WHAT IS IT?
Fundamental analysis is the application of micro- and macro-economic theory to markets to predict future trends. Major fundamental forces are frequently one of the key drivers of FX rates.
The following are a list of key economic indicators:
- BALANCE OF TRADE
- The trade balance reflects 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.
Trade balances are closely followed by players in Forex, because of the influence they can have. It is often used as an assessment of the overall economic activity in a country’s or region’s economy. 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 tends to generally have a weak currency. However, this can be offset by substantial financial investment inflows.
- CURRENT ACCOUNT
- The current account is an important part of international trade data as it is the broadest measure of sales and purchased 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.
- CONSUMER PRICE INDEX
- The Consumer Price Index (CPI) is a measure of inflation. It takes the average level of prices of a fixed basket of goods and services purchased by the consumers
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, which can be supportive for a currency in the short term. However, if inflation becomes a long-term problem, confidence in the currency will eventually be undermined and it will weaken.
- DURABLE GOODS INDEX
- 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. Rising durable goods orders are normally associated with stronger economic activity and can lead to higher short-term interest rates, which is usually supportive for a currency.
- GROSS DOMESTIC PRODUCT
- 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 (1st revision); and 3) final release (2nd 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 there are also inflationary pressures.
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.
- HOUSING STARTS
- 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 and can be predictive of higher short-term interest rates.
- PAYROLL EMPLOYMENT
- The Payroll employment (also known as the Labor Report) is currently regarded as the most important among all US economic indicators. It is usually released on the first Friday of the month. The report provides a comprehensive look of the economy and it 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 it is 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
- 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 gets passed straight through to consumers.
- PERSONAL INCOME AND PERSONAL CONSUMPTION EXPENDITURES(PCE)
- A measure of price changes in consumer goods and services. It consists of the actual and imputed expenditures of households and includes data pertaining to durables, non-durables, and services. It is essentially a measure of goods and services targeted towards individuals and consumed by individuals.
- TANKAN SURVEY
- An economic survey of Japanese business issued by the central Bank of Japan, which it then uses to formulate monetary policy. The report is released four times a year in April, July, October and mid-December. The survey covers thousands of Japanese companies with a specified minimum amount of capital, although firms deemed sufficiently influential may also be included. The companies are asked about current trends and conditions in the business place and their respective industries as well as their expected business activities for the next quarter and year.
- IMPLICIT DEFLATOR
- An estimate of an average price level relative to the price level in a chosen base period. In general, the implicit price deflator for an economic series is calculated by dividing a nominal value for that series by its real value measured in terms of some base period.
The following are some of the fundemental tools used for analysis:
- THE BUSINESS CYCLE
- As the economy moves through different stages in the cycle, the foreign exchange market reacts to these changes. Traders view these changes and take corresponding action, attempting to take advantage of changes in the economy.
- MONETARY POLICY
- Monetary policy is an attempt to control the supply money and credit in the economy. This will affect interest rates causing an increase or decrease in economic activity. The primary focus of monetary policy is the control of inflation.
- THE FEDERAL RESERVE SYSTEM
- The Federal Reserve System implements monetary policy in the United States. An act of congress established the Federal Reserve System, the nation's central bank, in 1973. The act divided the country into 12 Federal Reserve districts. Responsibility for coordination the activities of the district banks lie with the Federal Reserve Board of Governors in Washington D.C. The board has seven members appointed by the president and confirmed by the senate. Since money is primarily created by the commercial banking system, the Federal Reserve Board must control the banking system to implement monetary policy decisions.