go to basic 1 (2. fundamental)

8/10/2019 Go to Basic 1 (2. Fundamental)

1/32

Topics covered in this chapter:

The major theories in fundamental analysis , their detailed capabilities and limitations. Different methods to make sure you trade sufficiently often during your windows of

opportunity to make trading worthwhile. Different forms of short-term fundamental analysis using the most important indicators in the

U economy. The main characteristics of interest rates : time value, opportunity

cost, inflation and deflation e!pectations, and risk . "ow to assess the random walk theory and the market efficiency hypothesis in order to

understand the value of behavioral finance today, one of the basis of contrarian investing. entiment indicators, with which to measure traders positions and more importantly, their

e!pectations and intentions for the future.

#n a free market , all price movement comes down to a supply and demand e$uation. %s mentionedin Unit %, the same principle is valid for currencies: more demand indicates scarcity and leads to

higher prices, while weaker demand means lower prices. %t the same time, more supply and

abundance leads to lower prices and less supply makes prices increase.

#n this conte!t, it is usually said that fundamentals are what drives prices up and down defining

supply and demand .&undamentals are e!cellent for developing an overall picture of the markets,

sure, but still it's just a complementary perspective, and by no means the only one.

(onventional wisdom tells us that a wide gulf separates the theories forwarded by academic

economists and the day-to-day of those who trade the markets. )hen approaching fundamental

analysis from a practical perspective, as we shall do in this chapter, the wide gulf emerges as an

unbridgeable gap .

#f the principle mentioned at the start is true, then why do we periodically witness an increase

in demand while prices escalate higher* %ccording to the theory, it should be the other way round. #n

this chapter we e!amine whether or not traders can work around this apparent contradiction.

Many researchers agree that the disjunction actually exists: exchange rates

exhibit volatility and persistent misalignments which seem largely unconnected to

macroeconomic fundamentals . In this sense, we will examine how this comes to be and

display a series of guidelines to make fundamental analysis operational for traders. %s a starting point, a basic understanding of the different models used in fundamental analysis will

be conveyed. Then, we will guide you through e!planations on how to use this type of analysis to get

a long-term view of where prices are heading, as well as some hints on how to use it for near term

forecasting. %nd finally, a totally different perspective on fundamentals will be disclosed.
http://www.fxstreet.com/education/glossary/fundamental-analysishttp://www.fxstreet.com/education/glossary/fundamental-analysishttp://www.fxstreet.com/education/glossary/fundamental-analysishttp://www.fxstreet.com/education/glossary/fundamental-analysishttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/deflationhttp://www.fxstreet.com/education/glossary/riskhttp://www.fxstreet.com/education/glossary/riskhttp://www.fxstreet.com/education/glossary/random-walk-theoryhttp://www.fxstreet.com/education/glossary/random-walk-theoryhttp://www.fxstreet.com/education/glossary/contrarianhttp://www.fxstreet.com/education/glossary/contrarianhttp://www.fxstreet.com/education/glossary/positionhttp://www.fxstreet.com/education/glossary/positionhttp://www.fxstreet.com/education/learning-center/unit-1/http://www.fxstreet.com/education/glossary/demandhttp://www.fxstreet.com/education/glossary/demandhttp://www.fxstreet.com/education/glossary/demandhttp://www.fxstreet.com/education/glossary/demandhttp://www.fxstreet.com/education/glossary/supplyhttp://www.fxstreet.com/education/glossary/supplyhttp://www.fxstreet.com/education/glossary/supplyhttp://www.fxstreet.com/education/glossary/fundamentalshttp://www.fxstreet.com/education/glossary/fundamentalshttp://www.fxstreet.com/education/glossary/fundamentalshttp://www.fxstreet.com/education/glossary/fundamentalshttp://www.fxstreet.com/education/glossary/fundamental-analysishttp://www.fxstreet.com/education/glossary/fundamental-analysishttp://www.fxstreet.com/education/glossary/gaphttp://www.fxstreet.com/education/glossary/gaphttp://www.fxstreet.com/education/glossary/demandhttp://www.fxstreet.com/education/glossary/volatilityhttp://www.fxstreet.com/education/glossary/volatilityhttp://www.fxstreet.com/education/glossary/fundamentalshttp://www.fxstreet.com/education/glossary/fundamentalshttp://www.fxstreet.com/education/glossary/fundamental-analysishttp://www.fxstreet.com/education/glossary/fundamental-analysishttp://www.fxstreet.com/education/glossary/fundamental-analysishttp://www.fxstreet.com/education/glossary/fundamental-analysishttp://www.fxstreet.com/education/glossary/fundamentalshttp://www.fxstreet.com/education/glossary/fundamentalshttp://www.fxstreet.com/education/glossary/fundamental-analysishttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/deflationhttp://www.fxstreet.com/education/glossary/riskhttp://www.fxstreet.com/education/glossary/random-walk-theoryhttp://www.fxstreet.com/education/glossary/contrarianhttp://www.fxstreet.com/education/glossary/positionhttp://www.fxstreet.com/education/learning-center/unit-1/http://www.fxstreet.com/education/glossary/demandhttp://www.fxstreet.com/education/glossary/demandhttp://www.fxstreet.com/education/glossary/supplyhttp://www.fxstreet.com/education/glossary/supplyhttp://www.fxstreet.com/education/glossary/fundamentalshttp://www.fxstreet.com/education/glossary/fundamentalshttp://www.fxstreet.com/education/glossary/fundamental-analysishttp://www.fxstreet.com/education/glossary/fundamental-analysishttp://www.fxstreet.com/education/glossary/gaphttp://www.fxstreet.com/education/glossary/demandhttp://www.fxstreet.com/education/glossary/volatilityhttp://www.fxstreet.com/education/glossary/fundamentalshttp://www.fxstreet.com/education/glossary/fundamental-analysishttp://www.fxstreet.com/education/glossary/fundamental-analysishttp://www.fxstreet.com/education/glossary/fundamentalshttp://www.fxstreet.com/education/glossary/fundamental-analysis


