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Lesson 4
Fundamental Analysis
Fundamentals Every Trader Should Know
Currency prices reflect the balance of supply and demand for currencies. Two primaryfactors affecting supply and demand are interest rates and the overall strength of theeconomy. Economic indicators such as GDP, foreign investment, and the trade balance reflect the general health of an economy and are, therefore, responsible for the underlyingshifts in supply and demand for that currency. There is a tremendous amount of datareleased at regular intervals, some of which is more important than others. Data related tointerest rates and international trade is looked at the closest.
Interest Rates
If the market has uncertainty regarding interest rates, then any bit of news regarding interest rates can directly affect the currency markets. Traditionally, if a country raises its interest rates, the currency of that country will strengthen in relation to other countries, asinvestors shift assets to that country to gain a higher return. Hikes in interest rates,however, are generally bad news for stock markets. Some investors will transfer moneyout of a country's stock market when interest rates are hiked, believing that higherborrowing costs will affect balance sheets negatively and result in devalued stock,causing the country's currency to weaken. Which effect dominates can be tricky, butgenerally there is a consensus beforehand as to what the interest rate move will do.Indicators that have the biggest impact on interest rates are PPI, CPI, and GDP. Generallythe timing of interest rate moves are known in advance. They take place after regularly scheduled meetings by the BOE, FED, ECB, BOJ, and other central banks.
International Trade
The trade balance shows the net difference over a period of time between a nation’sexports and imports. When a country imports more than it exports, the trade balance willshow a deficit, which is generally considered unfavorable. For example, if US consumerswanted Japanese products, major automobile dealers might sell US dollars to pay for theimport of Japanese vehicles with yen. The flow of dollars outside the US would then leadto a depreciation in the value of the US dollar. Similarly if trade figures show an increasein exports, dollars will flow into the United States due to increased confidence in theeconomy and then the value of the US dollar would increase. From the standpoint of anational economy, a deficit in and of itself is not necessarily a bad thing. However, if thedeficit is greater than market expectations then it will trigger a negative price movement.
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