Forex Fundamental Market Analysis

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Fundamental Market Analysis

Most Forex traders rely on some kind of market analysis to make their trading plan and develop their trading strategies. Price movements can be analyzed and forecasted using two main methods - fundamental and technical analysis. We will come back and cover in depth the technical analysis but in this chapter we would like to focus on introducing you to the fundamental analysis.

First thing that you have to know and always keep in mind is that Forex market, as well as any other market, submits to the rules of supply and demand. If there is a demand for a particular currency and shortage of supply the price for that currency will go up inevitably this in turn will trigger some other changes and developments in country's economy and even political situation. The same way, currencies are affected by different economic and political developments in one country or sometimes even in the world. Nowadays, everything is interconnected in our globalized economy and sometimes economic or political changes in one country will affect the currency of another country. That is why it is so important to pay attention to economic and political development taking place in the word when you plan your trading or develop your strategy.

Fundamental analysis in its nutshell is a study that covers most fundamental, underlying economic and political elements that influence the economy of a country in subject. The study tries to predict future price actions and trends based on analysis of economic indicators, government policies, general political situation and social developments in a country.  For forex traders, the fundamentals are everything that makes a country operate. From interest rates and central bank policy to natural disasters, the fundamentals are a dynamic mix of distinct plans, erratic behaviors and unforeseen events. Therefore, it is best to get a handle on the most influential contributors to this diverse mix than it is to formulate a comprehensive list of all "The Forex Fundamentals."

Every nation has its central bank which is responsible for the well being of the economy. Central banks watch some economic factors that affect the economy and adjust their economic policy accordingly. These factors are announced regularly and the exact time of the announcement is known in advance. These factors are the fundamental indicators of the economy. The most important central banks are FED of USA, ECB of European Union, BOJ of Japan and BOE of United Kingdom. There are many fundamental indicators but there are few of them that are called the "market movers". They are called so because when they are announced they provide to the market the necessary steam to move. That happens because they have a great impact on economy and to traders' positions also.

In this course we will cover only main fundamental factors that influence the market but you have to keep in mind that it takes ages and formal education to understand in depth and use fundamental analysis for forex trading. So after you go through this course, make sure you continue educating yourself.

Economic News Releases

Most economic data and political events that are coming out in news releases and have an impact on the economy both directly and indirectly are considered fundamental factors. These fundamentals are divided into three major groups: economic factors, financial factors, and political factors. Obviously economic and financial factors have the most impact on the market, since currency itself is an economic element. Nevertheless, political factors should not be discounted in your analysis.

Economic news releases come out in so called "fundamental reports". These reports are kept under strict secrecy up to the time of the actual occurrence. Central banks, for example, change the discount rate confidentially and even though the markets closely watch these events, sometimes the outcomes do not coincide with the predictions. The deciding factor in whether a fundamental release will have an effect on the currency market is how closely the actual results come to economists' predictions. If the fundamental release matches predictions then it should have already been "priced in" to the market beforehand. However, if the release strays from the anticipated numbers, then it will have a bigger impact on the market.

The dates and times of economic data release are well known and are anticipated by the market. There are many resources available on the television, newspapers and internet that cover financial and economic indicators releases. We advise you to start your trading day with finding out what economic news releases are scheduled for that particular day, what market expectations are and when the actual release will take place. This will help you to plan your trades accordingly and, as you learn, conduct your own fundamental analysis. Here is what we suggest you to do: build up your plan; know in advance what important fundamental indicators are to be announced the following week; learn the expected number if it is available and try to forecast what will happen if it comes in better of worse figure. This is difficult for the beginners but after studying it will be easy.

As we already said, political factors should be closely watched and not overlooked because political situation in the country can impact market sentiment greatly and part of human psychology that plays important role in Forex market. Political factors can include elections, high level talks, and crises. Some political factors, such as a presidential election or a G-7 meeting are scheduled beforehand and can be anticipated. A political crisis such as a nuclear test by a rouge nation such as N. Korea, or a terrorist attack such as 9/11 can have dramatic effects on the currency markets and are almost impossible to predict. However, only big political events that can affect the patterns of trade or working of an economy or group of economies will have an effect on the financial markets.