2/32

)e deliver the know-how and you only have to decide if the resources provided are useful or not for

you. Do we have a deal* +reat, let's proceed

1. asic !heories "f #undamental $nalysis

ne of the dominant debates among financial analysts is the relative validity of the two primary

approaches of analy ing markets: fundamental and technical analysis. There are several points of

distinction between fundamentals and technicals but it's true that both study the causes of market

movements and both attempt to predict price action and market trends . &undamentals , our main

subject in this chapter, focus on financial and economic theories, as well as political developments to

determine forces of supply and demand.

#n general, the e!change rate of a currency versus other currencies is a reflection of the condition of

that country's economy, compared to the other countries' economies. This assumption is based on

the belief that the e!change is determined by the underlying health of the two nations involved in thepair.

)hen evaluating one nation's currency relative to another, fundamental analysis relies upon a broad

understanding of multi-national macroeconomic statistics and events. Usually it e!amines core

underlying elements that influence the economy of a particular currency. These might include, on the

one hand, economic indicators such as interest rates ,inflation , unemployment, money supply and

growth rates. n the other hand, it also e!amines socio-political conditions which could impact on

the level of confidence in a nation's government and affect the climate of stability.

everal e!perts agree on the fact that fundamental analysis is more effective in predicting trends for

the long-term /one year or more0, while technical analysis is more appropriate for shorter time scales

and intraday trading. 1onetheless, empirical evidence from the previous chapter reveals that

technical analysis is also capable of identifying long-term trends . 2oreover, in this chapter we will

prove that fundamental factors do trigger short-term developments on which you can capitali e.

ur aim is to leave you with an understanding of both types of analysis even if you prefer one or the

other as your primary tool to make your trading decisions.

ur &undamental 2arket 3iew section is constantly updated and an ideal place to get an overview of

the macro-economical arena.

&undamental analysts use different models to e!amine currency values and forecast future

movements. "erewith we describe the major models for forecasting currency prices, their principles

and limitations.

%urchasing %ower %arity
http://www.fxstreet.com/education/glossary/fundamentalshttp://www.fxstreet.com/education/glossary/trendhttp://www.fxstreet.com/education/glossary/trendhttp://www.fxstreet.com/education/glossary/fundamentalshttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/fundamental-analysishttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/money-supplyhttp://www.fxstreet.com/education/glossary/fundamental-analysishttp://www.fxstreet.com/education/glossary/trendhttp://www.fxstreet.com/education/glossary/trendhttp://www.fxstreet.com/education/glossary/intradayhttp://www.fxstreet.com/education/glossary/intradayhttp://www.fxstreet.com/education/glossary/trendhttp://www.fxstreet.com/education/glossary/triggerhttp://www.fxstreet.com/education/glossary/triggerhttp://www.fxstreet.com/education/glossary/triggerhttp://www.fxstreet.com/fundamental/market-view/http://www.fxstreet.com/fundamental/market-view/http://www.fxstreet.com/fundamental/market-view/http://www.fxstreet.com/education/glossary/fundamentalshttp://www.fxstreet.com/education/glossary/trendhttp://www.fxstreet.com/education/glossary/fundamentalshttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/fundamental-analysishttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/money-supplyhttp://www.fxstreet.com/education/glossary/fundamental-analysishttp://www.fxstreet.com/education/glossary/trendhttp://www.fxstreet.com/education/glossary/intradayhttp://www.fxstreet.com/education/glossary/trendhttp://www.fxstreet.com/education/glossary/triggerhttp://www.fxstreet.com/fundamental/market-view/


3/32

The purchasing power parity model is based on the theory that exchange rates between

currencies are in e&uilibrium when their purchasing power is the same in each of the two

countries . %n increase in a country's domestic price level means a change in its inflation rate. )hen

this happens, the inflation rate is e!pected to be offset by an e$uivalent but opposite change in

the e!change rate . %ccording to the purchasing power parity model, if the value of a hamburger, for

instance, is 4U D in the U and 5+67 in the U8, then the +679U D e!change rate must be 4U D

per 5+67 /+679U D 4. 0.

)hat if the actual interbank e!change rate displays +679U D 5.; * #n this case the 7ound

terling would be considered undervalued and the U Dollar overvalued.

Therefore, according to this model the two currencies should move towards the 4:5 ratio which is the

price difference that same goods in both countries have. This also means that when a

country's inflation is rising, the e!change rate f or its currency should depreciate in relation to other

currencies, in order to return to parity.

)hen reading about the purchasing power parity , you'll notice many authors compare prices of

hamburgers. There is a reason why hamburgers are a popular e!ample: the weekly news and

international affairs publication publishes the 6ig 2ac #nde! which is an informal

way to measure the purchasing power of two countries comparing the price of a 6ig 2ac hamburger

sold by 2cDonald's.

% more formal measurement is published by the rgani ation for =conomic (ooperation and

Development / (D=0 using a basket of consumer goods and provides information as to whether the

different currencies are under- or over valued against the U D.

?ou can use the below links to compare both indicators:
http://www.fxstreet.com/education/glossary/purchasing-power-parityhttp://www.fxstreet.com/education/glossary/equilibriumhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/offsethttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/purchasing-power-parityhttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/purchasing-power-parityhttp://www.fxstreet.com/education/glossary/purchasing-power-parityhttp://www.fxstreet.com/education/glossary/equilibriumhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/offsethttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/purchasing-power-parityhttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/purchasing-power-parity


4/32

6ig 2ac #nde!

