Fundamental analysis allows traders to see what trends are happening and make predictions of the direction of the currency in the long run.
What is fundamental analysis?
Forex fundamental analysis (FA) is the study of a country’s economic, political and social data to determine its impact on the value of the country’s currency.
Factors that influence the value of a currency
Central Bank
Central banks play the most significant role in a country’s economy. They direct the country’s monetary policy to achieve specific targets.
There are nine major central banks in the world today:
- Federal Reserve (Fed)
- Bank of England (BOE)
- European Central Bank (ECB)
- Bank of Japan (BOJ)
- Reserve Bank of Australia (RBA)
- Reserve Bank of New Zealand (RBNZ)
- Swiss National Bank (SNB)
- Bank of Canada (BOC)
- People’s Bank of China (PBOC)
Interest Rates
The central bank sets interest rates to control the inflation rate so that it is stable with economic growth.
Interest rates are the primary influence of investment flows.
Hawkish:
- The term refers to the central bank talking about raising interest rates.
- The economy is growing, and they are optimistic about the future.
- Market sentiment is bullish for the currency.
Dovish:
- The term refers to the central bank talking about lowering (or unchanged) interest rates.
- The economy is stagnant, and they are skeptical of the future.
- Market sentiment is bearish for the currency.
Source:
- https://www.fxstreet.com/economic-calendar/world-interest-rates
- https://tradingeconomics.com/country-list/interest-rate
- https://www.global-rates.com/en/interest-rates/central-banks/central-banks.aspx
Inflation
Inflation is the biggest influence on a central bank’s interest rate decision.
Inflation occurs when the price of goods increases.
Central banks generally believe that a stable inflation rate is around 2% or a bit below.
However, too much inflation can harm the economy. That is why the central bank constantly monitors inflation-related economic indicators such as the CPI.
- They will lower interest rates (rate cuts) to encourage economic growth. Cheaper for consumers and businesses to make loans. People have more money to spend. This causes the economy to grow and inflation to increase.
- If central banks want to fight inflation (3% and above), they will raise interest rates (rate hikes). Loans will be difficult and incur high-interest rates. Investors and consumers prefer to save money to earn interest. The economy slows, and inflation decreases.
Central banks are targeting stability in economic growth, more jobs, and more taxpayers. Meanwhile, consumers are more confident in spending with no sharp increase in the price of goods.
Source:
Quantitative Easing (QE)
https://www.bankofengland.co.uk/monetary-policy/quantitative-easing
https://www.investopedia.com/terms/q/quantitative-easing.asp
Tapering
https://www.thebalance.com/fed-tapering-impact-on-markets-416859
Negative Interest rates
https://www.investopedia.com/terms/n/negative-interest-rate.asp
Employment
The employment/unemployment rate is crucial to measuring the country’s current economic growth.
For example, the Non-Farm Payroll (NFP) report is one of the important announcements that could cause a significant movement in the Forex market.
The NFP figure is a key economic indicator of the U.S. economy.
This NFP data is released to the public every month by the Bureau of Labor Statistics (BLS).
Source:
- https://www.bls.gov/
- https://fred.stlouisfed.org/categories/10
- https://tradingeconomics.com/country-list/employment-rate
Economic Growth
Robust economy: Consumers and businesses are more confident about spending. On the other hand, companies can make a profit and pay taxes to the government. The value of the currency will increase with positive economic developments.
Weak economy: Only the government spends because consumers and businesses are afraid to spend money. They prefer to save because they are less confident about the economic situation. The currency’s value will decline due to a lack of flow in the market.
GDP (Gross Domestic Product)
Cash flow
If the country’s economy is strong and interest rates are high, more foreign investors will invest. It creates more demand for the country’s currency.
The opposite is true if the economy is poor and interest rates are low. Supply exceeds demand and devalues the currency.
Trade Balance
Positive (surplus): More exports than imports. The value of the currency increases because of a large amount of money exchanged from the importing country.
Negative (deficit): More imports than exports. The currency’s value decreased because more money was exchanged to the exporting country.
Politics
Stable political conditions create confidence in the economy, affecting relations with foreign countries as importers or exporters.
The unstable political situation has the opposite effect.
Where to get Forex news data?
Financial News Sources:
- https://www.bloomberg.com/
- https://www.reuters.com/
- https://www.wsj.com/
- https://www.marketwatch.com/
- https://www.cnbc.com/world/
- https://www.fxstreet.com/news
- https://www.investing.com/news/forex-news
Economic Calendars:
- https://www.forexfactory.com/calendar
- https://www.fxstreet.com/economic-calendar
- https://tradingeconomics.com/calendar
How to interpret the economic calendar?