There is plentiful information about fundamental indicators in the internet. Visit Bloomberg economic calendar and Yahoo economic calendar. Use keywords like "Forex fundamentals", or "Forex economic calendars" and you will find what you need. Study the meaning of these indicators and the relationships between them. Most Forex providers have a built in economic calendar with their trading platforms. The time on these economic calendars is frequently GMT. Learn your time zone and the difference between your zone and GMT and you will know the exact time the indicator will be announced. In these economic calendars market consensus, if available, is already reported. Study carefully the economic indicators. You will eventually have a great guide to help you in your trading.

Fundamental Indicators

There are many fundamental indicators and it is impossible to cover all of them in an introductory course.  US indicators have the greatest impact on market. European Union's indicators have less impact unless they are much different than expected. Watch out for central banks head officers speaking out and giving clues about inflation and interest rates. Today these are the two drivers of the economy. Words like vigilant or very vigilant about inflation from central bank's heads have great impact on the currencies.

When the inflation is up central banks try to keep it low by leveraging interest rates. When interest rates are up then the currency is supported. Learn what economic indicators reflect the inflation and the decision of central bank about interest rates and you have an extra tool in your arsenal in order to trade.

Two of the most important fundamental indicators are interest rates and international trade. Other indicators include the Consumer Price Index (CPI), Durable Goods Orders, Producer Price Index (PPI), Purchasing Manager's Index (PMI), and retail sales.

Interest Rates - can have either a strengthening or weakening effect on a particular currency. On the one hand, high interest rates attract foreign investment which will strengthen the local currency. On the other hand, stock market investors often react to interest rate increases by selling off their holdings in the belief that higher borrowing costs will adversely affect many companies. Stock investors may sell off their holdings causing a downturn in the stock market and the national economy.

Determining which of these two effects will predominate depends on many complex factors, but there is usually a consensus amongst economic observers of how particular interest rate changes will affect the economy and the price of a currency.

International Trade - Trade balance which shows a deficit (more imports than exports) is usually an unfavorable indicator. Deficit trade balances means that money is flowing out of the country to purchase foreign-made goods and this may have a devaluing effect on the currency. Usually, however, market expectations dictate whether a deficit trade balance is unfavorable or not. If a county habitually operates with a deficit trade balance this has already been factored into the price of its currency. Trade deficits will only affect currency prices when they are more than market expectations.

Other indicators include the CPI - a measurement of the cost of living, and the PPI - a measurement of the cost of producing goods. The Gross Domestic Product (GDP) measures the value of all goods and services within a country, while the M2 Money Supply measures the total amount of all currency.

Now let us look at some of the most important fundamental indicators more closely. Since these indicators greatly impact price movements and market sentiment we need to better understand how they work and what they show, plus how they impact a particular currency.

Interest Rates

The cost that banks are charged for borrowing money from Central Banks in case of the United State - Federal Reserve (Fed) is known in the market as Interest Rate. Why is this number so important? Simply because using interest rates central banks attempt to control inflation in the country. Inflation is caused by too much money available in the country and too few goods available in the market that the money can be spent for (or too much demand for too little supply), which causes prices to increase. By affecting the amount of money available for purchasing goods, central banks can control inflation.

If we look at interest rates in terms of foreign exchange market, we can say that basically, interest rates reflect how much you get paid for holding a currency that is why interest rates drive the Forex market. If interest rates are going up it suggests that the economy is in a growing cycle. Thus central bankers are inclined to ease off inflationary pressures with higher rates. The currency tends to appreciate as a result. If interest rates are neutral or going down, it typically means growth is slowing (as bond markets bring long term rates down in the expectation that central bankers will offer more lax monetary policy), and the currency tends to depreciate as a result.

Here is the table of the key interest rates by country as to May 2007:

Here is the description of 3 most important interest rates:

Federal Funds Rate - the interest rate at which member banks of The Federal Reserve System obtain short-term overnight credits. The decision about fluctuation of the key interest rate in the USA is made by the Federal Open Market Committee (FOMC) of the Federal Reserve System of the USA during its meetings. The Committee meets 8 times per year and discusses the question concerning the key interest rates fluctuation. Those meetings are usually held on Tuesdays. The first and the fourth meetings of the year are exceptions because they are usually held for two days (Tuesday and Wednesday). The result of the meeting is announced at 6.15 pm GMT either on the day of the meeting or on the second day of the meeting if the meeting was going for over two days. The Meeting Minutes are published a few days after the following scheduled meeting.

