Introduction to fundamental analysis

1. Fundamental analysis

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Introduction to fundamental analysis
the Most important and complex component of currency dealing is the ability to analyze the market's trends, and, accordingly, to predict the factors and how they affect currency rates. In the movements of prices laid down as the possibility of quick profit and possibilities of quick and substantial losses. Therefore, the correct forecasting of market movements, assessment or other events, as well as manipulation of rumors and expectations, is a necessary part of the work of the broker or dealer and the guarantee of its successful activity. There are many factors that influence how the whole currency market in General and on individual currency.

There are two basic ways to market analysis - fundamental and technical. The first is assessing the situation from the point of view of political, economic, financial and credit policies. The second is based on methods of graphic research and analysis based on mathematical principles.

as part of fundamental analysis examines the various messages about financial world events, the phenomena of political and economic life of both individual countries and the world community in General, that can affect the development of the market, to any change in the currency rates. It is important here is information about the operation of exchanges and major companies such as market-makers, the interest rates of Central banks, economic course of the government, possible changes in the political life of the country, as well as all kinds of rumors and expectations. Fundamental analysis is one of the most difficult parts - and at the same time, one of the key parts of the Forex market. To carry out fundamental analysis is much more difficult than any other, since the same factors in different environments, different importance to the market, or may decisive become absolutely insignificant. You must know the interrelation and mutual influence of two different currencies, reflecting the links between the different States, the history of currency, determine the cumulative result of various economic measures and establish communication between totally unrelated at first glance events. In addition to some of the original and most formal rules, to the greatest extent here requires expertise on the currency market.

the Fundamental factors are estimated, as a rule, from two perspectives:
• from the point of view of their influence on the official interest rate;
• from the point of view of the state of the national economy of the country.

Fundamental analysis
the Fundamental factors are the key macroeconomic indicators of the national economy, acting in the medium term, impacting the participants of the currency market, and the level of the exchange rate. Reuters publishes a special page of the forecast of major economic indicators for the developed countries: ECI/I. this is Usually macroeconomic data published by national statistical offices (in U.S. statistical offices in the ministries, in Russia - Goskomstat of the Russian Federation). Information агенпство Reuters supplying users with fresh statistical data at the moment of their publication (release of data). Known schedule of publication of statistical data from various countries: in what day and how much those or other indicators (figures) will be officially announced, and instantly transferred to the system of Reuters, having arisen on the screen рейтеровских monitors around the world.
The breakdown by days of the week are the weighted average forecasts of economists and research centers on the expected indicators of national statistics (column FORECAST). Given the time of their publication, and previous values of the indicators (column REVS). These data are carefully analyzed dealers and analytical departments of banks, and on their basis are made by the script behavior of the exchange rate and tactics arbitrage transactions.
Usually on world currency markets, where 80 percent of arbitrage operations are conducted with the U.S. dollar, the greatest influence are the data on the US economy, which leads to an increase or decrease in the dollar against the other currencies. We can distinguish two temporal aspect of the influence of fundamental factors on the exchange rate:
- lasting impact, that is, the set of fundamental factors determine the state of the national economy and, therefore, the trend of exchange rate changes over months and years. Such a medium-term forecast of the course is to open a strategic positions. For example, long-term negative U.S. trade balance with Japan is the reason for the constant decline in the dollar to Japanese yen (250 in 1985 to 80 in 1995). For medium - and long-term impacts are taken into account statistical indicators for the period more than a month (quarter, year).
- short-term, that is, the influence of the published statistical indicator on the exchange rate acting for several hours or sometimes minutes. For example, the data about reduction of trade balance deficit with Japan is capable to lead to a slight increase in the dollar against the yen in the next few hours (with 88.20 to 89.50). Short-term influence on the course have indicators for short periods (week or month).
Currency dealers who make the decisions about buying or selling of currencies after appearing on the screens of monitors messages about the importance of this economic indicator, must immediately answer the series of questions on the proper solution of which depends on the amount of profit or loss.

