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 Fundamental Analysis |
Fundamental analysis is the application of micro and macro economic theory to markets in an aim to predict future trends. Major fundamental forces drive the currency markets.
·· Balance of trade
·· Current account
·· Consumer price index (CPI)
·· Durable goods orders
·· Gross domestic product (GDP)
·· Housing starts
·· Payroll employement
·· Producer price index (PPI)
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| Balance of trade (Merchandise trade balance): |
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The Trade Balance is an indicator of the difference between a nation's exports and imports of goods. A positive Trade Balance, or a surplus, occurs when a country's exports exceed imports. A negative trade balance, or a deficit, occurs when more goods are imported than exported.
The Trade Balance and any changes in exports and imports are closely followed by the foreign exchange markets, as it is a major indicator of foreign exchange trends. Measures of imports and exports are important indicators of the overall economic activity in the economy. Trends in export activities not only reflect the competitive position of the country in question, but also the strength of economic activity abroad. Trends in the import activity reflect the strength of domestic economic activity.
A country that runs a significant Trade Balance deficit will generally have a weak currency as there will be a continually commercial selling of its currency. However, this can be offset by substantial financial investment flows for a long period of time. |
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The Current Account is the most important part of international trade data. It is the broadest measure of sales and purchases of goods, services, interest payments and unilateral transfers. The Trade Balance is contained in the Current Account. In general, a Current Account deficit can weaken the currency.
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| Consumer price index (CPI) |
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The Consumer Price Index (CPI) is a measure of the average level of prices of a fixed basket of goods and services purchased by the consumers. The monthly reported changes in CPI are closely followed as an indicator of inflation.
The CPI is a primary inflation indicator because consumer spending accounts for nearly two-thirds of economic activity. A rising CPI is often followed by higher short term interest rates and may therefore be supportive for the currency in the short term. However, if the inflation problem continues in the long term, confidence in the currency will eventually be undermined and it will weaken. |
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Durable Goods Orders are a measure of the new orders placed with domestic manufacturers for immediate and future delivery of factory hard goods. Monthly percent changes reflect the rate of change of these orders.
The Durable Goods Orders index is a major indicator of manufacturing sector trends as most industrial production is done on orders. Rising Durable Goods Orders are normally associated with stronger economic activity and can therefore lead to higher short-term interest rates, which is usually supportive for a currency at least in the short term. |
| Gross domestic product (GDP) |
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The Gross Domestic Product (GDP) is the broadest measure of aggregate economic activity available. It is an indicator of the market value of all goods and services produced within a country. GDP is reported quarterly and it is followed very closely as it is the primary indicator of the strength of economic activity.
The GDP report has three releases: 1) advance release (first); 2) preliminary release (1 st revision); and 3) final release (2 nd and last revision). These revisions usually have a substantial impact on the markets.
A high GDP figure is usually followed by expectations of higher interest rates, which is mostly positive for the currency concerned at least in the short term, unless expectations of increased inflation pressure is concurrently undermining confidence in the currency.
In addition to the GDP figures, there are the GDP deflators, which measure the change in prices in total GDP as well as for each component. The GDP deflators are another key inflation measure beside the CPI. In contrast to the CPI, the GDP deflators have the advantage of not being a fixed basket of goods and services, which means that changes in consumption patterns or the introduction of new goods and services will be reflected in the deflators. |
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Housing Starts measure initial construction of residential units (single-family and multi-family) each month. Housing Starts are closely watched as it gives an indicator of the general sentiment in the economy. High construction activity is usually associated with increased economic activity and confidence. It is as such considered a harbinger of higher short-term interest rates, which is usually supportive for the involved currency, at least in the short term.
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The Payroll employment (also known as the Labor Report) is regarded as the most important among all economic indicators. It is usually released on the first Friday of the month. The report provides a comprehensive look of the economy as it encompasses all major sectors of the economy. It is useful to examine trends in job creation in several industry categories because the aggregate data can mask significant deviations in the underlying industry trends.
Payroll Employment is a measure of the number of people being paid as employees by non-farm business establishments and units of government. Monthly changes in payroll employment reflect the net number of new jobs created or lost during the month and changes are widely followed as an important indicator of economic activity.
Large increases in the payroll employment are considered signs of strong economic activity that could eventually lead to higher interest rates, which is generally supportive of the currency at least in the short term. If, however, it is estimated that an inflationary pressure is building up, this may undermine the longer term confidence in the currency. |
| Producer price index (PPI) |
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The Producer Price Index measures the monthly change in wholesale prices and is broken down by commodity, industry, and stage of production.
The PPI gives an important inflation indication as it measures price changes in the manufacturing sector - and inflation at the producer level often get passed through to the consumer price index. A rising PPI is therefore normally expected to lead to higher consumer price inflation and thereby to potentially higher short-term interest rates. Higher rates will often have a short term positive impact on the currency, although significant inflationary pressure will often lead to an undermining of the confidence in the currency involved. |
