Many experienced forex traders prefer to use objective technical analysis methods to direct their short-term trading activities, especially when it comes to timing trade entry and exit points. Nevertheless, forex fundamental analysis continues to play a significant role in helping economists and other analysts to forecast the long-term behavior of exchange rates.

Furthermore, when some new fundamental information enters the forex market in a sudden way, it can prompt significant market moves and volatility as traders react to the new information. At such times, one of the most basic assumptions of technical analysis - the idea that "price discounts all" - breaks down until the new information has been duly assimilated.

As a result, it really pays to know what the likely effects of such key fundamental information could be so that a quick assessment of probably future direction can be made.

Major Fundamental Factors

Each of the following fundamental factors can have a significant impact on exchange rates and will probably be taken into account in a thorough fundamental analysis of a particular currency pair.

Differences in Interest Rates

Forex rates usually trend to favor currencies with higher interest rates, and central banks usually set benchmark interest rates to reflect their monetary policy. Statements from monetary policymakers indicating higher rates for the country tend to benefit its currency. Also, carry gains will accumulate over time on long positions in the currency with the higher interest rate, while losses would accrue on short positions. Interest rate differentials for currency pairs can also be looked at in a similar way to dividends in stocks.

Key Economic Data Releases

Typically released on a monthly basis, such data might include:

• Employment Data
• Gross Domestic Product (GDP)
• Trade Balance
• Retail Sales
• Industrial Production
• Consumer Price Index (CPI)

 

Supply and Demand Effects

Substantial flows of capital into a currency and out of another currency, perhaps as a result of large corporate transactions or managed portfolio shifts, can shift the exchange rate for the currency pair to favor whichever currency sees the higher demand.

Political Influences

Countries with stable governments tend to have their currencies favored over those of countries with less favorable political situations. Greater fiscal responsibility also tends to support a country's currency, while excessive government spending will tend to depreciate its currency.

Geopolitical Events

The forex market tends to value currencies of peaceful countries with growing economies and stable politics over the currencies of less stable countries that are at war or having their national security threatened in some other way.

Growth Rate Differentials

Those countries whose economies demonstrate a higher rate of growth will tend to see their currencies appreciate relative to weaker or recessionary economies.

Commodity Prices

The prices of key commodities like gold and oil tend to affect the valuation of the currencies of their primary exporters and importers. For example, higher oil prices help the British Pound and the Canadian Dollar, while they hurt the U.S. Dollar and the Japanese Yen, whose countries net import oil. Furthermore, higher gold prices tend to favorably impact the Australian Dollar, and by close association the New Zealand Dollar, since Australia exports that precious metal and so its currency will benefit from a rise in gold's value.

 

Risk Statement: Trading Foreign Exchange on margin carries a high level of risk and may not be suitable for all investors. The possibility exists that you could lose more than your initial deposit. The high degree of leverage can work against you as well as for you.