=(D 777 #nde! /click on < =(D statistics on 7urchasing 7ower 7arities /7770>0

#n the absence of transportation and other transaction costs such as tariffs or ta!es, competitive

markets should theoretically e$uali e the price of an identical good in two countries /with pricese!pressed in the same currency0. 6ut in reality such costs e!ist and influence the cost of goods and

services, and therefore should be considered when weighing prices. Unfortunately the purchasing

power parity model does not reflect those costs when determining the e!change rates, being this its

major weakness. %nother weakness is the fact that the model only applies for goods and ignores

services. &urthermore, other factors such as inflation and interest rate differentials impacting

e!change rates, are not taken into account in this model.

'oes the purchasing power parity model serves to determine exchange rates in the short(

term)

1o. This model is a measure to anticipate the long run behavior of e!change rates but not

to trigger trades in the short-term. The idea behind this model is that economic forces will eventually

e$uali e the purchasing power of currencies in different countries, a phenomenon which typically

takes several years as the empirical evidence of the model shows.

Interest *ate %arity

The interest rate parity model is based on the concept that when a currency

experiments appreciation or depreciation against another currency, this imbalance must be

brought to e&uilibrium by a change in the interest rate differential.

The parity is needed to avoid an arbitrage condition with a risk -free return. Theoretically, it works

like this: you borrow money in one currency, then e!change that currency for another currency in

order to invest in interest-bearing instruments. %t the same time you purchase futures contracts to

convert the currency back at the end of the holding period . The amount should be e$ual to the
http://www.economist.com/markets/Bigmac/Index.cfmhttp://www.oecd.org/department/0,3355,en_2649_34357_1_1_1_1_1,00.htmlhttp://www.fxstreet.com/education/glossary/transaction-costshttp://www.fxstreet.com/education/glossary/purchasing-power-parityhttp://www.fxstreet.com/education/glossary/purchasing-power-parityhttp://www.fxstreet.com/education/glossary/purchasing-power-parityhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/purchasing-power-parityhttp://www.fxstreet.com/education/glossary/purchasing-power-parityhttp://www.fxstreet.com/education/glossary/triggerhttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/appreciationhttp://www.fxstreet.com/education/glossary/appreciationhttp://www.fxstreet.com/education/glossary/depreciationhttp://www.fxstreet.com/education/glossary/equilibriumhttp://www.fxstreet.com/education/glossary/equilibriumhttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/riskhttp://www.fxstreet.com/education/glossary/riskhttp://www.fxstreet.com/education/glossary/futures-contracthttp://www.fxstreet.com/education/glossary/periodhttp://www.economist.com/markets/Bigmac/Index.cfmhttp://www.oecd.org/department/0,3355,en_2649_34357_1_1_1_1_1,00.htmlhttp://www.fxstreet.com/education/glossary/transaction-costshttp://www.fxstreet.com/education/glossary/purchasing-power-parityhttp://www.fxstreet.com/education/glossary/purchasing-power-parityhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/purchasing-power-parityhttp://www.fxstreet.com/education/glossary/triggerhttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/appreciationhttp://www.fxstreet.com/education/glossary/depreciationhttp://www.fxstreet.com/education/glossary/equilibriumhttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/riskhttp://www.fxstreet.com/education/glossary/futures-contracthttp://www.fxstreet.com/education/glossary/period


5/32

returns from purchasing and holding similar interest-bearing instruments of the first currency.

%n arbitrage would occur if the returns for both transactions were different, thus producing a risk -free

return.

@et's see with an e!ample: supposing the U D has a ;A annual interest rate and the %UD BA,

the e!change rate is %UD9U D .C , and the forward e!change rate implied by a contract

maturing in 54 months is %UD9U D .C . #t is obvious that %ustralia has a higher interest rate than

the U . The arbitrage consists in borrowing in the country with a lower interest rate and invest in the

country with a higher interest rate . %ll else being e$ual, this would help you make money without

any risk . % Dollar invested in the U at the end of the 54-month period will be:

5 U D /5 E ;A0 F 5. ; U D

and a Dollar invested in %ustralia /after conversion into %UD and back into U D at the end of the 54-

month period will be:

5 U D / .C9 .C0/5 E BA0 F 5. B U D

The arbitrage would work as follows:

1. 6orrow 5 U D from the U bank at ;A interest rate .

+. (onvert U D into %UD at current spot rate of .C %UD9U D giving 5.G4B; %UD.

. #nvest the 5.G4B; %UD in %ustralia for the 54 month period .

-. 7urchase a forward contract on the .C %UD9U D /that

is, covering your position against e!change rate fluctuations0.

%nd at the end of the 54-month period :

1. 5.G4B; %UD becomes 5.G4B; %UD /5 E BA0 F 5.;G4C %UD

+. (onvert the 5.;G4C %UD back to U D at .C %UD9U D, giving 5. CHB U D

. 7ay off the initially borrowed amount of 5 U D to the U bank with ;A interest, that is, 5. ; U D

The resulting arbitrage profit is 5. CHB U D I 5. ; U D F . 4HB U D, which is almost J cents of

profit per each U D.

The basic idea behind the arbitrage pricing theory is the law of one price, which states that 4

identical items will be sold for the same price and for if they do not, then a riskless profit could be

made by arbitrage : buying the item in the cheaper market then selling it in the more e!pensive

market.

6ut contrary to the theory, arbitrage opportunities of this magnitude vanish very $uickly because

a combination of some of the following events occurs and reestablishes the parity: the U interest

rates can go up, the forward e!change rates can go down, the spot e!change rates can go up or the

%ustralian interest rates can go down.

