What is Fundamental Analysis? Interest Rates, Monetary Policy, Hawkish and Dovish Central Banks, Forex News and Market Data

Know the Nitty-gritty of Fundamental Analysis

If you ever hear of the words fundamental analysis, then understand that the people are discussing the economic conditions of a currency’s host nation. These may include an extensive collection of information, such as environmental reports, political news, economic scenario, events, data or announcements. An event like credit rating downgrade also comes under fundamental data.

Fundamental analysis is the study and application of these factors to predict the future price direction of currencies. It analyzes the things going across the country and world, and mainly focuses on macroeconomic factors.

The fundamental study offers insight into the way price action may react in response to an economic event. It can be a simple report issued by the U.S. Fed on existing home sales, or it can be a change in stance on monetary policy. The issue of this information can have an impact on the economic landscape, which further affects the decision-making process of speculators and investors.

Even anticipation of a report can create a buzz in the market. In the past, currency pairs have shown to move 100 pips before the release of major economic news. Hence, many forex traders look to initiate trade before the release of certain economic events.

Economic indicators form a significant part of the data used in fundamental analysis. They are an indication of the way an economy is faring. However, it is vital to understand the numeric value of an economic indicator and the market’s anticipation of that value.

Fundamental analysis is of not much use in estimating currency price direction. There are many loopholes in this analysis as the fundamental data is unclear than real technical indicators. But that doesn’t mean fundamental analysis should be ignored. The economic data should be understood, keeping in mind the broader economic picture.

Why Interest Rates Matter to Forex Traders

The Importance of Interest Rates in Forex Trading

Global interest rates play an essential role in the world of forex trading. They are one of the factors in deciding the predicted value of a currency. Therefore, it makes sense in devoting time to understand the way any nation’s central bank decides its monetary policy.

Monetary policy of any country is impacted by inflation. It is a general notion that moderate inflation is indicative of economic growth. On the other side, a notable increase in inflation is detrimental to the economy’s health. It is the reason why central banks remain wary of inflation-linked economic indicators, like the PCE and CPI. They can increase interest rates to curb inflation, which may result in lower overall growth. This happens because higher interest rates force businesses and customers to save more and borrow less, adversely impacting economic activity.

To the contrary, lower interest rates result in cheaper loans, supporting capital and retail spending, hence helping in the growth of the economy.

Here, it is vital to understand how the changes in interest rates impact the trading in currency. Currencies depend on interest rates as these commands the flow of global funds into and out of a nation. Accordingly, investors decide if they want to invest in a nation or look for some other options. The higher a nation’s interest rate, the more probability is that its currency will strengthen.

It should be noted that domestic interest rates directly impact how international market players perceive a currency’s value as compared to another. Also, interest rates tend to change in line with monetary policy.

Many forex traders apply a technique of assessing interest rate of different currencies, what we call as the interest rate differential, as the starting step for deciding the strength in a currency. A reducing differential is considered good for the lower-yielding currency. There are times when the interest rates of the two nations shift in opposite directions. Such a scenario results in a substantial swing in the forex market.

How Monetary Policy Affects the Forex Market

Impact of Monetary Policy on the Forex Market

The central banks of nations formulate monetary policy to attain certain economic objectives. Some of these objectives are the same as that of the world’s central bank, while some are specific for the respective economies. Eventually, monetary policy is the key to maintaining and promoting economic growth and price stability.

To achieve their objectives, central banks define monetary policy mainly to regulate the following:

• the money supply,
• the rise in inflation,
• the interest rates tied to the cost of money,
• lending to commercial banks,
• And reserve requirements over banks.

Types of Monetary Policy

The different types of monetary policies are:

• Contractionary or restrictive monetary policy
• Expansionary monetary policy
• Accommodative monetary policy
• Tight monetary policy
• Neutral monetary policy

Contractionary monetary policy can be defined as the one when there is a reduction in the size of the money supply. There can also be a hike in interest rates so that the economic growth can be slowed. Loans become expensive, which lowers investment and spending by both businesses and customers.

Expansionary monetary policy tends to expand the money supply or lower the interest rate. The objective of this change is to boost investment and spending.

Then there is accommodative monetary policy, the goal of which is to boost economic growth by reducing the interest rate.

Another type of monetary policy is a tight monetary policy which aims to lower inflation or limit economic growth by increasing interest rates. The last one is a neutral monetary policy which plans to neither fight inflation nor creates growth.

Hawkish and Dovish Central Banks

The Stances of Central Banks

Currency prices are impacted considerably affected by changes in a nation’s interest rates. And interest rates are impacted by a central bank’s stance on the price stability and economy. Central banks work just like other organizations in the way they have a chairman, a president, and a leader. They work as a team to come up with a decision on monetary policy. However, not all central bank representatives carry the same weight.

It is vital to know what will be coming from the changes in future monetary policy. For this part, central banks are improving themselves by offering better and clearer communication.

Central bank speeches hold immense potential in triggering a market response. Speeches can be on any of these matters like changes to existing interest rates, talks about economic growth outlook and measurements and monetary policy announcements. The news agencies from different regions ensure that the updates are available to the public.

