The Fundamental Analysis of Foreign Exchange

The Fundamental Analysis of Foreign Exchange



The price of the foreign exchange is a kind of state of equilibrium that reflects the currency supplies and demands. The two main factors that influence the demand and supply are the interest rate and economical performance. In each economic indicator, like the gross national product, foreign capital inflow or perhaps the international trade representative are the national economical performance, also decides the national currency supplies and demand. Each day there are different kinds of economic indicator announcement, Forex traders must have the ability to judge which is more important, but within these numerous data, the interest rate and the international trade are the most worth taking.

The fundamental analysis involves finance, economic theory and political situation development, thus it is a factor which judges the demand and supply. The most obvious difference between the fundamental analysis and the technical analysis, the fundamental analysis studies the reasons behind the market movement, but the technical analysis studies the effect of the market movement.

When estimating a country currency by using another country currency, basic surface analysis includes the macroscopic economic indicator, property market as well as political factor research. The macroscopic economic indicator includes the numeral and economic growth rate, by essential factor computation and so on GDP, interest rate, inflation rate, unemployment rate, money supply, foreign exchange reserve as well as productivity. Property market includes stock, bond and real estate. The political factor can affect a country government's confidence level, the social stability climate and confidence.


Elementary theory

Interest rate

If the trend of the market rate is unclear, then any news which is related to the interest rate could influence the trend of the exchange rate. Generally, if a country raised its interest rate, this country's currency could relatively become strong, because the investors would transfer their properties into these countries in order to expect for a higher return rate in the future. But, if the interest rate is too high, it is bad news for the stock market, the investor would transfer their fund out of the country's stock market which will cause the currency price to drop. It is knowledge to judge strength is much stronger, this is decided according to the overall economic environment before the change of the interest rate. The most important economic indicators that could influence the interest rate are the consumer price index, the buyer price index and the gross national product, these indicators could the reference for various countries' central bank (BOE, FED, ECB, BOJ) before deciding the interest rate.


International trade

According to a country's trading balance, Forex traders could refer the difference between the import and export of a country, when a country's import is bigger than the exportation, there will be a trade deficit, and this usually is not good news. Take US as the example, in order to pay import debts, the government must sell its currency in order to buy another's currency to pay the debts, because the outflow of the currency could cause the U.S dollar to depreciate. If, balance show that the export ratio increases, US dollar can flow back to its homeland cause the U.S dollar to become strong. According to economical point of view, trade deficit may not be all negative but if the trade deficit is bigger than the market expectation, it could create a reverse side effect.


Purchasing (PPP)

This purchasing theory stipulated that, the exchange rate is decided by the identical group commodity relative price. For example, let's use hamburger as a classical case, if a hamburger in U.S is worth 2.00 U.S dollar each, but in Britain the value is 1.00 British pounds, according to the purchasing theory, the exchange rate certainly is 2 US dollar equals to1 British pound. If is in vogue the market exchange rate is 1.7 US dollars to each British pound, then the British pound has depreciated, but US dollar is has appreciated. This theory supposition these two currencies finally to 2:1 relational change.

The purchasing theory main drawback lies in its assumption that the commodity can be traded freely, and does not count transaction cost and customs duty, quota and payment of taxes. Another drawback is it only suitable for the commodity, actually it has neglected the service, but service has the extremely remarkable value disparity space. Moreover, besides the difference between the inflation rate and the interest rate difference, but there are also certain factors that could affect the exchange rate, for instance: Economical digital issue/report, property market as well as political situation development. Before 1990s, the purchasing theory is lack of fact to support its effectiveness. After 1990's, this theory is only suitable for long period (3 - 5 years). In during the span cycle, the price finally closes up to the fair price.


Interest rate fair price (IRP)

The interest rate fair price stipulated that, if the American interest rate is higher than the Japanese interest rate, then US dollar to a Japanese Yen depreciation, the depreciation scope decides according to the prevented the non- risk fraudulently obtained foreign exchange. In the future the exchange rate could reflect in the forward exchange rate as stipulated. In our example, the Japanese Yen which is bought by the forward exchange rate is much shorter then the Japanese Yen which is bought by the immediate exchange rate the Japanese Yen. The Japanese Yen is regarded as the premium. After 1990s, without any evidence indicated that the interest fair price theory is still ineffective. Is clearly opposite with this theory, currency usually does not depreciate based on high interest rate, instead it will prevent the inflation to rise in the future and it will appreciate as a highly benefited currency.


International payment balance pattern

This theory said that the foreign exchange rate must be in its balance level - - namely it is able to have the stable checking account remaining sum exchange rate. Country which has trade deficit, its foreign exchange reserve will be reducing, and finally it will cause its domestic currency value to reduce (depreciation). Cheap currency causes this country’s commodity to have the price superiority in the international market, simultaneously also causes the import product to become expensively. After a period of adjustment, the import quantity is compelled to drop, exportation quantity rise, thus causes the trade remaining sum and the currency is stable to the state of equilibrium.

It is same with the purchasing theory, the international payment balance pattern mainly stresses on the trade commodity and the service, but has neglected the whole world circulation of capital day by day vital function. In overall, the money not only pursues the commodity and the service, moreover from generally says, pursues financial property and so on the stock and bond. This kind of capital class enters the international payment balance capital account project, thus may balance in the checking account deficit. The circulation of capital increase has the property market pattern.


Intervention

In addition, sometimes, the government can intervene in the money market, it prevents the currency from a non-ideal level. The money market intervention is carried out by the Central Bank, usually it has short-term influence to the foreign exchange market. The Central Bank may adopt another way of buying and selling the domestic country currency, or unites other Central Bank to carry the intervention together, it obtains a more remarkable effect. Or, some countries can try to influence the currency value by giving warning or threat.