Forex Fundamentals- FOMC, GDP, CPI, PPI, ISM

After going through this article you should be able to know the Forex Fundamentals.

Forex Fundamentals will cover the following:

Understanding Forex  Fundamentals

Modern-day economies are operated on “free market” principles with demand and supply situations determining prices for everything. No government or any central authority dictates the relative value of goods and services available in a marketplace. Foreign exchange or forex market is no different. The relative value of one country’s currency against another depends on the economic situations of those countries which in turn affect the actual supply and demand situation of those respective currencies.

In order to understand the price movements of different currencies, it is imperative to understand the economic and political dynamics of the two nations involved in a certain forex pair. Forex traders and speculators alike have a wide range of fundamental issues to take into account before going for actual trade.

With the proliferation of news media, we are constantly bombarded with different types of information like economic reports released by different government agencies, newsletters, private research conducted by different brokerage firms, predictions by analysts on television talk shows, and multiple other resources.

In fact, the amount of information can be overwhelming and at times can cause an information glut. Here comes the challenge! A trader is supposed to differentiate the most important information from the less important ones. Although it is very difficult to trade based only on the forex fundamentals factors.

For example, as a trader, you may have a certain trading strategy that may predict that you should purchase the Euro tomorrow, but tomorrow may coincide with the release of the US employment report or perhaps it might be a day when the Federal Open Market Committee (FOMC) is scheduled to meet. These are events that cause price actions and volatility in the forex market.

As the headline says, the entire forex fundamentals analysis thing can be summarized in the above sentence. The national life of a country or to be specific an economy gets affected by two different types of events and those are:

There are events that no one knows that is going to happen. For example, no trader in the world had prepared for the unfortunate events of 11 September 2001 as no one knew that it would happen. Similarly, the Tsunami of 2004 in South Asia is another case in point. The 9.0 – 9.1 magnitude earthquake that ravaged Japan in 2011, which cost the nation $235 billion, was also devastating for the forex market along with the general economy. Such incidents, though part of trading in the real world, fortunately, are still infrequent. Even if some genius may come up with a prediction of such an event, he or she will not be able to judge how the said event will impact the economy in general and the forex market in particular.

If a trader or a market participant keeps a tab on the undergoing developments in the market and industries of their target segment of the economy then they may be able to foretell the upcoming events. Like if a soybean trader had monitored the freight rates for the past couple of months then they may not be shocked if China all of a sudden announces huge purchases of soybeans to drive up the prices. There are also events like the timing of a general election, meetings of FOMC or ECB, the release of different government reports. These are events that are known to traders in advance and traders can decide their strategies accordingly.

Four things should be kept in mind for forex fundamentals before analyzing any impact of these on the market and those are:

United States Watch List: Since the USD is the leading currency of trading and reserve in the foreign exchange market so any news or information coming out of that country has the most bearing on the price movements of different currency pairs. Whatever strategy traders pursue currency trading, they should have an idea when these meetings or releases are scheduled because of the volatility but also for short-lived price moves that they may trigger.

Forex Fundamentals Instruments :

Federal Open Market Committee (FOMC) Meetings

Federal Reserve Systems or Fed is the central bank of the United States of America. This institution is mandated to carry out the nation’s monetary policy. It was founded on 23 December 1913 with the enactment of the Federal Reserve Act. Over the years, different economic events like the Great Depression of the 1930s, and the Great Recession of the late 2000s have led to the broadening of the scope of this organization.

It has a committee in it called the Federal Open Market Committee (FOMC) which is responsible for setting the monetary policy. It consists of all seven members of the board of governors and the twelve regional presidents of the federal reserve. The twelve members of FOMC meet on eight different occasions in a given year to decide the monetary policy. Any change in the policy results in either purchasing or selling the US government securities on the open market to finetune the national money supply. It also publishes a statement on the interest rate, making its posture known to the people vis-a-vis interest rate.

Beige Book

As mentioned earlier, the Federal Reserve or Fed has twelve different regional districts and each district provides reports on the economic outlook for that region. Beige Book is the grand report which combines these individual reports into a single composite one. Statistics placed on this report often guide the FOMC in deciding the monetary policy.

Index of Leading Economic Indicators (LEIs)

Most of the economic reports that are released worldwide are basically “lagging” reports, meaning those reports are based on past economic data. But there are sets of indicators that predict the health of a country’s economy in advance and those are known as “leading” indicators. But for predicting the health of the economy accurately, one needs to combine it with other indicators.