Forex traders and analysts focus on such kind of news as they try to understand the overall language and tone of the announcement. Their main focus remains on interest rate changes and central bank activity as any different outcome from market expectation has the potential to trigger a big response.

With the changes in the way updates on monetary policy are released, it has become easier to understand the way a monetary policy will grow over time. Still, there remains a probability that central bankers may change their outlook differently from general expectations.

Central bankers are stated as hawkish when they favor the decision of hiking interest rates to combat inflation. On the contrary, dovish central bankers, favor employment and economic growth over higher interest rates.

Fundamental Factors That Affect Currency Values

Factors Affecting the Value of Currency

The long-term weakness of strength of major currencies usually depends on some basic factors, and these can impact on your forex trading.

Economic Growth Outlook

The economy is normally perceived as either strong or weak depending on various aspects. When the economy is strong consumers will feel safe and happy, and they tend to spend more. Companies will take the money from the consumers, and as a result, they will have to equally spend more, and thus, the government gets to enjoy healthy tax revenue. As a result, the government will also begin spending, and with everybody spending that creates a positive effect on the economy.

On the other hand, when talking of weak economy, consumers tend to spend less, and businesses don’t make money and thus won’t spend, and the only segment that is spending is the government. In both cases, whether there is a negative or positive economic outlook either will affect the currency market directly.

Capital flow

With technological advancement, globalization, and the age of the internet, investing money has become easy, and you can invest virtually anywhere across the globe. You can easily invest in the New York Exchange or the London Stock Exchange, or you can open a forex account anywhere and trade in euros, US dollars or other currencies.

Measurement of capital flows usually depends on the amount of money that is trickling into and out of the economy as a result of capital investment buying and selling.  In this case, what you should be noting is whether there is a balance in the capital flow, which can be negative or positive. If there is a positive capital flow balance, then it means there is a more foreign investment into the country than those going out, and a negative balance in capital flow means there is more leaving the country than what is coming in.

When there is a positive cash flow balance demand for currency grows as foreign investors have to sell their currency so that they can acquire local currency. An increase in demand for the currency increases the value of the currency. Alternatively, when there is a negative cash flow balance supply tends to be high than demand, which results in the value of the currency declining.

If foreign investors and domestic investors decide to leave, then you will have more of the local currency because everyone is selling and purchasing currency of the country they want to invest in. Investors always will want to invest in countries with a strong economy and high-interest rates. Therefore, is a country’s domestic financial market is growing that is even better because the high-interest rates and the flourishing stock market will attract foreign investors. Increase in demand for a local currency usually results in growth in value of the currency.

Trade balance and trade flows

The world is one market place where countries trade with each other through exports and imports. When you buy something you will give up some cash and then from whoever you buy from they will also do the same thing. Importers will exchange money with exporters when they buy goods. Buying and selling of products result in the exchange of cash, which in return affects the flow of currency in the economy.

A balance of trade measures the ratio of imports to exports in the economy, demonstrating the demand for goods and services in the country as well as its currency.  In situations where there are more exports than imports, then there is a trade surplus, which means a positive trade balance. Equally when there are more imports than exports, then there is a trade deficit, which means a negative trade balance.

When there is a trade deficit, the currency price is pushed down relative to other currencies. The net importers will be forced to sell their currency for them to buy the foreign currency of the merchant selling the products. When there is a negative trade balance, the local currency is sold to purchase foreign products. As a result, there is a

lower demand for the currency relative to a country with a positive trade balance.

Countries that have high net exports have a high demand for their currency because of the interest of those purchasing the exports. If there is more demand for the currency, then its value is prone to grow.

The Government

In a global economic crisis such as that of 2008, most focus is normally on the government on how it responds to existing financial difficulties. The government has the fiscal responsibility of ending woes that are faced during the recession. Equally instability in government or administration change can have an impact on the economy of the country and that of its neighbors. Any change in the economy is likely to have an impact on exchange rates.

Where to Find Forex News and Market Data

Where to Find Forex News and Market Data

If you try searching for forex new or forex data from the conventional search engines such as Google, Yahoo, and Bing, you will get around 30 million results. The results are way too many, which can make the processing of such information confusing.  Regardless this information is vital if you are to become a successive trader. Price changes are always associated with interest rate changes, economic reports, and change in leadership in the central bank.

To be successful in forex trading, you have to spend more time learning so that you can understand why price changes move the way they do. All you need to succeed is to understand the forex news and data to help you make the right decisions. Market data and news can be found through numerous sources, which include internet sources, print media, and TV services.

Traditional Financial News Sources

Although there are numerous financial sources offering information, it would be better to stick to the big fish. The sources provide continuous coverage of the market through the provision of daily updates on important needs that traders should keep tabs on such as economic report releases, central bank announcements as well as analysis among others.

Most of the renowned players equally have formal contacts that can offer explanations regarding daily events.  Some of the big players include Bloomberg, The Wall Street Journal, Reuters, and Marketwatch.com.

