Tuesday, 10 February 2009 10:45

Forex Fundamental Analysis and Economic Indicators

Fundamental analysis for Forex or any other financial market is the comparative analysis of various economies. It not only takes into account the current economic indicators to gauge the strength or weakness, but also the political factors, natural disasters and everything which can have an impact on the overall global economy as well as on the fundamentals of the specific economies in question. 

The Forex market is very dynamically changing market and often the price-actions are quite volatile.  Technical analysis helps for short-term trades but the overall longer-term moves are dictated by the fundamentals of the economies concerned. Forex fundamental Analysis is like the canvas and technical analysis is the colors on it. Even we base our trade positions on technical indicators or pure price action but we cannot ignore the fundamentals and any sudden changes in those.

What is Fundamental Analysis?

Importance of Fundamental Analysis in Forex trading

Fundamental analysis for Forex trading is all about the supply and demand of a particular currency and the health of the economy of the country or region in question.

Fundamental Analysis is used to analyze the valuation of currencies by monitoring various economical, social, political and environmental factors. There are a number of economic indicators, such as interest rates, unemployment rates, gross domestic product (GDP) and many other which need to be monitored. We need to track various economic releases from various countries/economies which come out periodically.

Even in its basic form the fundamental analysis is a complex subject. It is not something only black and white or absolute in nature. The fundamentals of economy need a very in-depth study and that is not the scope of this section. What we need to know is the major indications which can bring major changes in the price actions. The scope of this article is to point out what we should look out for, without going in the depths of economic study and analysis.

The main things for which we need to keep an eye open for our basic fundamental analysis are as follows:

  1. Economic data releases
  2. Major News about change in the political leadership and any policies changes.
  3. Any political or other unrests and natural disasters.
  4. Countries central bank's policy changes.

There are indicators which measure the economic strengths directly and there are can be factors which can affect the economy or the economic sentiments indirectly. Similarly there is quantitative economic data and also qualitative data which can strengthen or weaken the market sentiments. These all factors drive the price action and strength and weakness of currencies in the Forex market. Some of these indicators may have short-term effects because of sudden but temporary change in the sentiments and some may have longer-term impacts for a long uptrend or downtrend.

Direct Measures for Economic Strength

Economic data like gross domestic product, unemployment situation, retail sales etc. are the tools to measure the economic strengths directly to know the strength of the fundamentals of the economy in question. 

Indirect Measures for Economic Strength

Political situation, natural disasters and even some qualitative economic data may act as indirect measures to affect the sentiments and hence drive the price actions in the Forex market. For example a big natural disaster which causes a lot of damage may have immediate adverse effects but in the longer run it may be perceived as an opportunity for the growth in certain sectors. For example a big natural disaster in a developed country will soon end up as a boom in the construction industry and improve the employment situation and many other directly or indirectly linked economic fundamentals. On the other hand the same disaster in an underdeveloped country may bring a longer-term weakness in the market sentiments as the country may not have the resources for rebuilding the nation.

Changes in the political situation and hence possible changes in policies, again, can bring volatile moves in the Forex rates. Similarly, economic quantifiable data like inflation may have different effects on the currency strengths in different situations and for different currencies. for example  sudden increase in inflation rate in Australia may strengthen the Australian dollar more than a inflation increase in some other country for that country's currency. The reason is simple that Australian dollar attracts a lot of carry trades. 

Indirect measures may also include impact on one country's currency because of change in the economic fundamentals of some other country if the economic interdependence is too high. For example any positive economic data from China would bring positive effect on Australian dollar very fast because Australia's exports dependency on China.

Quantitative economic data

Some of the earlier mentioned economic releases like employment situation, gross domestic products, retails sales and many others are quantitative in nature because these represent the strength or weakness of the economy in absolute figures. 

Qualitative economic data 

Qualitative economic releases are also represented in the figures but those figures do not measure the economic strength directly. Examples of qualitative data could be various economic surveys e.g. consumer sentiment survey and various market sentiments and confidence surveys.