%s we have seen in recent years during the (arry Trade , currencies with higher interest rates have
http://www.fxstreet.com/education/glossary/arbitragehttp://www.fxstreet.com/education/glossary/arbitragehttp://www.fxstreet.com/education/glossary/riskhttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/arbitragehttp://www.fxstreet.com/education/glossary/arbitragehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/riskhttp://www.fxstreet.com/education/glossary/riskhttp://www.fxstreet.com/education/glossary/periodhttp://www.fxstreet.com/education/glossary/periodhttp://www.fxstreet.com/education/glossary/periodhttp://www.fxstreet.com/education/glossary/periodhttp://www.fxstreet.com/education/glossary/arbitragehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/spot-ratehttp://www.fxstreet.com/education/glossary/periodhttp://www.fxstreet.com/education/glossary/periodhttp://www.fxstreet.com/education/glossary/forward-contracthttp://www.fxstreet.com/education/glossary/coverhttp://www.fxstreet.com/education/glossary/coverhttp://www.fxstreet.com/education/glossary/positionhttp://www.fxstreet.com/education/glossary/positionhttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/periodhttp://www.fxstreet.com/education/glossary/arbitragehttp://www.fxstreet.com/education/glossary/arbitragehttp://www.fxstreet.com/education/glossary/arbitragehttp://www.fxstreet.com/education/glossary/arbitragehttp://www.fxstreet.com/education/glossary/arbitragehttp://www.fxstreet.com/education/glossary/arbitragehttp://www.fxstreet.com/education/glossary/combinationhttp://www.fxstreet.com/education/glossary/combinationhttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/carry-tradehttp://www.fxstreet.com/education/glossary/carry-tradehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/arbitragehttp://www.fxstreet.com/education/glossary/riskhttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/arbitragehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/riskhttp://www.fxstreet.com/education/glossary/periodhttp://www.fxstreet.com/education/glossary/periodhttp://www.fxstreet.com/education/glossary/arbitragehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/spot-ratehttp://www.fxstreet.com/education/glossary/periodhttp://www.fxstreet.com/education/glossary/forward-contracthttp://www.fxstreet.com/education/glossary/coverhttp://www.fxstreet.com/education/glossary/positionhttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/periodhttp://www.fxstreet.com/education/glossary/arbitragehttp://www.fxstreet.com/education/glossary/arbitragehttp://www.fxstreet.com/education/glossary/arbitragehttp://www.fxstreet.com/education/glossary/arbitragehttp://www.fxstreet.com/education/glossary/combinationhttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/carry-tradehttp://www.fxstreet.com/education/glossary/interest-rate


6/32

characteristically appreciated rather than depreciated on the reward of future containment

of inflation and of a higher yielding currency. This is the reason why this model alone is not useful

either.International alance of %ayments Model

Until the H 's the balance of payments theory focused primarily on the balance of trade, a sub

account of the current account. This was due to the fact that capital flows were not as significant as

nowadays and the trade balance made up the major part of the balance of payments for most world

economies.

Under this model, a nation with a trade deficit will e!perience a reduction of its foreign

e!change reserves it used to pay for the imported goods, as we have seen when we e!plained the

trade balance in the video of (hapter % 4 . % country has to change its own currency for the

e!porters currency to pay for the goods - this makes its own currency depreciate.

#n turn a cheaper currency makes the nation's e!ported goods and services less e!pensive in theglobal market place while making imports more e!pensive. The simplified balance of payments

model states that after an intermediate period , imports are forced down and exports rise, thus

stabili ing the trade balance and the currency towards e&uilibrium .

6ased on this model, many analysts forecast that the U D would fall in value against other major

currencies, specially the =uro, due to the e!panding U trade deficit. 6ut in reality,

international capital flows in the last decade have been characteri ed by global investors ac$uiring

billions of assets in the U , yielding a net capital account surplus . This surplus , despite of statistical

discrepancies and currency fluctuations, balanced the current account deficit.

ince the balance of payments is not only made up of the trade balance - it is largely made up of the

current account balance - this model failed to accurately forecast e!change rate moves. The balance

of payments model focuses largely on trade, while ignoring the increasing role of

international capital flows such as foreign direct investment, bank loans and, more

importantly, portfolio investments. These capital flows go into the capital account item of the balance

of payments, and in some occasions a positive capital flow balances a deficit in the current account.

The e!plosion of capital flows and the trading of financial assets have given rise to the asset market

model. The new reality has reshaped the way analysts and traders look at currencies as flows of

funds into financial assets increase the demand for the currency they are denominated in.(onversely, a flow out of a countries' financial assets, such as e$uities and bonds , produces a

decrease in the demand for its currency.$sset Market Model

This model is similar to the balance of payments model, but instead of taking into account the

balance of payments it focuses primarily on the current account . #n order to understand both

models, let's lay out some basic definitions:
http://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/reserve-currencyhttp://www.fxstreet.com/education/glossary/reserve-currencyhttp://www.fxstreet.com/education/learning-center/unit-1/chapter-2/global-trade-and-the-currency-market/http://www.fxstreet.com/education/learning-center/unit-1/chapter-2/global-trade-and-the-currency-market/http://www.fxstreet.com/education/glossary/periodhttp://www.fxstreet.com/education/glossary/periodhttp://www.fxstreet.com/education/glossary/equilibriumhttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/surplushttp://www.fxstreet.com/education/glossary/surplushttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/portfoliohttp://www.fxstreet.com/education/glossary/portfoliohttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/demandhttp://www.fxstreet.com/education/glossary/demandhttp://www.fxstreet.com/education/glossary/equitieshttp://www.fxstreet.com/education/glossary/bondhttp://www.fxstreet.com/education/glossary/bondhttp://www.fxstreet.com/education/glossary/demandhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/reserve-currencyhttp://www.fxstreet.com/education/learning-center/unit-1/chapter-2/global-trade-and-the-currency-market/http://www.fxstreet.com/education/glossary/periodhttp://www.fxstreet.com/education/glossary/equilibriumhttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/surplushttp://www.fxstreet.com/education/glossary/surplushttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/portfoliohttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/demandhttp://www.fxstreet.com/education/glossary/equitieshttp://www.fxstreet.com/education/glossary/bondhttp://www.fxstreet.com/education/glossary/demand