Refinancing Tender - the European analogue of the Federal Funds Rate. Refinancing Tender is the minimum possible interest rate for requests for obtaining funds in the European Central Bank tender. Every two weeks ECB holds a tender to float funds, which is necessary for supporting liquidity in the financial system. This is the minimal rate at which ECB runs transactions on the open market. The decision about key interest rates fluctuation in Europe is made by the Governing Council of the European Central Bank. Since the 7th of January 1999, Council meetings are held on Thursdays once every two weeks. Exceptions in the meetings schedule are made only during holiday periods and during the period of summer vacations in ECB.

Repo Rate - interest rate at which the Bank of England offers credits according to the repossession scheme, i.e. Bank of England buys short-term stocks from banks with an obligation to sell them back to the same banks in a certain stipulated time. The decision about key interest rates changes in the UK is made by the Bank of England Monetary Policy Committee during its monthly meetings. The meeting of the Bank of England Monetary Policy Committee is held for two days. Usually it is the Wednesday and Thursday following the first Monday of each month, but sometimes there are exceptions when the meetings are held on Tuesday and Wednesday. The result of the Monetary Policy Committee meeting is announced at noon GMT on the second day of the meeting. The Minutes of these meetings are published on Wednesday following the week of the meeting.

Balance of Trade

The balance of trade is the difference between the monetary value of exports and imports in an economy over a certain period of time. A positive balance of trade is known as a trade surplus and consists of exporting more than is imported; a negative balance of trade is known as a trade deficit or, informally, a trade gap.

The balance of trade is one of the most misunderstood fundamental indicators of the economy. For example, many people believe that a trade deficit is a bad thing. However, whether a trade deficit is bad thing or not is relative to the business cycle and economy. In a recession, countries like to export more, creating jobs and demand. In a strong expansion, countries like to import more, providing price competition, which limits inflation and, without increasing prices, provides goods beyond the economy's ability to meet supply. Thus, a trade deficit is not a good thing during a recession but may help during an expansion.

Trade balance is derived primarily from three factors:

1. The price of goods in a country
2. Tax and tariff levies on imported or exported goods
3. The exchange rate between two currencies.

This last factor is very important to foreign exchange trading. Since the trade balance depends so heavily on the current state of exchange rates between two countries, trade balance is a key coincident indicator for the state of a foreign exchange asset market.

There are a number of ways to measure trade balance, but one of the chief sources of information on the state of trade in the US is the International Trade report released monthly by the Census Bureau and the Bureau of Economic Analysis. This report is released around the third week of every month and details the performance of several exported goods and services in various sectors of the economy

There are a number of factors that work to diminish the market impact of Trade Balance upon immediate release. The report is not very timely, coming some time after the reporting period. Developments in many of the figure's components are also typically anticipated well beforehand. Lastly, since the report reflects data for a specific reporting month or quarter, any significant changes in the Trade Balance should plausibly have already been felt during that period - and not during the release of data.

However, because of the overall significance of Trade Balance data in forecasting trends in the Forex market, the release has historically been one of the more important reports out of the any country. We encourage you to read about this indicator as much as possible and always follow any news related to it.

Consumer Price Index (CPI)

The Consumer Price Index is one of the leading economic indicators that measure the pace of inflation. Simply put, CPI measures the acceleration of price in a fixed basket of goods and services. Higher CPI indicates that prices of the basket as a whole have increased and as such, it costs more of the local currency to buy the same basket of goods. CPI is also broken down to a core level which strips out the volatile components of the index, which usually include food and energy, but this varies by country. Usually, central banks pay far greater importance to the core numbers than the headline numbers. Excessive inflation will induce a central bank to consider raising interest rates while falling inflation would give them the flexibility to lower interest rates.

Because each country has different living standards and consumption habits, each country has a unique CPI with different baskets of goods and services. Each country may also choose to benchmark their prices to different years, reflective of differing monetary policy for each country's central bank.

Thus comparing one country's CPI to another is never perfect - 2.0% inflation in the US may be different than 2.0% CPI in Japan. However economist and traders pay attention to developing trends in inflationary figures, specific to the country, to help forecast future rates.

Because excessive volatility may exist for certain components of CPI, countries may release "Core" CPI figures, which control for the most volatile goods and services. Components excluded from Core CPI usually consist of fresh food and energy, but will vary from country to country. Many countries also release seasonally-adjusted CPI figures, as prices can fluctuate with seasonal regularity.

Take a look how markets react on CPI announcements.

