Fundamental Analysis

Fundamental Analysis 2017-05-03T13:51:39+00:00

Fundamental Analysis

Fundamental analysis is the interpretation of statistical reports and economic indicators. Things like changes in interest rates, employment reports, and the latest inflation indicators all fall into the realm of fundamental analysis.

Forex traders must pay close attention to economic indicators which can have a direct – and to some degree, predictable – effect on the value of a nation’s currency in the forex market.

Given the impact these indicators can have on exchange rates, it is important to know beforehand when they are due for release. It is also likely that exchange rate spreads will widen during the time leading up to the release of an important indicator and this could add considerably to the cost of your trade.

Therefore, you should regularly consult an economic calendar which lists the release date and time for each indicator. You can find economic calendars on Central Bank websites and also through most brokers.

COMMON ECONOMIC INDICATORS:

Gross Domestic Product(GDP)

One of the most influential of the economic indicators, GDP measures the total value of all goods and services produced by a country during the reporting period.

An increase in GDP indicates a growing economy, and for this reason, GDP is used to measure the level of inflation within the economy.

Consumer Price Index(CPI)

Measures the cost to buy a defined basket of goods and services. It is expressed as an index based on a starting value of 100.

A CPI of 112 means that it now costs 12% more to buy the same basket of goods and services today than it did when the starting index value was first determined.

By comparing results from one period to the next, it is possible to measure changes in consumer buying power and the effects of inflation.

Inflation is a concern to currency traders as it affects the price of everything bought and sold within an economy, and this has a direct impact on the supply and demand for a country’s currency.

Inflation is an increase in the price of goods and services. While inflation by its very definition suggests economic growth, inflation that occurs too rapidly actually weakens consumer buying power as prices increase at a faster rate than salaries.

Producer Price Index(PPI)

Also an inflation indicator, the PPI tracks the changes in prices that producers receive for their products.

Expressed as an index relative to 100.

Excludes volatile items such as energy and food to avoid distorting the index.

By measuring the prices received by domestic producers, it is possible to project how the consumer-level prices could be affected.

Employment Report

Employment reports have an immediate impact on currencies because employment levels directly affect current and future spending habits.

An increase in unemployment is a negative indicator as it implies that more people are not receiving a regular salary. This is a sure signal that consumer spending will decline.

Interest Rate

Most Central Banks maintain a “benchmark” interest rate.

Depending on the jurisdiction, the Central Bank rate serves as the guide for the rate at which the Central Bank and other commercial banks lend each other funds to meet short-term operational needs.

Commercial lending rates are also affected by the Central Bank rate, and it is this linking of short-term rates to the commercial rates that makes interest rate policy the primary monetary tool for Central Banks.

As noted earlier, the Central Bank can increase rates during periods of high growth (inflation) in a bid to reduce consumer spending which should help bring growth back to a more manageable level.

If deflation is a problem and the economy needs a boost, Central Banks can lower interest rates to entice more consumer lending. The expected outcome is that overall consumer spending will increase as consumers have access to less costly loans.

Forex traders in particular pay close attention to changes in interest rates as investors tend to seek out currencies offering higher returns and this demand can cause a currency to appreciate.

Also, the greater the interest rate differential between two currencies, the greater the profit potential of a carry trade strategy.

Yield Curve

Yield is the interest on fixed-income securities which includes such investments as futures contracts and government bonds.

Referred to as “fixed” income because the payment stream (the yield) remains constant until maturity.

For example, a simple 5-year bond with a 3 percent annual yield, would pay $300 a year for the next five years on an initial $10,000 investment.

The yield curve shows the relationship between the yield, and the time to maturity.

When dealing with fixed-income securities, investors want to ensure that the fixed yield remains profitable right up until maturity.

As an investor you may be happy with a 5 percent return when the basic lending rate is 2 percent. However, if short-term interest rates rise and the lending rate jumps to 6 percent, your 5 percent return is no longer so attractive, and there are probably other options that could generate more income for your investment.

Liquidity spread is the term used to describe the difference between the yield and short-term rates.

If short-term interest rates rise above the fixed yield, the bond holder is said to be in a position of negative liquidity spread.

Institute of Supply Management(ISM)

The ISM report is another inflation indicator. It measures the level of new orders and helps predict manufacturing activity for the upcoming period.

It is expressed as an index based on 50. A number less than 50 means that manufacturing has contracted from the previous period, while a number greater than 50 indicates growth for the previous period.

Because the ISM captures current factory production levels, it provides insight into the expected level of consumer demand for goods in the immediate future.

Retail Sales Report

The Retail Sales Report tracks consumer spending patterns – items such as health care and education are not included.

An increase in the Retail Sales Report is likely to be seen as positive for the currency as it suggests growing consumer confidence.

Industrial Production Index(IPI)

Shows the monthly change in production for the major industrial sectors including mining, manufacturing, and public utilities.

Considered an accurate assessment of employment in the manufacturing sectors, average earnings, and overall income levels.

An increase in IPI suggests continued growth which is seen as a positive for the economy.

Commodity Price Index(CPI)

Tracks the changes in the average value of commodity prices such as oil, minerals, and metals.

This index is particularly relevant for countries like Canada and Australia (known as the “commodity dollars”) that serve as major commodity exporters.

For commodity exporters, an increase in this index suggests greater potential for earning higher prices from these exports.

Trade Balance

Compares the total value of imports to the total value of exports for a reporting period.

A negative value indicates that more goods were imported than were exported (a trade deficit) – while a positive trade balance means that exports exceeded imports (a trade surplus).

If the balance of trade shows a surplus or declining deficit, then there may be an increased demand for the currency.

If the report shows a growing deficit, then the increased supply – together with a decrease in demand for the exporting currency – could lead to a devaluation against other currencies.

 

Disclaimer: Kindly note that this selection is not extensive. The provided information is only for information purpose and does not represent any investment advice. Independent advice should be considered prior to making an investment decision