Exchange rate purchasing power parity (Purchasing Power Parity Rate - PPP Rate)
Course at purchasing power parity is an ideal exchange rate, calculated as a weighted average price for the standard basket of industrial, consumer goods and services of the two countries. In the ideal model of formation of the exchange rate on the basis of only prices of trade of the two countries with each other the real exchange rate would be equal to the rate of purchasing power parity.
In its simplest form, abstracting from the real trading volumes and share of different goods in the consumption structure, the formula for finding the course of purchasing power parity may look as follows: where РiDEM and PiUSD - rates respectively in German marks and US dollars for goods and services in Germany and the United States, included in a standard basket of industrial and private consumption of these countries; Wi - share of these goods and services in the structure of industrial and private consumption (GNP or national income); n - number of the goods included in the basket. The larger the sample, the more representative the result of the exchange rate.
a Method of identifying and adjustments in accordance with the purchasing power parities of currencies is peculiar system of fixed exchange rates (the gold standard, Bretton woods system); currently used by countries of the European monetary system (courses in European currencies tied to each other and are adjusted on the basis of purchasing power parity). In the USSR before the start of reforms in the sphere of currency regulation of the dollar-to-ruble periodically determined by the method of purchasing power parity and then weekly adjusted depending on the fluctuations of the dollar to other currencies.
According to the calculations of experts in June 1994. the exchange rate of the dollar to the German mark at purchasing power parity was:
by consumer prices (consumer prices) 1.68
industrial prices (producer prices) 1.82
the cost of services (the services prices) 2.05
On average 1.82
In fact the rate of the dollar to the brand in June 1994, was at the level of 1.65, i.e. much lower than the value of PPP.
In the long term (several years), the real exchange rate tends to fluctuate around the value of purchasing power parity, but the parity continuously recalculated as changes in the level of prices in the two countries (for example, in 1990. the dollar rate to the German mark at purchasing power parity amounted to 2.13).
the Theory of purchasing power parity (PPP) makes an attempt to bring together the economic factors that explain formation of demand and supply of currencies and their dynamics.
One of the fundamental concepts underlying the theory of PPP - rule of one price: goods are the same - bought directly for foreign currency or after the conversion. In other words, for each article, the following applies:
Pi(t) = S(t) x P i(t)
t - index moment of time;
i - index of the goods;
S(t) is the current exchange rate;
Pi(t) - price of goods in national currency;
P i(t) - price of the goods in foreign currency.
In this setting, the rules of one price laid hypothesis of zero circulation costs, the absence of trade barriers (both tariff and non-tariff) and the uniformity of the goods. Rule of one price true only if all the goods are of equal weight in both countries. This implies a serious conclusion: if the structures of the economies are not the same, the PPP theory is wrong, even if the rule of one price is fair.
In the relativistic version of the PPP theory is taken not absolute price levels, and their indexes. Thereby, are not measured by purchasing purchasing abilities currencies, and their index:
P(t+T)/P(t) = [S(t+T)/S(t)]x[P`(t+T)/P`(t)]
Such a formulation of the theory of PPP rather than its absolute version. Nevertheless, it is not good enough because the glitches in cases where the production structure and the relative prices of goods in different economies are changing. However, for short periods of time the theory of PPP could give достаточноправдоподобные explanation of the trends of changes in exchange rates.
the Theory of PPP is also good that it allows to take into account the effects of inflation. Let f be an inflation rate in the national economy, and f` - the rate of inflation in the foreign economy. Then, by definition, inflation,
--------- = 1+f
P(t) P`(t+T)
---------- = 1+f`
Using the relativistic definition of PPP theory, we obtain:
S(t) = 1+f
1+f` S(t+T) - S(t)
S(t) = f - f`
The meaning of this expression is that the revaluation occurs when the national inflation stronger than foreign.
estimates of PPP is widely practiced for the development of national economic policy. Central banks rely on PPP estimates in determining the parity of their currencies. This is of particular importance for the management of the real exchange rate (R):
R(t+T) = --------------------------------------
[S(t+T)/S(t)] x [P`(t+T)/P`(t)]
If there is, R<1, then the real purchasing power of the national currency against foreign goods falls and export competitiveness is growing and Vice versa, R>1 means that the national currency depreciates faster than the differential between domestic and foreign inflation.

Gross National Product GNP
Gross national product is a key indicator of the state of national economy and includes as part of major economic indicators. Formula GNP is as follows: GNP = C + I + G + X - M,
where C is consumption (Consumption); I - investment (Investments); (G - public expenditure (Government Spendings); X - export; M - import.
Сгществует direct correlation between the change in GNP and the exchange rate:
Logic here can be the following: GNP growth means a General good condition of the economy, the increase of industrial production, the inflow of foreign investments in the economy, the growth of exports. The increase in foreign investment and exports increasing the demand for the national currency from foreigners, that is expressed in the growth rate. Ongoing for several years, the growth of GNP leads to "overheating" of the economy, a rise in inflation trends and, hence, to the expectation of higher interest rates as the main anti-inflationary measures), which also increases the demand for currency.