Real-time Feeds

There are financial TV networks that provide immediate access to market movements around-the-clock throughout the week. They offer real-time feeds that keep you updated on every minute action on financial markets across the globe.

In the US, for instance, some of the top financial TV networks include CNBC, CNN, MSNBC, Fox Business, Bloomberg as well as BBC. You can also get real-time data from the forex trading platform because most brokers have live newsfeeds that provide immediate and easy access to news and events of the market. However, you should check the availability of the feature from your broker because all brokers do not offer the feature.

Economic Calendars

It is advisable to look at your calendar and mark the exact month when the Fed will be announcing interest rates. Be keen on what rate is expected and what will occur and the impact the change will have on the currency market.  Data reports and economic events occur more often than we can keep up with. The data and news can potentially change markets in the near term and speed the movement of the currency pair that might interest you.

The good thing is that the most important economic news for forex traders is normally scheduled in advance. You can look at the BabyPips.com economic calendar to get some insight.

Information tips on the market

You should consider the suitability of the economic data that you get. Most of the information you get will be what has happened and how the market has adjusted the prices in consideration of the data. If the market makes a move ready to revise your strategy and adjust your intellect. Always check how old the news is lest you find yourself with news that is not latest.

Sometimes there are economic data rumors, and they normally happened minutes to hours prior to a release.  The rumor may be important in creating a near-term action, and at times, they can leave a lasting effect on the market. Institutional traders are usually the ones behind large moves, although it is difficult to establish the truth with a spot forex market that is decentralized.

As a forex trader, you should craft a good trading strategy and be able to have a quick response to news regarding rumors once it is established that they are true or false.

Lastly, it is important to discern the source of the news which can be from economists, analysts, or even the owner a forex blog or a central bank analyst as you watch and read forex news and report you to get to know who can provide reliable and accurate information. Everyone reporting news events has an agenda as well as strengths and weakness, so it is important to know the people who are reliable so that you also get to know.

Market Expectations of News and Their Impact on Currencies

Market expectations of news and the effect on currencies

When it comes to predicting market reactions to events and data, there is no specific formula on the same. Usually, the initial market response is short-lived but always full of activity. After traders have had time to make reflections on the impact of the report or news on the market, there comes a second reaction.

It is after the second reaction that the market decides whether the news event went against or within the market expectation or whether the reaction was appropriate.

Market consensus

The market consensus expectation is the comparable agreement on the news forecasts or the expected economic report.  Leading economists usually make the economic predictions from financial institutions and banks as well as securities associated entities. The various predictions from different analysts are pooled and averaged so that the averages can appear in calendars and charts to show the level of expectation for the event or report.

The consensus is ground zero with which the actual data will be compared against.  The actual data is denoted as “as expected” which is data close to the consensus prediction, “Better than expected” when the reported data exceeds the consensus forecast and “worse than expected” when the reported data falls short of the consensus projection.

In the reported data meets or does not meet the consensus forecast that is a significant evaluation that is employed in the determination of price action. It is as significant as the determination of how worse or better the reported data is relative to the consensus if there are considerable inaccuracies, the possibility and extent of price action increase once the actual report is released.

Since forex traders should be smart always and ahead of the curves, some already have “priced in” the consensus predictions into the market and their trading even before the release of the report. Pricing in helps traders to view the outcome of the event and bet on it before the actual news release.  If the report is likely to change the price, then traders will price in sooner on the forecast.

Always be on top of the market commentary to establish the price action will be before the report is released. That will provide insight on the extent with which the market has priced in. There seems to be a lot of activity before the report is released, so always try to be on the lookout.

Sometimes market sentiment can be worse or improve prior to a report to be keen because price action can be against or with the market trend. The data report can at times mass predictions totally, and therefore, you should not bank on the expectations of others such that in the event there is a miss you will still witness some price movement. Anticipate such uncertainty by playing the “what if” card.

You should consider both situations and ask yourself how the market will react to either outcome. Consider the number of pips the price is likely to move and what can happen to the report to result in a 40 pip decrease.

What to do if data is revised

Usually, data can be revised, and that is the nature of economic reports. For instance, let’s consider the Non-Farm Payroll employment numbers. This report is released on a monthly basis, and it always comes with the revisions of the previous month’s data.

Let’s assume that the economy of the US is on the decline and the NFP figure for January drops by 50,000 equivalent to a number of lost jobs. In February we assume the predicted NFP will decline by 35,000, but the reported NFP drops by 12,000 which is unforeseen. Therefore the revised data of January will be in the February report that was revised upwards to indicate just 20,000 decreases.

If you are not aware that the data has been revised, you are likely to make a negative reaction and in this case to the 12,000 additional jobs in February.  That will be two months of decline, which is bad news. However, taking into consideration the January revision and the better than expected NFP reading in February, you will see the beginning of a starting point.

Always ensure that you establish if there are revised data and the extent of the revision. If the revisions are huge, then there is more weight attached when analyzing the current data. Revisions are vital in helping to affirm a potential trend change, so take into consideration what is being released.