Definition Fundamental analysis
When it comes to predicting foreign exchange and other rates, the science of fundamental analysis involves considering a variety of relevant economic and political factors for a currency relative to the other currency.
A fundamental analyst will periodically review as many of these points as possible for each currency and then compare the two to make a forecast. In general, such forecasts are not specific objective figures for the exchange rate, but a general trend-setting outlook on the currency pair.
For example, their outlook may be positive, negative or neutral after analysis. This would mean that the analyst expects the exchange rate for the currency pair to rise, fall, or remain constant.
In addition, if some new fundamental information suddenly enters the forex market, it can lead to significant market movement and volatility as traders respond to the new information. At such moments, the basic assumption of market equilibrium that all information is priced into the price of the underlying no longer applies. This situation continues until the market has processed the new information.
If you have a trading system based on purely technical indicators, this is really important because a number of important fundamental factors can and often influence market movements, which can lead to unexpected results when trading systems based on technical analysis.
Therefore, it is really worth knowing what impact such important basic information could have so that a quick assessment of the likely future direction can be made.
Important fundamentals are regularly published by relevant authorities or agencies (e.g. Ifo Institute). This statistical data is eagerly awaited by the Exchange and its participants.
The value of the figures to be published is divided into different groups. Labour market figures from the USA, for example, have a higher weighting on the global stock and currency markets, especially the EUR/USD exchange rate, than those from Brazil.
Among the basic data elements that will have the most impact on a country’s currency and a brief description of their likely impact are the following:
Key economic factors
Many traders conduct a daily review of the economic calendars for the currency pairs in which they hold positions. This is because the publication of such key information can often lead to significant short-term volatility in the forex market and to short-term mood swings.
A list of the major economic factors that are regularly covered in the latest news and that can move the market when published is provided below:
A key element in the valuation of one currency against another. When interest rates are increased, the country’s currency becomes more attractive against other currencies with lower interest rates.
If a country employs an increasing percentage of its citizens, its currency will become stronger. These indicators are typically in the form of unemployment claims, pay slips or a country’s unemployment rate.
If the country is in an inflationary business cycle, as indicated by the consumer and producer price indices, the CPI and the PPI, this would increase the likelihood that the central bank of that country would raise interest rates to contain the rise in inflation. An increase in interest rates would tend to revalue the currency.
Gross Domestic Product (GDP):
Represents the total number of goods and services produced by a country and reflects economic growth.
A strong industrial base will tend to strengthen a nation’s currency.
Strong retail sales are generally favorable for one currency and the country’s economy as a whole.
Consumer Price Index (CPI):
A measure of inflation. Rising inflation in a country suggests that national central banks may soon tighten interest rates and thus tend to let their currency appreciate.
Trade or currency account balance:
A trade or current account surplus or deficit either favors the exchange rate for the country with a surplus or weakens the rate for the country with a trade deficit.
Another economic factor that directly affects exchange rates. If a country has borrowed excessive amounts of money from other nations or from the IMF, its currency will certainly reflect the country’s high indebtedness.
Changes in the country’s gross domestic product or GDP that are a useful measure of growth. A growing economy tends to strengthen a currency.
The level of short-term interest rates, such as the Fed funds rate, in the country of origin of the currency influences exchange rates, as higher interest rates provide an investment incentive that should strengthen the currency.
The country’s trade and current account balance may affect exchange rates as persistent trade or current account deficits tend to devalue the country’s currency.
Impact on supply and demand:
Significant capital flows into one currency and out of another, perhaps as a result of large corporate transactions or managed portfolio shifts, can shift the exchange rate for the currency pair in favor of the currency that sees the higher demand.
Due to the impact of monetary policy on interest rates, this is an important element in the valuation of a currency. A tighter monetary policy that implies higher interest rates, while a swallow-heavy or loose monetary policy indicates lower interest rates.
Currencies of countries with stable governments are preferred by investors over countries with less favorable political conditions. Greater fiscal responsibility also tends to support a country’s currency, while excessive government spending tends to weaken its currency.
The prices of important commodities such as gold and oil tend to affect the valuation of the currencies of their major exporters and importers. For example, higher oil prices help the (GBP) British Pound and the (CAD) Canadian Dollar, while they damage the US Dollar and the Japanese Yen, whose countries import oil. In addition, the higher gold prices tend to have a positive effect on the AUD (Australian Dollar) and the close link to the NZD (New Zealand Dollar), as Australia exports this precious metal and its currency will benefit from a rise in the gold value.