period then the interest rates will probably go higher. That is good news for Forex investors and therefore, better labor figures lead to currency appreciation.

■ Major Global Employment / Unemployment Reports

Country	Report Name	Information
Eurozone	Unemployment Statistics	Eurostat: http://ec.europa.eu/eurostat/statistics-explained/index.php/Unemployment_statistics
United States	Non-Farm Payroll (NFP)	Bureau of Labor Statistics: http://www.bls.gov/
Japan	Unemployment Statistics	Japanese Statistics Bureau: http://www.stat.go.jp/english/data/roudou/results/month/
United Kingdom	Claimant Count Change	Office for National Statistics: http://www.ons.gov.uk/
Australia	Wage Price Index	Australian Bureau of Statistics: http://www.abs.gov.au/
Canada	Labor Force Survey	Canada Statistics: http://www.statcan.gc.ca/

 

3. ECONOMIC GROWTH REPORTS

There are a lot of different economic reports that that can highlight the growth potential of an economy: GDP, Housing Permits, Manufacturing Production, Manufacturing Inventories, Consumer Spending, Retail Sales, and etc. Some reports carry more weight than others. Let’s see closer some of these growth reports:

(a) GROSS DOMESTIC PRODUCT (GDP)

The Gross Domestic Product or GDP is a measure of the total value of goods and services that are produced by a country or by an economic area. Any GDP change can be used as an indicator of either economic expansion or contraction. The GDP figure is very popular in Western economies and plays also a very important psychological role.

■ Global GDP Growth (WorldBank): http://data.worldbank.org/indicator/NY.GDP.MKTP.KD.ZG

(b) RETAIL SALES REPORT

The US Retail Sales Report is one of the key figures to watch out when you are trading the Foreign Exchange Market. Retail Sales indicate the real consumer spending pattern but also consumer confidence. This is happening as non-dynamic spending (education, health care, etc.) is not included on this report.

■ US Retail Sales Report: http://www.census.gov/retail/index.html

(c) INDUSTRIAL PRODUCTION INDEX

The Industrial Production Index measures the change in the production level regarding crucial industrial industries such as manufacturing and mining.

■ IPI Reports (US): https://research.stlouisfed.org/fred2/series/INDPRO

 

4. INFLATION REPORTS

Inflation reports are important as inflation is considered an indicator of growth but also because extended periods of higher inflation leads to higher interest rates. Forex markets favor strong growth and adore higher interest rates.

INSTITUTE OF SUPPLY MANAGEMENT (ISM)

The ISM report is an inflation indicator that shows the level of new orders and production but also forecasts upcoming manufacturing activity in the US. ISM is an index based on 50. If ISM exceeds 50, it indicates economic growth, and if it is lower than 50, it indicates economic contraction.

PRODUCER PRICE INDEX (PPI)

The Producer Price Index measures the changes in prices that producers receive for their products. PPI is based on 100 and can help economists forecast consumer-level prices based on the cost of domestic producers.

 

5. TRADE BALANCE

Trade balance measures the difference in value between a country’s imports and exports of goods and services. A surplus occurs if exports exceed imports. A deficit occurs if imports exceed exports.

Trade balance is important for Foreign Exchange rates as on every import the domestic currency has to be sold and on every export the domestic currency has to be purchased. In other words, a trade surplus enhances the demand for the domestic currency and a trade deficit enhances the supply of the domestic currency.

Note that the negative market sentiment based on a trade deficit can be recovered if the amount of foreign capital investment is equally strong.

 

6. GEOPOLITICAL RISKS AND EVENTS

Forex exchange rates are very sensitive to geopolitical events and new political risks. Geopolitical risks include civil unrest, terrorism, war, extreme weather conditions or anything else that may jeopardize the economic stability and create uncertainty. Uncertainty reduces consumer spending and postpone investment decisions. Furthermore, uncertainty makes Forex investors willing to sell their currency positions. In the case of a major geopolitical event, Forex investors sell no matter the price they receive. During periods of extended global geopolitical uncertainty, the US Dollar and the Swiss Franc are considered as Safe Heavens for currency investors.

 

7. COMMODITY PRICES

Commodity prices are affecting the Foreign Exchange market in a complicated way. Changes in the commodity prices affect currencies according to the use of those commodities in each and every country. In certain cases, significant changes in commodity prices may turn the Forex market upside down. That is happening if a country’s exports are highly depended on a certain commodity. As for example, Australia, and gold or as Canada, and crude oil.

• When Crude Oil price increases you should expect USDCAD and USDRUB to move lower and CADJPY to move higher.
• When Gold Price is rising you should expect AUDUSD to move higher.

IMF PRIMARY COMMODITY PRICE INDICES

■ The IMF Commodity Indices track changes in the average price of commodities:  http://www.imf.org/external/np/res/commod/index.aspx

 

8. GOVERNMENT BONDS AND YIELDS

The yield of fixed-income securities which includes government bonds may pinpoint the confidence in a particular economy. They are called "fixed-income” because their payment remains unchanged until maturity. But these fixed-securities are traded in organized exchanges, and their yield changes as price changes. The price of fixed-securities change based on fundamental data but also based on the general market sentiment.

The difference between the fixed-yield and the short-term interest rates is called the Liquidity Spread. Significant changes in the Government bonds yields, is an early-signal that something is going on.

 

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