Gross Domestic Product (GDP)

This is the most common measurement tool for an economy as it provides the overall picture of the activity going on in that economy. In the United States, this GDP report is released in three different stages and those are preliminary, advanced, and revised.

Balance of Payments

In an economy, there are several aspects that involve interaction between different nations. Import and export are one of them. The net result of this trading activity is either a surplus trade balance or a trade deficit. The United States has been running a trade deficit for quite some time. Being the engine that drives world economies, the US is in a very important position. Strong imports may be a sign of a thriving U.S. economy and good news for those nations sending their produce to the US, but it may not be good for the value of the dollar. Another important thing in the interaction between two different sovereign nations is the current account flows, the amount of money flowing into a nation versus the amount of money flowing out. Cash is known to be flowing into the US economy rather than vice versa.

Employment Reports

US Bureau of Labor Statistics publishes a monthly report on employment called “Non-farm Payroll”, which is released on the first Friday of each month. The key segment of this report is the number of jobs created in the economy in the past month. Other important data in these reports are “average hourly workweek”, and “average hourly earnings”.

Consumer Price Index (CPI)

Consumer Price Index or CPI is the index that measures the “price levels” of various goods and services against certain levels which existed in the past and which is known as “base period”. This report is primarily released to gauge the inflation rate in an economy. However, since this report excludes the prices for fuel or food which may fluctuate wildly, some analysts or traders do not put much credence on this report.

Producer Price Index (PPI)

This is another version of CPI but the difference is that this report measures the inflation rate that exists at the producer level rather than the consumer level.

Consumer Confidence Report

In the United States a survey called the “Consumer Confidence” is released by the Conference Board, University of Michigan, and others to gauge consumer attitude prevailing in the economy. This is a general report which predicts the consumer’s outlook of the US economy.

Retail Sales

Retail sales is the area that is directly affected by consumer confidence. Times like the Christmas holiday are the season where the power of retail sales to drive economic growth is seen in full. To make the report more meaningful, traders usually compare same-store sales with that of previous years.

Housing Stats and New and Existing Home Sales

This is the report which indicates the effect that housing and construction have on the US economy. Robust home sales mean more demand for raw materials such as lumber or copper and for appliances and all the other primary goods that are needed to build and maintain a home. Production and sales of all those items affect economic growth which is good for the US economy.

Durable Goods Orders

The next step after a home purchase is the need to furnish those houses with refrigerators, air conditioning, heaters, washing machines, televisions, and other home appliances. These are known as “durable goods”. More orders for durable goods mean busy factories and increased economic activities.

Construction Spending

Another report which gauges the confidence of the business community in the economy is the construction spending report. This report discloses the spending for office buildings, shopping malls, and other buildings constructed for different business purposes. Increased construction spending means increased confidence of the business community and captains of industry on the near-term prospect of the economy.

Institute of Supply Management (ISM) Index

If any report exists that portrays the composite situation of the national manufacturing conditions then it is the Institute of Supply Management (ISM) Index. Any readings above 50% are considered an indication of an expanding factory sector and readings below 50% is a sign of a contracting manufacturing sector growth.

Industrial Production and Capacity Utilization

For gauging the health of a nation’s economy one needs to go through the data related to the industrial production level of that country. Another important aspect that this report sheds the light on, is the factory capacity that is being utilized. Factory utilization tells us whether the nation’s factories are operating at full capacity or not. Factories are naturally supposed to maximize their usage rate for exploiting the “economies of scale” but a capacity utilization level which is above 85 percent is considered “overheated” and could trigger inflationary pressure in the economy.

Business Inventories

After producing the goods, they are transported to the middlemen to be sold to the final consumers. What is and how much is left on the shelves of different departmental stores, wholesalers, and godowns of different retailers is a good indication of how strong or weak economic demand is. It also provides clues about future economic activities.

Personal Income and Personal Spending

In a developed economy, consumer spending is the main driver of economic activities. And consumer spending depends on consumer income. If consumers have a surplus of income overspending, they will have the cash to purchase more goods or services and push up prices or put into investments such as stocks or savings accounts. On the other hand, if consumer spending exceeds income, buying will slow down, potentially triggering a downturn in the economy.

Forex Fundamentals of International Watch List

Along with the United States of America, forex traders and speculators should keep an eye on the economic reports coming out from different parts of the world as well. Countries like Japan, the People’s Republic of China, the United Kingdom, Switzerland, Australia, New Zealand, the European Union (EU), Canada, Singapore, and many more are also participants in this market.

