Professional traders watch the fundamental economic indicators that move currency pairs and so should any trader starting out. As a basic example, if economic fundamentals in the United States improve, the U.S. dollar (USD) will most probably strengthen because forex investors will buy dollars. Conversely, if U.S. economic fundamentals weaken, the U.S. dollar (USD) will most likely struggle. In this section, we will help you build a strong fundamental foundation by examining:
- Which fundamental economic indicators are most important? – Why are interest rates so important? – What impact does inflation have on interest rates? You can read about the most topical economic indicators of the day in TradingFloor.com’s Macro Update.< Not all economic indicators are important Globalisation and technology have made the world smaller and brought information to our fingertips. Part of becoming a successful forex trader entails learning how to ignore most of the news and information and focus on the key bits. Many fundamental economic announcements do not warrant much attention. For instance, unemployment in Ireland is not normally as important as unemployment in the United States. While Irish unemployment is certainly important in Ireland, the U.S. economy has a much larger impact on the global economy so investors watch U.S. economic announcements more closely. The key indicators The most important fundamental economic indicators can be divided into three groups: – Interest rates – Economic strength – Capital and trade flow You will learn more about economic strength and capital and trade flow indicators in later sections. In this section, you are going to learn about interest rates, the most important fundamental economic indicator for forex. Interest rates rule. Currencies representing economies with higher interest rates tend to be stronger than currencies representing economies with lower interest rates. Investors are always looking for the greatest return possible on their investments, and economies with higher interest rates usually have higher yields on their investments. Imagine you are walking down the street looking for a place to put your money and you see two banks, one on either side of the street. The bank on the right side of the street is offering to pay 6 percent interest on any money you deposit there. The bank on the left side of the street is only offering to pay 2 percent interest on any money you deposit there. Naturally, you would choose the bank offering to pay 6 percent interest because you want to make a better rate of return on your investment. The same principle applies to economies and their respective currencies. If you can get a 6 percent return on your investments in the United Kingdom, but you can only get a 2 percent return on your investments in Switzerland, you are most likely going to invest in the United Kingdom. So how does this affect the value of the British pound (GBP)? As more and more people put their money in investments in the United Kingdom, demand for British pounds (GBP) increases. Basic economics tells us that as demand increases, the value of the British pound (GBP) also increases. Watch Central Banks (the organisations that set interest rates) closely to see if they are likely to raise, lower or leave interest rates unchanged in the future. The most important central banks are: – United States—Federal Reserve (The Fed) – European Union—European Central Bank (ECB) – United Kingdom—Bank of England (BOE) – Japan—Bank of Japan (BOJ) – Switzerland—Swiss National Bank (SNB) – Canada—Bank of Canada (BOC) – Australia—Reserve Bank of Australia (RBA) – New Zealand—Reserve Bank of New Zealand (RBNZ) Inflation impacts interest rates It is not just about watching the central banks, but also the economic numbers that central banks watch, in an effort to determine the central banks next move. One extremely important economic indicator to central banks is inflation. Inflation is a general rise in prices for goods and services. For example, you most certainly pay more for a litre of milk or a loaf of bread than you did 10 or 20 years ago. You’ve probably also heard people from earlier generations comment on how expensive everything is these days. We all deal with inflation. Example Inflation ran rampant in Germany after World War I. Brutal economic instability caused the dramatic devaluation of the German mark. You can get a sense of just how bad the situation was by looking at the price of German postage stamps. In April 1921, it cost approximately 0.60 German marks to mail a letter from one city to another. However, by December 1923—merely 15 months later—it cost approximately 100,000,000,000 marks to mail that same letter from one city to another. While this is certainly an extreme example, it drives the point home that inflation will always be a part of our lives. Moderate inflation is generally accepted as a natural by-product of economic growth. Too much inflation, however, can hurt an economy. Central banks are always on the lookout for rising inflation. When they see inflation rising to uncomfortable levels, they often act to dampen the inflationary pressure. Interest rates are a tool to curb inflation — central banks can combat rising inflation by raising interest rates. Higher interest rates make it more difficult for businesses and individuals to borrow money to buy and build new items, which slows economic growth and, as a result, inflation. Traders watch inflation rates to get a glimpse into what central banks may do with interest rates. If inflation is rising, central banks will most likely raise interest rates, which is good for the representative currency of that economy. There are two key economic inflation indicators to watch, and they come with different names in the major economies, but in outline they are: Consumer Price Index (CPI): the economic indicator that measures how much a basket of goods that consumers regularly buy costs. The more money consumers have to spend on essential goods and services, the less money they have to spend on extra goods and services. Producer’s Price Index (PPI): the economic indicator that measures how much producers must pay for the raw materials they use to produce their finished goods. If prices for producers are rising, they will most likely pass those costs onto consumers.
Similar Posts:
- What is Fundamental Analysis?
- Forex Markets Look to Interest Rates for Guidance
- SA Rand in Bubble Territory
- Record Commodities Prices and the Forex Markets
- Korean Won Rises Despite Currency War