7/32

The international balance of payments accounts for all the international economic transactions

between individuals, businesses and government agencies in the domestic economy with the rest of

the world. =very international transaction involving different currencies results in a credit and a debit

in the balance of payments.

/redits are transactions that increase the amount of money to domestic residents from foreigners,

and debits are transactions that increase the money paid to foreigners. &or instance, if a company

in 6ra il buys panish machinery, the purchase is a debit to the 6ra ilian account and a credit to the

panish account.

The balance of payments account is divided in two main accounts: the current account and

the capital account. The current account consists of international trade in goods and services and

earnings on investments. #n other words, it is the sum of the balance of trade /e!ports minus imports

of goods and services0, net income receipts /such as interest and dividends derived from the

ownership of assets0 and net unilateral transfer payments /such as direct foreign aid, workerremittances from abroad, etc.0.

The capital account consists of capital transfers /including debt forgiveness and migrant's transfers,

among others0 and the ac$uisition and disposal of non-produced and non-financial assets

/representing the sales and purchases of non-produced assets such as franchises, copyrights, etc.0.

% subdivision of the capital account, the financial account , records transfers which involve

financial capital . #t is the net result of public and private international investment flowing in and out of

a country. This includes foreign-owned investment in the domestic economy /government and

corporate securities, direct investment, domestic currency, etc.0, and domestic-owned assets abroad

/official reserve assets, government assets, and private assets0.

The official reserves account , which is a part of the financial account, is the foreign currency held

by central banks , and it is used to compensate deficits in the balance of payment. )hen there is a

trade surplus , the officia lreserves increase. (onversely, it decreases when there is a deficit.

This model strives to attain the e&uilibrium - a condition where the sum of debits and credits of the

current account and the capital and financial accounts e$ual to ero. Under a balanced condition,

the value of the domestic currency should also be at its e$uilibrium level. "owever, practical

evidence shows that it deviates from e$uilibrium .

@et's take the e!ample of the U and its trade deficit. )e know that a country with a persistentcurrent account deficit is importing more goods and services than selling. #n the balance of

payments, this appears as an inflow of foreign capital . Therefore, under this model, the U should

finance the difference by borrowing or selling more capital assets, that is, creating

a capital account surplus to compensate the current account deficit. #n fact both accounts do not

e!actly offset each other because of statistical discrepancies in the model and e!change

rate movements that modify the value of the recorded international transactions. 6ut the main
http://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/dividendhttp://www.fxstreet.com/education/glossary/dividendhttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/reserve-currencyhttp://www.fxstreet.com/education/glossary/central-bankhttp://www.fxstreet.com/education/glossary/surplushttp://www.fxstreet.com/education/glossary/reserve-currencyhttp://www.fxstreet.com/education/glossary/reserve-currencyhttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/equilibriumhttp://www.fxstreet.com/education/glossary/equilibriumhttp://www.fxstreet.com/education/glossary/equilibriumhttp://www.fxstreet.com/education/glossary/equilibriumhttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/surplushttp://www.fxstreet.com/education/glossary/offsethttp://www.fxstreet.com/education/glossary/offsethttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/dividendhttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/reserve-currencyhttp://www.fxstreet.com/education/glossary/central-bankhttp://www.fxstreet.com/education/glossary/surplushttp://www.fxstreet.com/education/glossary/reserve-currencyhttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/equilibriumhttp://www.fxstreet.com/education/glossary/equilibriumhttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/surplushttp://www.fxstreet.com/education/glossary/offsethttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/exchange-rate


8/32

limitation to the model is that no direct correlation has been proved between the value of a nation's

currency and the imbalance between the nation's capital account and current account.

The asset model approach considers currencies as being asset prices traded in an efficient financial

market and conse$uently demonstrating a strong correlation with other markets, particularly e$uities .

This is not always the case as many empirical studies evidence. ver the long run, it seems there is

no relationship between a nation's e$uity markets and its currency value.Monetary Model of 0xchange *ate 'etermination

This model aims to provide an e!planation for the dynamic adjustment process that occurs

as e!change rate moves towards a new e$uilibrium by considering monetary fundamentals such

as money supply , income levels, or other variables .

The concept behind it is that an increase in money supply leads to high interest rates as a

result of a growing inflation . !his is then followed by a depreciating currency as a means

of correction towards a new e&uilibrium .&ollowers of this model therefore see the growth of a nation's money supply in relation

with inflation and inflation e!pectations. They sustain that a currency increases in value if there is a

stable monetary policy and decreases if the monetary policy is erratic or unstable.

#n a later section, we shall see the relationship between money supply , inflation and interest rates .