Real Interest Rates
This factor is extremely important, because determines the overall yield of investments in the economy of the country (the percentage of Bank deposits, the yield on investments in bonds, the average rate of profit and so on). A change in interest rates and the exchange rate is in direct relation to:
Speaking of rates, it is necessary to bear in mind the real interest rate, i.e. the nominal interest rate less the interest of inflation. If the nominal rates grow slower, than inflation growth and GNP, the currency may even decline. For example, in the USA in 1994. in conditions of stable growth of economy, increase of interest rates lagged behind the growth of the GNP and inflation real interest rates tended to decrease. The Federal reserve (the U.S. Central Bank) within a year repeatedly raised the interest level of the interest rate, however slightly, fearing a sharp actions hamper the process of recovery after the recession of the 1990). In the end, the rate of the dollar against major hard currencies decreased during 1994. (for example, USD/DEM fell 1.76 in January to 1.48 in October 1994).
by Conducting more in-depth analysis , it should be noted that in the formation of the exchange rate of two currencies, the main role plays the difference in interest rates between the two countries (interest rate differential). If in two countries approximately the same level of real interest rates, which characterizes the same yield of investments in the economy of any country, the increase in the Central Bank of one of the countries the level of the discount rate, causes a shift in the yield in favour of investments in this currency, which leads to increased demand for foreign currency and increase in its rate.

Unemployment Rate
the Factor of employment may be considered in terms of two values: either unemployment (i.e. the percentage of the number of unemployed to the total number of working age population), or as a reverse him indicator number of employees.
the unemployment rate is published usually in percent: unemployment rate = 8.6%; and there is an inverse correlation between changes in the unemployment rate and the exchange rate:
In accordance with the modern economic theory cannot be achieved zero unemployment rate (there is always a seasonal, structural and frictional unemployment). Therefore, the macroeconomic state of full employment for the industrialised countries corresponds to the level of unemployment, equal to about 6%.
Change in employment (in particular, in the United States) indicator characterizes the NFP - Non-Farm Payrolls, i.e. the number of employed in the nonagricultural sectors of the economy. The growth rate NFP describes the growth of employment and leads to us dollar rate growth.

the Level of inflation or devaluation of national currency, measured in the growth rate of prices. There are two indicator of price changes:
PPI (Producer Price index) changes in the production prices (wholesale shipments of manufactured goods). This indicator, which is calculated in percentage to the previous period, which is the first sign of inflation, since the production rates are included in consumer prices;
CPI (Consumer Price Index) - consumer price index - direct indicator of the level of inflation.
the Level of inflation and changes in the exchange rate are inversely:
One of the indicators, affecting the inflation is the amount of money in the money supply consisting of several monetary aggregates, differing by the degree of liquidity from the M1 (in the UK M0) to the M4. The largest inflationary influence has the growth of aggregate M1 - cash balances on current accounts balances.
Inflation has a strong impact on employment. In 1958 the British economist A. Phillips suggested graphical model of inflation of demand, expressing such impact. Using data English statistics for 1861, he built a curve clearly shows the inverse relationship between changes in wage rates and unemployment. Curve A. Phillips found that the increase in unemployment in England in excess of 2.5-3% led to a sharp deceleration in the growth of prices and wages. Phillips made a conclusion that the government may increase inflation to combat unemployment. Later this conclusion theoretically argued economist R. Lipsi.
Phillips Curve shows the inverse relationship between inflation and the norm of unemployment. The higher the inflation rate, the lower the unemployment rate. It also created the modification of the Phillips curve for the development of economic policy. This work has been done by American economists R. Solow and P. Samuelson. They replaced the curve of the wage rate on the growth rate of commodity prices, or inflation. Using this curve was possible to count the balance between the rather high levels of employment and production and certain stability of prices. If the government considers the level of unemployment in the country is extremely high, to decrease are the fiscal and monetary measures to stimulate demand. This leads to the expansion of production and creation of new jobs. Norm of unemployment is reduced, but at the same time, the rate of inflation increases. Such manipulation can cause overheating of the economy and as a consequence of the crisis.

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