The dollar was gaining grounds against euro right after the CPI release but a post-CPI rally was quickly erased by a sharp reversal. The chart above shows the extreme nature of these price moves, with the EURUSD briefly piercing the 1.2900 mark before adding over 60 points in the course of an hour. Markets were seemingly taken by surprise by the respectable print, but the dollar bullish move found little foundation as the dust cleared. Indeed, market commentators broadly hailed the CPI release as a sign of slowing price inflation-prompting a more neutral outlook on the future of dollar-linked interest rates.

This is a very good example of how one report can move markets in both ways. Decrease in CPI number seems to be at first glance very good sign for the economy but for the currency it is actually a bad sign. This is because slow down in inflation means that central bank, in case of United States, the Fed will have more flexibility with interest rates and even might decrease them, since there is not need to control the inflation any more. We always need to pay attention to this kind of developments and keep in mind that something good for the economy some times is not that great for the currency.

Gross Domestic Product

GDP is the monetary value of all the finished goods and services produced within a country's borders in a specific time period, though GDP is usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments and exports less imports that occur within a defined territory.

GDP is commonly used as an indicator of the economic health of a country, as well as to gauge a country's standard of living. Critics of using GDP as an economic measure say the statistic does not take into account the underground economy - transactions that, for whatever reason, are not reported to the government. Others say that GDP is not intended to gauge material well-being, but serves as a measure of a nation's productivity, which is unrelated.

If the figure increases, then the economy is improving, and thus the dollar tends to strengthen. If the number falls short of expectations or meets the consensus, dollar bearishness may be triggered. This sort of reaction is again tied to interest rates, as traders expect an accelerating economy, consumers will be affected by inflation and consequently interest rates will rise. However, much like the CPI, a negative change in GDP is more difficult to trade; just because the pace of growth has slowed does not mean it has deteriorated. On the other hand, a better than expected number will usually result in the dollar rising as it implicates that a quickly expanding economy will sooner or later require higher interest rates to keep inflation in check. Overall though, the GDP has fallen in significance and its ability to move markets since most of the components of the report are known in advance

Due to the timeliness of this report and because data on GDP components are available beforehand, the actual GDP figure is usually well anticipated. But given its overall significance GDP has the tendency to move the market upon release, acting to confirm or upset economic expectations. Robust GDP growth signals a heightened level of activity that is generally associated with a healthy economy. However economic expansion also raises concerns about inflationary pressures which may lead to monetary policy tightening.

Durable Goods Orders

The value of orders placed for relatively long lasting goods. Durable Goods are expected to last more than three years. Such products often require large investments and usually reflect optimism on the part of the buyer that their expenditure will be worthwhile. 

Because orders for goods have large sway over the actual production, this figure serves as an excellent forecast of U.S. output to come. Durable Goods are typically sensitive to economic changes. When consumers become skeptical about economic conditions, sales of durable goods are one of the first to be impacted since consumers can delay purchases of durable items, like cars and televisions, only spending money on necessities in times of economic hardship. Conversely, when consumer confidence is restored, orders for durable goods rebound quickly. The data is highly volatile as well, some volatility is eliminated with the Durable Goods Orders excluding Transportation figure, making it the more closely watched indicator.

The Durable Goods Orders figure is also reported excluding transportation expenditures. Orders for items like civilian vehicles or aircrafts are fairly expensive and fluctuate idiosyncratically, distorting the Durable Goods Orders figure. Such goods are excluded to provide a better measure of durable goods orders. Monthly fluctuations in durable goods orders are frequent and large and skew the underlying trend in the data. In fact, even the yearly change must be viewed carefully because of the volatility in this series.

The first release, the advance, provides an early estimate of durable goods orders. About two weeks later, more complete and revised data are available in the factory orders report. The data for the previous month are usually revised a second time upon the release of the new month's data. (Bureau of the Census, U.S. Department of Commerce)

Unemployment Rate

The unemployment rate represents the fraction of the labor force that is unemployed. It is published monthly in the government's employment report covers also information on payroll jobs, employment, average workweek, average hourly earnings.  It increases or falls following a change in economy activity. The unemployment figure is typically calculated by dividing the number of out of work individuals in the labor force, by the total labor force.

More generally, unemployment is indicative of the economy's production, private consumption, workers' earnings, and consumer sentiment. A lower unemployment rate translates into more employed individuals with paychecks, which leads to higher consumer spending, economic growth and potential inflationary pressures. Conversely, high levels of unemployment are connected with lower incomes, lower spending, and economic stagnation.