Fundamentals and Forex Trading Decisions

Economies do not change overnight but various economic data and news from a country can change the sentiments overnight. Sometimes the effects of such changes may be temporary but at other times those can results in the change of the trend in the currency prices for weeks or months. Hence while we keep a look on the long-term fundamentals, we cannot use those for the day-today trading. Trading is different from investing and even a medium-term trade may last only for a few days or a couple of weeks. What governs the price movement during short-term or medium-term is the day-today economic releases and news which may have some effects on the economic sentiments. 

Apart from the periodic releases of the economic data, a news can be a major merger or acquisition of  major corporations or a political news indicating some major change in the political leadership which may affect economic policies or even a natural disaster. We use the fundamental analysis by keeping track of the economic events and releases and also any other such news items. We take our trade positions in the direction of changing market sentiments.

Major Economic Releases

Every nation or economic zone comes out with various economic data which indicate the health of the economy. Some economic indicators are critical and a change in those may bring a major change in the price action while some other releases may not be so critical. The first step is to analyze and understand the importance of various economic indicators and then to keep an eye on the periodically released data. 

The importance of various indicators change from country to country. For example a decline in housing and house construction may have a major effect on U.S. Dollar but the same data may not have the same effect on Japanese Yen. The reason is simple that for an average Japanese person, owning his or her own house is not  one of the important objective as it may be for his or her American counterpart. 

As we have mentioned earlier, even if we base our trading decisions only on technical analysis, it is always better to keep the fundamentals in mind as they can cause major volatilities at times. Sometimes the changes in the trend may be long-lasting and sometimes those are just temporary but even at those times, there may be quite volatile price actions just before and after any important economic data is released

Economic Indicators for Fundamental Analysis

We are listing below some of the major economic releases and economic indicators which are important for the change in sentiments for the price actions in the Forex market. Every country and economic zone has a version of these.

