Some traders call fundamentals ‘funny-mentals’ to belittle their importance in the forex markets. Yet, we classify analysis in currencies as either being technical or fundamental.
Hence, fundamentals are indeed catalysts in much of the price movements we see on our charts. Like technical analysis, one may feel bombarded by the amount of data they see on their economic calendars daily.
Aside from the ‘usual suspect’, significant fundamental indicators like interest rates and GDP (Gross Domestic Product), industrial productions, leading weekly indexes, building permits, housing starts, purchasing managers indexes, and many more feature pretty regularly.
In truth, there is an overwhelming number of fundamental indicators you can observe. Well, fortunately, this article will focus only on the top 5, the most significant in the markets, briefly detailing what they are and how they influence the economies of their respective currencies.
1. Interest rates
The significance of interest rates is often simply summed up as the ‘price of money.’ All developed economies thrive or wane based on how much they lend and borrow. Such an effect trickles down to institutions and citizens in that particular country, meaning interest rates are a big deal.
In the context of foreign exchange, the interest rate refers to the rate central banks charge for lending to themselves and commercial, financial institutions. The interest rate is the most crucial indicator for regulating monetary policies related to inflation and stimulating economic growth.
It is considered a leading indicator with varying levels of influence in the short and long term. So, what is the major impact of interest rates? Put simply; such rates affect the level of foreign investment and the extent to which citizens borrow and spend money, factors determining the demand of the currency in question.
Generally, a currency with a higher interest is perceived as more valuable, while the opposite is true. Most central banks, particularly those managing the currencies in the major pairs, release new interest rate data around eight to ten times yearly at a predetermined month and day.
2. Gross Domestic Product (GDP)
Most fundamental analysts would agree the GDP comes second in order of importance after interest rates. While the latter pertains to broader monetary policies, GDP is a growth-focused indicator measuring a country’s overall economic performance and prosperity.
The gross domestic product quantifies the total value of all services and goods produced in a particular country within a certain period, usually a quarter. Hence, the GDP report comes out every three months on a predetermined day in March, June, September, and December.
Some countries also publish a preliminary report before the main one, which traders perceive with similar significance to its counterpart. While most analysts consider the GDP a lagging indicator, it doesn’t diminish the importance of such data.
Generally, a higher than expected GDP is taken as a bullish sign, meaning the currency is seen as more valuable due to a prosperous economy. Of course, the opposite is true.
3. Consumer Price Index (CPI)
If you want to gauge the inflation and cost of living for a specific nation, this is what the CPI aims to evaluate. The index is a weighted average of prices (expressed as a percentage) paid for several consumer goods and services monthly.
Purchasing power and the CPI go hand in hand. If the CPI is lower than the previous figure, it suggests consumers are spending less on goods and services for several reasons, resulting in a weaker currency.
Conversely, an uptick in the CPI tells traders citizens are spending more money on things, increasing the money supply and, thus, making a currency more valuable. You can typically expect new CPI data from most countries once monthly on any predetermined day of a particular week.
4. Trade balance
Trade balance or balance of trade reports are other indicators reflecting economic growth. They are a measure between the total imports and exports in goods and services. Put simply, the equation is:
Trade balance = exports total value – imports total value
If a country exports more goods than imports, economists refer to this as a positive trade balance or trade surplus, consequently creating demand for a currency.
Needless to say, a negative trade balance or trade deficit suggests a nation is importing more than it exports, therefore producing less demand for a currency.
Trade, the buying and selling of services and goods,’ is at the core of all economic activity. People are trading (no pun intended) primarily to have a return on their money.
A concept related to trade balance is trade flow, referring to the inflow and outflow of foreign investment. In simplified terms, if more foreign money comes into a country, it makes a particular currency more valuable as it gets used more; the opposite is true.
Likewise, all this data is significant in forex, and you can expect its release at least monthly in most economies.
5. Employment reports
As expected, employment reports look at how many jobs have been added or subtracted in a country. Like the GDP, such data tells a story on economic growth.
It’s pretty self-explanatory that if more jobs are added, it translates into citizens having more funds to spend and, thus, increasing the value of a currency. An employment decrease, of course, produces a negative effect since fewer people are getting paid, hence reducing a currency’s value.
Employment data is typically released monthly by a country’s respective statistics bureau. Fundamental analysts pay considerable attention to these numbers as they impact price movements, particularly in the near term.
Final word
If it were as simple as immediately buying a currency after a higher-than-expected interest rate or selling it after a lower-than-expected interest rate, the fundamental analysis would be relatively straightforward.
Fundamentals are a lot more complex primarily because you’re studying two distinct economies concurrently and the relationships between the economic indicators.
Ultimately, it’s about tying it all together and understanding all the different factors, both fundamental and technical, affecting currency before forming a simple bullish or bearish bias.
One of the secrets is comprehending the market expectations versus the eventual reality of the data outcomes. Often, what is expected can be more crucial than the data release itself. Markets can certainly move based on anticipated information.
Overall, things can change in a flash where forex fundamentals are concerned, but these indicators are ubiquitously regarded as the most significant and should be the main ones you consider in your analysis.