#n her book, < Day Trading and wing Trading the (urrency 2arket>, 8athy @ien e!plains about the

2onetary 2odel:

K ne of the few ways a country can keep its currency from sharp devaluing is by pursuing a

tight monetary policy . &or e!ample, during the %sian currency crisis, the "ong 8ong dollar came

under attack from speculators. "ong 8ong officials raised interest rates to J percent to halt the

"ong 8ong dollar from being dislodged from its peg to the U. . dollar. The tactic worked perfectly as

speculators were cleared out by such sky-high interest rates . The downside was the danger that the

"ong 8ong economy would slide into recession . 6ut in the end the peg held and the monetary

model worked.K

ource: 8athy @ien, Day Trading and wing Trading the (urrency 2arket, )iley Trading, econd =dition, 4 H, pag.;4

KDay Trading and wing Trading the (urrency 2arket K by 8athy @ien is a must read we recommend

to all &ore! traders.

The problem with this model is that it doesn't take into account the variables of the balance of

payments described in the above model, specially the capital inflows that would take place as a

result of higher interest rates in the domestic currency or a booming e$uity market. #n any case its

theoretical approach can be used to complement the big picture.*eal Interest *ate 'ifferential Model
http://www.fxstreet.com/education/glossary/correlation-http://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/correlation-http://www.fxstreet.com/education/glossary/correlation-http://www.fxstreet.com/education/glossary/equitieshttp://www.fxstreet.com/education/glossary/equityhttp://www.fxstreet.com/education/glossary/equityhttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/equilibriumhttp://www.fxstreet.com/education/glossary/fundamentalshttp://www.fxstreet.com/education/glossary/money-supplyhttp://www.fxstreet.com/education/glossary/variablehttp://www.fxstreet.com/education/glossary/variablehttp://www.fxstreet.com/education/glossary/money-supplyhttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/correctionhttp://www.fxstreet.com/education/glossary/equilibriumhttp://www.fxstreet.com/education/glossary/equilibriumhttp://www.fxstreet.com/education/glossary/money-supplyhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/monetary-policyhttp://www.fxstreet.com/education/glossary/monetary-policyhttp://www.fxstreet.com/education/glossary/money-supplyhttp://www.fxstreet.com/education/glossary/money-supplyhttp://www.fxstreet.com/education/glossary/money-supplyhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/day-tradinghttp://www.fxstreet.com/education/glossary/monetary-policyhttp://www.fxstreet.com/education/glossary/monetary-policyhttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/peghttp://www.fxstreet.com/education/glossary/peghttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/recessionhttp://www.fxstreet.com/education/glossary/peghttp://www.fxstreet.com/education/glossary/peghttp://www.fxstreet.com/education/glossary/day-tradinghttp://www.fxstreet.com/education/glossary/day-tradinghttp://www.fxstreet.com/education/forex-books/day-trading-and-swing-trading-the-currency-market/http://www.fxstreet.com/education/glossary/variablehttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/equityhttp://www.fxstreet.com/education/glossary/correlation-http://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/correlation-http://www.fxstreet.com/education/glossary/equitieshttp://www.fxstreet.com/education/glossary/equityhttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/equilibriumhttp://www.fxstreet.com/education/glossary/fundamentalshttp://www.fxstreet.com/education/glossary/money-supplyhttp://www.fxstreet.com/education/glossary/variablehttp://www.fxstreet.com/education/glossary/money-supplyhttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/correctionhttp://www.fxstreet.com/education/glossary/equilibriumhttp://www.fxstreet.com/education/glossary/money-supplyhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/monetary-policyhttp://www.fxstreet.com/education/glossary/monetary-policyhttp://www.fxstreet.com/education/glossary/money-supplyhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/day-tradinghttp://www.fxstreet.com/education/glossary/monetary-policyhttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/peghttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/recessionhttp://www.fxstreet.com/education/glossary/peghttp://www.fxstreet.com/education/glossary/day-tradinghttp://www.fxstreet.com/education/forex-books/day-trading-and-swing-trading-the-currency-market/http://www.fxstreet.com/education/glossary/variablehttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/equity


9/32

The real interest rate differential model is a variant of the above monetary model with a stronger

focus on capital flows . #t stipulates that the spot e!change rate tends to its e$uilibrium depending

on the real interest rate differential . #n recent years we have witnessed very high interest

rates across the major economies. &or many investors, currencies with high interest rates were

attractive assets to buy, resulting in even higher e!changes rates for these appreciated currencies.

%s with other models, the concept has its supporters and its detractors. (ritics of the model argue

that it focuses too much on capital flows and omits the nation's current account balance and other

factors such as inflation , growth, etc. #n any case, this model can be employed together with other

models to determine the direction of the e!change rate move since its basic premises are $uite

logical./urrency ubstitution Model

6y currency substitution it is meant the holding of a foreign currency at the expense of the

domestic currency . #ndividuals usually adopt these measures as a protection againste!pected depreciation of the domestic currency or to take advantage of an increasing value of the

foreign currency.

This theoretical model of e!change rate determination has assumed growing importance in recent

years. (urrency substitution, it has been argued, is a critical factor in the volatile behavior of

e!change rates. #t also has radical implications on monetary policy , although the model shows more

convincing results when applied in underdeveloped countries where the impact of smart money

rushing in and out has a deeper effect on the domestic economy.

%nalysts following this model are looking for shifts in e!pectations of a nation's money supply as

these can have an impact on the e!change rates - the same premise as in the monetary model. #n

anticipation of the reaction , investors position themselves accordingly in the market, triggering

the self-fulfilling prophecy of the monetary model.

&ollowing the monetary model, if a country increases money supply it is e!pected that inflation rises

/there is more money to purchase the same goods0. The investor following the currency substitution

model would take advantage of the cause-effect described in the monetary model and sell the

currency which is e!pected to lose value. This is the basic assumption of the model which

theoretically brings prices towards parity.