The employment report also covers information on payroll jobs, including employment, average workweek and average hourly earnings. The report is released monthly by Department of Labor.  Larger-than-expected monthly fall in the unemployment rate is considered inflationary causing interest rates to rise. The Forex market views an increase in unemployment rate as unfavorable especially when the economy is close to full capacity and the unemployment rate is close to its "natural rate". A falling unemployment rate makes it more likely that the central bank or the Fed, in case of United State, will increase its interest rate that is also favorable to the Forex market.

From 1948 to 2004, the monthly U.S. unemployment rate has ranged between about 2.5% to 10.8%, averaging approximately 5.6%.  The unemployment rate is considered a lagging indicator, confirming but not foreshadowing long-term market trends. 

Non-Farm Payroll - statistic researched, recorded and reported by the U.S. Bureau of Labor Statistics intended to represent the total number of paid U.S. workers of any business, excluding the following employees:

- general government employees
- private household employees
- employees of nonprofit organizations that provide assistance to individuals 
- farm employees

This monthly report also includes estimates on the average work week and the average weekly earnings of all non-farm employees. The total non-farm payroll accounts for approximately 80% of the workers who produce the entire gross domestic product of the United States. The non-farm payroll statistic is reported monthly, on the first Friday of the month, and is used to assist government policy makers and economists determine the current state of the economy and predict future levels of economic activity. Market mover and needs to be closely watched.

We have introduced you above to most commonly followed economic indicators in Forex market. There are many more that need to be studied and watched because they have their own, some times great impact on market moves. Below, please find a table of economic indicators importance as most Forex market analysts and traders see it.

Rarely affects markets
Moderate market impact
Tends to move markets on release

United States - USD

Gross Domestic Product - GDP Tends to move markets on release                                      Non-Farm Payroll -  to move markets on release
ISM Manufacturing Tends to move markets on release
Philadelphia Fed Survey Tends to move markets on release
Empire State Manufacturing Survey Tends to move markets on release
Durable Goods Orders Tends to move markets on release
Business Inventories Rarely affects markets
Wholesale Inventories Rarely affects markets
Factory Orders Rarely affects markets
Industry Productivity and Costs Rarely affects markets
Capacity Utilization Rarely affects markets
Industrial Production Rarely affects markets
Richmond Fed Manufacturing Survey Rarely affects markets
Chicago PMI Rarely affects markets
ISM Non-Manufacturing Rarely affects markets
EIA Crude Oil Stocks Rarely affects markets
Monthly Budget Statement Rarely affects markets

Euro-Zone - EUR

Euro-zone Gross Domestic Product
Euro-zone Gross Fixed Capital Formation (GFCF)
Euro-zone Household Consumption
Euro-zone Industrial Production
Euro-zone Industrial New Orders
Bloomberg Euro-zone Retail Purchasing Managers
Euro-zone Construction Production Index  
Euro-zone Government Expenditures
German Annual Gross Domestic Product (GDP)
German Domestic Demand
German Private Consumption
German Industrial Production
German Factory Orders
German Equipment Investment
German Government Spending
French Gross Domestic Product Quarterly (GDP)
French Industrial Production

United Kingdom - GBP

British Gross Domestic Product (GDP)
NIESR GDP Estimate - UK
British Industrial Production
CBI Industrial Trends Survey - UK
Manufacturing PMI - UK
Pre Budget Report - UK
Public Finances - UK
Public Sector Net Borrowing - UK

Japan - JPY

Japanese Gross Domestic Product (GDP)
Japanese Industrial Production
Machine Tool Orders
All Industry Activity Index
Capital Spending
Capital Spending Including Software
Japanese Capacity Utilization
Japanese Machine Orders
Japanese Shipments
Japanese Coincident Index

Canada - CAD

Canadian Gross Domestic Product Quarterly (GDP)
Ivey Purchasing Managers Index (PMI) - Canada
Survey of Manufacturing - Canada
Manufacturing Inventory to Shipment (IS) Ratio - Canada
Consumption Spending - Canada
Labor Productivity - Canada
Capacity Utilization Rate - Canada

 Switzerland - CHF

Gross Domestic Product (GDP)
Swiss Industrial Production
SVME Manufacturing PMI
UBS Consumption Indicator

Australia - AUD

Gross Domestic Product (GDP)
Private New Capital Expenditures and Expected Expenditures
Inventories - Australia
AIG Performance of Service Index
Company Operating Profits

New Zealand - NZD 

Gross Domestic Product (GDP) - New Zealand
Performance of Manufacturing Index (PMI) - New Zealand
Manufacturing Activity Report - New Zealand