Fundamental Analysis is based on the analysis of the main economic indicators. Just like in any market, the rates of a currency reflect the balance between supply and demand, interest rates and the strength of the economy represent the two most important factors for the analysis of a currency.
The most observed indicators in order to determine the direction of supply and demand are Gross Domestic Product, Foreign Investments and Balance of Trade. These factors are decisive in reflecting the balance between supply and demand. The data are published at regular intervals. Generally, fundamental analysts concentrate most of their attention on foreign trade and interest rates data.
How does a change in the interest rate affect the value of a currency?
If there is uncertainty in the market on the modifications of the interest rate, then the forex market may be affected. The effect of a rise in the interest rate of a country will be reflected on the strengthening of that country’s currency. However, the interest rate increase is generally unfavorable news for the stock market, as some investors will withdraw their stock investments in the country as the increase in the interest rate creates a higher indebtedness cost and companies shall then have an adverse effect on their balance sheet with devaluated shares, thus weakening the country’s currency.
The effect of an increase in the interest rate may be misleading; however, in general there is some consensus on how the increase in the interest rate will affect the value of the currency. The modification of the interest rate is usually influenced by the Consumer Price Index, the Wholesale Price Index and the Gross Domestic Product. Changes in the interest rate are disclosed after the regular meetings held by the main Central Banks worldwide (Bank of England, US Federal Reserve Bank, European Central Bank, Bank of Japan) and other Central Banks, especially the Central Banks of the G8.
Generally, interest rate changes are anticipated on the basis of the results of the main indexes and the GDP.
How does international trade affect the value of a currency?
The balance of trade reflects the balance between a country’s exports and imports. Generally, the period of time analyzed is quarterly or annual. For example, if a country imports more than it exports, the result of its balance of trade shall be negative, i.e. there shall be a deficit which will cause a reduction of its currency reserves, thus diminishing their value. If we take into account this example and we invert it, the balance of trade shall result in a surplus which will then strengthen the currency of a country.
For deficit to cause an adverse effect on the value of a currency, it must exceed market expectations.
For example, if a country has a deficit on its balance of trade, it means that it buys more products than it sells and the products it purchases are effectively paid in foreign currencies; therefore, this country will be selling its currency which would then lead to a depreciation of the same.
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