This model tries to anticipate changes in the money supply and conse$uently gives more emphasison interventions in the foreign exchange market . ne of its limitation, though, is that

domestic inflation depends not only on domestic but also on foreign financial policy because of the

linkages between countries. =ven in the long run, fle!ible e!change rates do not permit monetary

interdependence.

%s with the previous mentioned models, this one also fails to comprehend the whole picture as it is

difficult to take in consideration all the factors affecting the relative value of currencies. &or instance,
http://www.fxstreet.com/education/glossary/real-interest-ratehttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/equilibriumhttp://www.fxstreet.com/education/glossary/equilibriumhttp://www.fxstreet.com/education/glossary/equilibriumhttp://www.fxstreet.com/education/glossary/real-interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/depreciationhttp://www.fxstreet.com/education/glossary/depreciationhttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/volatilehttp://www.fxstreet.com/education/glossary/volatilehttp://www.fxstreet.com/education/glossary/volatilehttp://www.fxstreet.com/education/glossary/monetary-policyhttp://www.fxstreet.com/education/glossary/monetary-policyhttp://www.fxstreet.com/education/glossary/money-supplyhttp://www.fxstreet.com/education/glossary/reactionhttp://www.fxstreet.com/education/glossary/positionhttp://www.fxstreet.com/education/glossary/selffulfilling-prophecyhttp://www.fxstreet.com/education/glossary/selffulfilling-prophecyhttp://www.fxstreet.com/education/glossary/money-supplyhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/money-supplyhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/real-interest-ratehttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/equilibriumhttp://www.fxstreet.com/education/glossary/real-interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/capitalhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/depreciationhttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/volatilehttp://www.fxstreet.com/education/glossary/monetary-policyhttp://www.fxstreet.com/education/glossary/money-supplyhttp://www.fxstreet.com/education/glossary/reactionhttp://www.fxstreet.com/education/glossary/positionhttp://www.fxstreet.com/education/glossary/selffulfilling-prophecyhttp://www.fxstreet.com/education/glossary/money-supplyhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/money-supplyhttp://www.fxstreet.com/education/glossary/inflation


10/32

a country with a strong current account surplus /resulting from a strong balance of trade surplus 0 has

demonstrated that despite increasing its money supply /to buy stocks and bonds in the market place,

for instance0, it is unable to make its currency lose value. The money flowing into the country to pay

for e!ported goods and services compensates the amount of new money injected into the economy.

Using fundamental models to forecast trends in the e!change rates can be $uite difficult. The analyst

shall e!amine several economic reports as many times the figures from one model alone are not

sufficient. #t is also important to go behind the figures, read the reports closely, and analy e their

meaning in the global picture. #n other words, you must read more than the headlines and see what

is said between the lines

#f you feel interest in using these approaches, make sure you are not seduced by the theory which

represents a very common phenomenon. They can be intellectually $uite stimulating but on the other

side they can also overload you and make you succumb to the Lemember

our first lesson in Unit % and the importance of building the big picture, but do not confound it with thepractical decision making process.

+. 0conomical Indicators *elated

%n economic indicator is a statistical or informative data collected and published on a regular basis

by a government or private entity. The indicator records the activity in a particular economic sector or

in an entire economy.

0conomic indicators are important to #orex traders, because they represent vital data to

understand the macro picture of a currency2s economy. !hey also help to anticipate future

market activity and to determine whether a particular currency is over( or under valued.

Macroeconomic indicators include figures such as growth rates, interest rates , inflation ,

employment, money supply and productivity.

ince any foreign currency transaction involves the e!change of one currency for

another, fundamental analysis is also related to the supply and demand of each currency.

Lemember that in a free floating market it's supply and demand what ultimately determines

the e!change rate . "ence, fundamental analysts try to ascertain the supply and demand balance by

studying various economic indicators.

&rom the fundamental models covered in the previous section , we can understand that some

economic indicators will affect the supply and demand of the domestic currency, while other

indicators will be affected by it. %s with technical indicators , fundamentals can also be classified

as leading or lagging . The difference lies in whether an indicator tracks economic factors that will
http://www.fxstreet.com/education/glossary/surplushttp://www.fxstreet.com/education/glossary/surplushttp://www.fxstreet.com/education/glossary/money-supplyhttp://www.fxstreet.com/education/glossary/bondhttp://www.fxstreet.com/education/glossary/bondhttp://www.fxstreet.com/education/glossary/bondhttp://www.fxstreet.com/education/glossary/trendhttp://www.fxstreet.com/education/glossary/trendhttp://www.fxstreet.com/education/learning-center/unit-1/chapter-2/global-trade-and-the-currency-market/http://www.fxstreet.com/education/learning-center/unit-1/chapter-2/global-trade-and-the-currency-market/http://www.fxstreet.com/education/glossary/economic-indicatorhttp://www.fxstreet.com/education/glossary/economic-indicatorhttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/money-supplyhttp://www.fxstreet.com/education/glossary/money-supplyhttp://www.fxstreet.com/education/glossary/fundamental-analysishttp://www.fxstreet.com/education/glossary/floating-positionhttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/learning-center/unit-2/chapter-2/basic-theories-of-fundamental-analysis/http://www.fxstreet.com/education/learning-center/unit-2/chapter-2/basic-theories-of-fundamental-analysis/http://www.fxstreet.com/education/glossary/technical-indicatorhttp://www.fxstreet.com/education/glossary/fundamentalshttp://www.fxstreet.com/education/glossary/fundamentalshttp://www.fxstreet.com/education/glossary/lagginghttp://www.fxstreet.com/education/glossary/surplushttp://www.fxstreet.com/education/glossary/surplushttp://www.fxstreet.com/education/glossary/money-supplyhttp://www.fxstreet.com/education/glossary/bondhttp://www.fxstreet.com/education/glossary/trendhttp://www.fxstreet.com/education/learning-center/unit-1/chapter-2/global-trade-and-the-currency-market/http://www.fxstreet.com/education/glossary/economic-indicatorhttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/money-supplyhttp://www.fxstreet.com/education/glossary/fundamental-analysishttp://www.fxstreet.com/education/glossary/floating-positionhttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/learning-center/unit-2/chapter-2/basic-theories-of-fundamental-analysis/http://www.fxstreet.com/education/glossary/technical-indicatorhttp://www.fxstreet.com/education/glossary/fundamentalshttp://www.fxstreet.com/education/glossary/lagging


