The main objective of fundamental analysis is to make financial forecasts such as a possible rise in one currency relative to another. By understanding the economic situation and macroeconomic events, theories can be developed to anticipate certain trends.
Macroeconomics analysis looks at the underlying forces responsible for market developments. This in-depth study serves as a tool primarily for long-term investors, but can also be used by traders who prefer to trade assets on a short-term basis. It is a combination of fundamental and technical analysis that enables trading professionals to develop sophisticated strategies and achieve successful results (Turnovsky, 1977).
When using macroeconomic analysis, it is important to define objectives. Given the vastness and complexity of international markets, it is easy to be confused by extraneous factors and inadvertently omit key details. In trading, fundamental analysis always begins with the choice of a single currency pair. It is by focusing your attention on these two currencies alone that you will be able to highlight certain factors that will enable you to establish a winning trading strategy.
The key macroeconomic indicators that influence the global market
Gross Domestic Product is published monthly and quarterly. Its role is to measure the value of all goods and services produced in the country and thus assess the strength of the economy. Central Bank managers use the published reports to update their monetary economic policy. Comparison of rates from one quarter to the next or from one year to the next is very revealing of a country’s economic growth and thus the relative value of its currency. For example, in the United States, GDP in the first quarter is usually the weakest, while growth resumes in the second and finally strengthens in the last quarter of the year (Sutton, et al., 2007).
Measured on a monthly or quarterly basis through the Consumer Price Index (CPI), inflation reflects the increase or decrease in the value of a basket of the most consumed goods and services: food, clothing, transportation, fuel. In general, rising inflation is a sign of a healthy economy. However, too sudden a surge in inflation can cause central banks to raise interest rates to contain this type of excess. There are other factors that can affect inflation, such as currency appreciation or depreciation, oil and commodity prices, or import taxes. Most central banks make every effort to fulfill their mandate and to achieve an inflation target of 2% to ensure price stability. Consequently, an increase in inflation is often seen as a sign that rates will rise, while deflation usually causes rates to fall (Fakhri, 2011).
A labor market report based on a household or business survey is published once a month. It highlights the general state of the labor market: the number of people active in the market, the unemployment rate, and the wage scale. Wage growth in the labor market is an important indicator that subsequently influences the inflation rate (Phelps, 1970).
One of the main objectives of central banks is to achieve full employment. In order to achieve this, a combination of a large number of economic factors is necessary. One of the easiest tools available to banks is the setting of interest rates for large financial institutions, banks in particular. On a macroeconomic scale, even the smallest change can have a significant impact on the country’s economy as a whole, either by attracting foreign investment or by affecting the trade balance (Aggarwal & Schirm, 1992).
Economic indicators not only report past data but also provide a basis for monitoring economic developments and anticipating future trends.
The Purchasing Managers’ Index (PMI)
This is the result of a monthly survey of selected companies in the manufacturing, service, and construction sectors. The PMI is an index above 50 points, an expansion below 50 marks a contraction and vice versa. The Purchasing Managers’ Index provides a snapshot of the overall outlook for a country’s industrial sector. Among the most eagerly awaited reports are the Institute of Supply Management (ISM) for the United States and the Markit PMI for the United Kingdom and the Eurozone (Koenig, 2002).
Retail sales data is used as a measure of household sales and consumption over a certain period of time. In an expanding economy, consumers tend to spend more and thus show greater demand for goods (which increases GDP, which in turn influences the labor market and inflation).
This report assesses the performance of the industrial sector and also considers manufacturing production. Industrial production does not contribute much to the economy’s GDP but is used by analysts to assess the state of the industrial and construction sector, particularly with respect to employment and inflation.
Aggarwal, R. & Schirm, D. C., 1992. Balance of trade announcements and asset prices: influence on equity prices, exchange rates, and interest rates. Journal of International Money and Finance, 11(1), pp. 80-95.
Fakhri, H., 2011. Relationship between inflation and economic growth in Azerbaijani economy: is there any threshold effect?. Asian Journal of Business and Management Sciences, 1(1), pp. 1-11.
Koenig, E. F., 2002. Using the purchasing managers’ index to assess the economy’s strength and the likely direction of monetary policy. Federal Reserve Bank of Dallas Economic and Financial Policy Review, 6(1), pp. 1-14.
Phelps, E. S. A. A. A. a. C. C. H., 1970. Microeconomic foundations of employment and inflation theory. New York: WW Norton.
Sutton, P. C., Elvidge, C. D. & Ghosh, T., 2007. Estimation of gross domestic product at sub-national scales using nighttime satellite imagery. International Journal of Ecological Economics & Statistics, 8(S07), pp. 5-21.
Turnovsky, S. J., 1977. Macroeconomic analysis and stabilization policy. CUP Archive.