7 features for the fundamental analysis of the fx market

Fundamental analysis of the currency market is an assessment of a change of a currency value on the basis of the economic situation, financial policy of Central Banks, availability of cash in circulation and other macroeconomic indicators.

The currency market differs from the stock one with:

• Bigger stability. At first sight, this statement seems awkward, but when you analyze it you will understand that there are no sharp falls of everything at the same time, like it happens in the stock market. If one currency falls, another one is bound to grow.
• Global character. Currencies are traded round-the-clock.
• Smaller number of markets. There are thousands of companies and only dozens of currencies.

Both long-term position investors and intraday traders use fundamental analysis. Long-term investors identify the main trend and hold the position. Intraday traders use high volatility when news are broadcast.

Basic currencies in the Forex market are USD, EUR, JPY, CHF and GBP. It is believed that the currency value is identified by demand and supply and is in ‘free floating’. Although, there are exceptions, like, for example, it has been with the Turkish Lira (TRY) recently. While TRY was falling, the TRY/USD rate was rather strictly regulated by the government.

One can trade currencies not only in Forex, but also in the forward exchange market (futures).

Trading futures currency contracts in the forward market is more interesting for traders because:

• futures contracts have the Open Interest (OI). Globally, the Open Interest shows inflow or outflow of money from the markets. The Moscow Exchange broadcasts the Open Interest online. CME (Chicago Mercantile Exchange) provides data about the Open Interest with a delay, instead it splits it into different groups. And traders can see what major manufacturers, small speculators and hedgers do. Larry Williams built one of his indicators (Willco) using this data.
• exchanges show real volumes of traded contracts.
• futures contracts with different expiration days are traded at the same time. One can forecast future movement of currency prices or trade spreads.
• guarantee collateral on futures contracts allows trading even with a small starting capital. The minimum amount for trades with micro-contracts on CME is from USD 135 to USD 320. The guarantee collateral on futures contracts on the Moscow Exchange is even less – from RUB 2,200 to RUB 13,200.

Central Bank is the main state organization in a country. Central Banks ensure stability of national currencies. They have various instruments of influence on demand and supply. The US Central Bank is called the Federal Reserve System or simply the FED. Central Banks conduct different monetary policy, depending on the state of the economy and business cycle:

• Expansionist – to stimulate the falling economy. They buy out securities from banks and supply them with cash, decrease interest rates and increase the money supply.
• Restrictive – to avoid inflation and heavy crisis of the rising economy. Central Banks sell securities, increase interest rates and decrease the money supply. Such a policy results in more expensive loans, growing unemployment and falling consumer demand.

Trade Balance is the difference between export and import. Theoretically, if export is bigger than import, the inflow of foreign currency into the country grows and demand on the national currency grows too, since it is needed for exchange. Consequently, the national currency exchange rate gets stronger. If import is bigger than export, it is the opposite and the national currency gets weaker. We said ‘theoretically’, when speaking about the trade balance, for a reason. In real life, macroeconomic factors mix and influence each other, that is why it is impossible to accurately calculate the trade balance influence on currency exchange rates. However, broadcast of news about the growth of a trade deficit of international trade could result in the exchange rate fall. The trade balance also reflects demand on commodities abroad. The low cost of the national currency is good for exporters. They have an advantage in the global market, since their commodities are cheaper. Consequently, the low cost of the currency results in export growth. That is why Central Banks could decrease the currency value for increasing export. Export has a significant influence on economic growth of a country.

Stock indices behaviour or demand on stock also influences the currency exchange rate. Permanent buying interest in stocks, nominated in a certain currency, increases the exchange rate of this currency.

• The main American Index is S&P 500.
• The main Russian Index is RTS.

Money supply – surplus of one currency creates an increased supply and reduces the value of this currency. Consequently, the currency deficit increases its value, because the demand increases and supply decreases. The M2 money stock is the key one for the US, while M3 money stock is the key one for the Euro Zone.

Interest rates – the higher the interest rates, the higher the currency exchange rate is. Interest rates depend on the state of the economy and from such indicators as CPI (Consumer Price Index), consumer expenditures, real estate market and employment. Interest rates are set by Central Banks.

• Check American data on reference websites.

Inflation – growth of inflation decreases purchasing capacity of money. Central Banks fight inflation by means of increasing interest rates. This way they remove some money from circulation, because it becomes more profitable to invest into financial assets. As soon as some money is invested into financial assets, the purchasing capacity goes down and inflation also goes down. Growth of money supply increases inflation. Inflation in the sphere of services lags behind inflation in the commodity markets by 6-9 months. The higher the inflation, the lower the unemployment level is. Inflation in the US is measured with the help of two indicators – CPI and PPI. We will consider them in more detail in the following section.

• Check American data on reference websites.

Unemployment rate (UNR) is a leading indicator at the highs of the business activity and lagging indicator at the lows. Each percent of unemployment decreases GDP growth by 2 percent – Okun’s law. The currency exchange rate goes up when the unemployment level goes down and vice versa. It is impossible for any country to reach the zero unemployment level due to seasonality.

• Check American data on reference websites.

GDP – the stronger the GDP grows, the stronger the national currency is.

• Check American data on reference websites.

The volume of industrial production (IP) grows and the national currency becomes stronger along with export. The business cycle could be tracked by this indicator.

• Check American data on reference websites.

Let’s consider now the key US indicators, which influence the USD exchange rate, in more detail.

Report on unemployment in the nonfarm sector – Nonfarm Payrolls.

We marked traders’ reaction to the publication of data on May 3, 2019, with a rectangle in the 5-minute E-mini Euro futures (E7M9) chart below. The data were not just good but much better than the forecasts. The EUR/USD currency pair price jumped down on increased volumes during a short period of time. However, it is rather difficult to see such pronounced reactions nowadays, since political factors and a combination of other economic factors exert influence on currency exchange rates.

Consumer Price Index (CPI) or consumer basket price index.

Producer Price Index (PPI) is the indicator of the wholesale trade of products in the domestic market.

Use of production capacities (CAPU) is the general output (total productivity). The indicator is closely connected with business cycles and allows forecasting behaviour of Central Banks in difficult moments. Takes big values during recession.

Durable goods orders is the indicator of confidence of a consumer in the future and willingness to spend money on expensive commodities. The growing number of orders stimulates production.

Average Hourly Earnings. Salary increase, which goes ahead of productivity, sends a signal about a possible price increase, which would result in the interest rate increase.

Average Weekly Hours is one of the business cycle indicators. It goes down at the initial stage of the fall, since employers want to keep employees.