European Union (EU)

After the United States of America, the European Union or EU is the largest trading block in the world. This block has its own currency known as European Euro or EUR. The single most important agency within this block is called European Central Bank (ECB). Like central banks all over the world, this institution is also legally mandated to conduct the monetary policy of the eurozone.

The Eurozone consists of diverse economies and nations and the EU project can be described as a project which is very much in the making. Britain has come out of the union. Whereas there are nations that may find a seat in the union like Ukraine, and Turkey. Here the trick is as an individual trader you will have to keep a tab of different countries like Germany, France, Italy, Spain, Portugal, Hungary, and so on along with the comprehensive view of the zonal economic situation.

Japan

Being a stable mature democracy, the Japanese currency yen is considered a currency of “safe haven”. At times of heightened volatility in the forex market, investors and traders alike flock to the yen. As a result, any economic data coming out of Japan takes the center stage. The Ministry of Finance (MoF) is probably the single most important political and fiscal authority in Japan.

It usually requires a single statement from the concerned ministry official to have an impact on the value of the yen. The Bank of Japan (BoJ), the country’s central bank, is another institution that influences the value of the yen. Being the sole agency tasked with deciding the nation’s monetary policy, its pronouncement on the interest rate, the inflation situation has a good bearing on the value of the yen.

Like other central banks, the BoJ also purchases ten-year and twenty-year bonds issued by the Japanese government. BoJ does that every month to inject liquidity into the Japanese economy. The yield on the benchmark ten-year Japanese government bonds serves as a key indicator of long-term interest rates. The difference between ten-year yields on those bonds and those on U.S. ten-year Treasury notes is an important influencing factor of the USD/JPY exchange rates.

Another biggest Japanese government institution that has an oversized influence on the value of the yen is the Ministry of International Trade and Industry (MITI). MITI looks after the interests of Japanese industry and defends the international trade competitiveness of Japanese corporations.

United Kingdom (UK)

The Bank of England (BoE) is the sole monetary authority of the United Kingdom of Great Britain and Northern Irelands. The BoE has a committee that decides the nation’s monetary policy and meets on the first week of every month. The legally mandated inflation target for BoE is 2.5%. Any change in the “base interest rate” has the largest impact on the country’s currency, the Pound Sterling. Like Japanese Government Bonds, the spread between the yield on ten-year British government bonds, and the yield on the ten-year U.S. Treasury note usually impact the exchange rate.

Another aspect that determines the value of GBP/USD is the difference between futures contracts on three-month eurodollar and euro sterling deposits. The next most-important currency pair is EUR/GBP and the cross-rate that you should keep an eye on is the difference between ten-year British government bonds and German bunds.

Switzerland

Swiss Franc is an exceptional currency of Europe. Like the Japanese Yen, the Swiss Franc has also been considered a “safe haven” currency with investors and traders alike seen flocking towards it during times of turmoil in the international economy.

Due to the Swiss National Bank, the central bank of Switzerland’s independence in preserving the monetary stability, the secrecy of the Swiss banking system, and neutrality of the Swiss political position, the Swiss Franc is considered as the most stable currency the forex market offers. As the sole monetary institution, the Swiss National Bank (SNB) sets the monetary and exchange rate policy. This organization sets its targets for the Swiss franc based on “annual inflation rates”.

Australia

Australian Dollar is the official currency of Australia with the Reserve Bank of Australia (RBA) the sole controlling authority in that country. Australia is a liberal, stabilized democracy with an economy that is highly reliant on commodity goods. Like any other currency, the value of the AUD is also affected by the data on GDP, retail sales, industrial production, inflation, and the country’s trade balance. Being a commodity currency, any news on crop planting, weather, harvests, mine output, and metal prices all can move the Australian currency.

New Zealand

Reserve Bank of New Zealand (RBNZ) is the central bank of New Zealand. It was established in 1934 and is re-constituted under the Reserve Bank of New Zealand Act 1989. Like central banks of different democracies, RBNZ is also mandated to maintain a fine balance between inflation and unemployment. Due to its high-yielding nature, New Zealand Dollar is also considered a carry-trade currency along with its being a commodity currency. International powder milk prices and NZD have a positive correlation. The same is the case with the country’s tourism figures.

To know more about forex fundamentals analysis affecting other currencies, you can check our “Currency Profiles” section.