It’s important to understand that fundamental data such as economic reports, interest rate levels, monetary policy and global flows of trade and investment are the core drivers of the foreign exchange market.In addition to this there are also political and geopolitical influences such as elections, wars, terror attacks and debt crises (like we have seen in Europe and the United States), Brexit etc that can also significantly effect currency prices.
Understanding and interpreting all of this constantly flowing information is all part of forex fundamental analysis, which is an essential part of your forex trading education. Therefore in this section we will be covering the topic of fundamental / economic analysis in great detail.It is vital that you have a solid understanding of this area.
So what are the most important fundamental factors in global forex trading? Which reports and announcements have the power to shake the forex market?
Here are some factors that influence the market:
1. Interest Rates
Probably the most important fundamental indicator for a nation’s currency prices is the interest rate. High interest rates are generally associated with strong currencies. Of course they can also have a relationship with inflation rates.
Announcements of interest rate cuts or increases in any of the major currencies can have a massive and sudden effect on the forex market. In the short term, a cut in the interest rate will lead to investors selling that currency and so the price drops. At the same time of course they will buy another currency whose price will rise. You can often predict which other currency will benefit from this and get involved for a profitable trade.
Often, the effect can be longer term too. An interest rate change announced by the central bank is often an indicator of a steady fall or rise in the economy. This can lead to a trend that traders can profit from.
2. Gross Domestic Product (GDP)
GDP is the primary indicator of the economic strength of a nation. You could consider it as being like a profit or loss figure for a country. A higher GDP tends to be associated with a strong currency. Confidence will rise in times of high GDP.
Most countries report their GDP figures quarterly. There are usually predictions of the expected figures and the short term effect on currency prices at the time of the announcement may be more to do with whether the predictions were met than with the results themselves. For example if the prediction is for good results, and the results announced are good but not as good as expected, the currency price might actually fall. However, longer term the currency will usually show a fairly strong correlation to GDP.
3. Consumer Price Index (CPI)
Again a high CPI is an indicator of a strong economy. Currency prices in the global forex trading market will often respond accordingly.
4. Producer’s Price Index (PPI)
Less well known but equally important for the economy, the PPI is an earlier indicator of inflation because changes in prices for producers will affect the consumer price index a little further down the line.
5. Retail Sales
The retail sales figure is a measure of the receipts of retail stores and therefore also of consumer spending. Rising sales usually indicate a strong economy and rising currency prices.
6. Employment figures
Employment is another indicator of the health of an economy. Large job losses indicate a weak economy and are likely to lead to lower retail sales as people have less money to spend. More jobs being created shows an active economy and is likely to result in consumer confidence, higher retail sales and a higher GDP.
7. Durable Goods Orders
This figure measures orders placed with manufacturers in a country. Again a rise is associated with a strong economy. This is an important indicator for the manufacturing sector and also for export figures and the GDP. Correlation with global forex trading prices is not as strong as for some of the other factors but it can have an effect.