Economic
Indicators
Country/
Economy
Description Impact of volatility Remarks
Current Account All Current Account Medium to High A high reading is seen as positive (or Bullish) for thecurrency, whereas a low reading is seen as negative (or Bearish).
Trade Balance All Trade Balance Medium to High A high reading is positive or bullish, while a low reading is negative (or bearish). Trade balance generally creates more volatility for USD.
Treasury International Capital (TIC) US Treasury International Capital (TIC) Medium A high reading is positive (or bullish) for the USD, while a low reading is negative (or bearish).
Manufacturing/ Physical Output of factories, Mines & Utilities US ISM Manufacturing Index Medium A result above 50 is seen as positive (or bullish) for the USD, whereas a result below 50 is seen as negative (or bearish).
US Empire State Business Conditions Index Medium A positive result indicates bullish for US Dollar, while a negative result shows poor growth of US Dollar.
All Industrial Production Low to Medium (Medium for Japan) High reading is positive (or bullish), while low reading is negative (or bearish)
All Purchasing Managers' Index Medium A result above 50 signals is bullish for the currency, whereas a result below 50 is seen as bearish.
Durable Goods US Durable Goods Orders Medium A high reading is positive (or bullish) for the USD, while a low reading is negative or bearish.
Consumer Confidence All Consumer Confidence Medium A high reading is positive (or bullish) for the currency, while a low reading is negative (or bearish).
US Reuters/
Michigan Consumer Sentiment Index
Medium A high reading anticipates positive (or bullish) for the USD, while a low reading is seen as negative (or bearish).
All Retail Sales Medium to High (High for US) A high reading is seen as positive (or bullish), while a low reading is seen as negative (or bearish).
US Retails Sales Ex Autos High A high reading is seen as positive (or bullish), while a low reading is seen as negative (or bearish) for USD.
US Personal Spending High A high reading is seen as positive (or bullish), while a low reading is seen as negative (or bearish) for USD.
Japan Consumer Confidence House Holds Medium A result above 50 is positive (or bullish) for the JPY, whereas a result below 50 is seen as bearish.
Inflation US Personal Consumption Expenditure -Price Index, Core High A high reading is bullish for the USD, while a low reading is bearish.
All Consumer Price Index (CPI) Medium to High A high reading is seen as positive or bullish for the currency, while a low reading is seen as negative.
US Gross Domestic Purchase price Index High A high reading is seen as positive, or bullish for the USD, while a low reading is seen as negative, or bearish.
UK Core Consumer Price Index Medium A high reading is seen as positive (or bullish) for the GBP, while a low reading is seen as negative (or Bearish).
UK Retail Price Index High A high reading is seen as positive (or bullish) for the GBP, whereas a low reading is seen as negative (or bearish).
All Producer Price Index (PPI) Low to Medium A high reading is seen as positive (or bullish) for the currency, whereas a low reading is seen as negative (or bearish).
US Consumer Price Index (CPI) Ex Food & Energy Medium A high reading is seen as positive (or bullish) for the USD, while a low reading is seen as negative (or Bearish).
All Import Price Index Low to Medium. Medium for US A high reading is seen as positive (or bullish), while a low reading is seen as negative (or bearish).
UK BOE Inflation Letter High A high reading is seen positive (bullish) for the GBP, whereas a low reading is seen as negative (bearish). It is worth noting that this tentative letter is only published when the CPI (YoY) is above 3.0%.
Interest Rate All Interest Rate Decision High Raising interest rate is positive, or bullish, for the currency. While interest rate cuts are negative or bearish for the Forex pair.
Employment US Non-Farm Employment Rate High A high reading is seen as positive (or bullish) for the USD, while a low reading is seen as negative (or bearish).
All Unemployment Rate (Jobless Rate) High to Medium A decrease of the figure is seen as positive (or bullish) for the currency, while an increase is seen as negative (or bearish).
US Personal Income High A high reading is positive for the USD, whereas a low reading is negative.
US Average Hourly Earning High A high reading is also positive for the USD, while a low reading is negative.
US Average Weekly Hours High A high reading is positive (or bullish) for the USD, while a low reading is negative.
Employment US FOMC Meeting Minutes High (specially in volatile markets) If they show a hawkish outlook, that is seen as positive (or bullish) for the currency, otherwise it is seen as negative (or bearish).
All Central Bank Chairman/
Governor's Speech
High (specially in volatile markets) If they show a hawkish outlook, that is seen as positive (or bullish) for the currency, otherwise it is seen as negative (or bearish).
UK Bank of England (BOE) Minutes High The comments may determine a short-term positive or negative trend. If they show a hawkish outlook, that is seen as positive (or bullish) for the currency, otherwise it is seen as negative (or bearish).
GDP All Gross Domestic Product Medium to High (High for US) A rising trend has a positive effect on the currency, while a falling trend is seen as negative (or bearish).
Market Sentiment Reports Germany ZEW Survey Medium An optimistic view is considered as positive (or bullish) for the EUR, whereas a pessimistic view is considered as negative (or bearish).
Germany IFO- Business Climate and Expectations Medium The positive economic growth anticipates bullish movements for the EUR, while a low reading is seen as negative (or bearish).
Japan Tankan Index Medium for Non- Manufacturing. Low for Manufacturing A result above the 0 level is seen as positive (or bullish) for the JPY, whereas a result below 0 is seen as negative (or bearish).
Housing US Mortgage Bank Association (MBA) Mortgage Applications Medium A high reading is seen as positive (or bullish) for the USD, while a low reading is seen as negative (or bearish).
US New Home Sales Medium A high reading is seen as bullish for the USD, whereas a low reading is seen as bearish.
US Housing Price Index Medium A high reading is seen as positive (or bullish) for the USD, while a low reading is seen as negative (or bearish).
US Construction Spending Medium A high reading is seen as positive, or bullish for the USD, while a low reading is seen as negative, or bearish.
US/Canada Housing starts Low to Medium. Medium for Canada and US A high reading is seen as positive (or bullish) for the Currency, while a low reading is seen as negative (or bearish).

We always believe in using Forex Technical analysis in combination with Fundamental Analysis when trading currencies. Please also check the Fundamental analysis Forex forum.

 

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