11/32

affect the future of the general economy or records an economical activity that has already taken

place. (entral banks , for instance, rely on economic indicators to formulate their monetary

policy which, in turn, can have a significant effect on foreign e!change rates.

ome indicators work thus as leading indicators for other economical data. #n this section, we will

see how economic indicators are interrelated. The information herewith disclosed will help you

design a plan of action, perfectly suitable to be combined with a technical approach.$ subse&uent approach

2any analysts and traders agree that fundamental analysis can be very effective to see the big

picture. 6ut trading fundamentally in the long-term might not produce enough actual trades during

your window of opportunity to make it worthwhile. 6esides, many analysts also sustain

that fundamental analysis has its limitations when used in the short-term, arguing that it can be very

subjective. The following section is meant to deal with these limitations, and show you there is a way

to trade fundamentally.There is no doubt e!change rate movements in the short-term can be news-driven. %nnouncements

about interest rate changes or changes in the growth path of economies are some of the factors that

impact e!change rates also in the short run. 1onetheless, when a report is to be released, the trader

can have the analysis absolutely nailed but he could see no market reaction or even the e!change

rate going in the opposite direction of what was e!pected.

This is because every economical data is somehow related to other data. The announcements have

to be seen in their actual conte!t, and there is a lot of information to keep track of. 2oreover, it is

more about the traders' perception of the announcement than the published figure itself.

Therefore, by means of the trading approach you are about to learn, you shall have the chance to

focus on specific reports and how they relate to other reports in the conte!t of certain economies.

ure it takes time to do it properly, especially when you are just starting, but it can be a very powerful

tool. #f you have the time and inclination, it's something worth e!ploring.

=conomical reports are considered to have notable effects on the financial markets with some clear

ramifications for the &ore! market. The below map shows the indicators we are going to study and

how they are related to each other.
http://www.fxstreet.com/education/glossary/central-bankhttp://www.fxstreet.com/education/glossary/monetary-policyhttp://www.fxstreet.com/education/glossary/monetary-policyhttp://www.fxstreet.com/education/glossary/monetary-policyhttp://www.fxstreet.com/education/glossary/leading-indicatorhttp://www.fxstreet.com/education/glossary/fundamental-analysishttp://www.fxstreet.com/education/glossary/fundamental-analysishttp://www.fxstreet.com/education/glossary/fundamental-analysishttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/reactionhttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/central-bankhttp://www.fxstreet.com/education/glossary/monetary-policyhttp://www.fxstreet.com/education/glossary/monetary-policyhttp://www.fxstreet.com/education/glossary/leading-indicatorhttp://www.fxstreet.com/education/glossary/fundamental-analysishttp://www.fxstreet.com/education/glossary/fundamental-analysishttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/reactionhttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/glossary/exchange-rate


12/32

6ecause of the U D status as reserve currency it is arguably the currency of reference. That is the

reason why economic indicators in many major countries don't have the same impact on the

e!change rates as the U data. &or this reason the listed indicators are some of the more important

U indicators.

@ater, in the 7ractice part of this Unit we will do the same study with other major economies.

bviously, there are many more indicators for the U economy than the ones listed here. 6utinstead of listing the huge amount of figures that e!ist, we will pick only the ones that are being

followed by the vast majority of traders worldwide, and relate them to each other. )e will study here:

(onsumer 7rice #nde! /(7#0 7roducer 7rice #nde! /77#0 +ross Domestic 7roduct /+D70 Letail ales 7ersonal #ncome Trade 6alance #nstitute for upply 2anagement 2anufacturing #nde! /# 20 7hiladelphia &ed #nde! +oods and ervices #mports

Take into account that economical indicators fade in importance depending on the economical

circumstances. They come in and out of vogue and there are times traders pay much attention to a

particular announcement and then it is replaced by another indicator which becomes more popular.
http://www.fxstreet.com/education/glossary/reserve-currencyhttp://www.fxstreet.com/education/glossary/reserve-currencyhttp://www.fxstreet.com/education/learning-center/unit-2/chapter-2/economical-indicators-related/#cpihttp://www.fxstreet.com/education/learning-center/unit-2/chapter-2/economical-indicators-related/#ppihttp://www.fxstreet.com/education/learning-center/unit-2/chapter-2/economical-indicators-related/#gdphttp://www.fxstreet.com/education/learning-center/unit-2/chapter-2/economical-indicators-related/#rsaleshttp://www.fxstreet.com/education/learning-center/unit-2/chapter-2/economical-indicators-related/#pincomehttp://www.fxstreet.com/education/learning-center/unit-2/chapter-2/economical-indicators-related/#tbalancehttp://www.fxstreet.com/education/learning-center/unit-2/chapter-2/economical-indicators-related/#ismhttp://www.fxstreet.com/education/learning-center/unit-2/chapter-2/economical-indicators-related/#pfihttp://www.fxstreet.com/education/learning-center/unit-2/chapter-2/economical-indicators-related/#gsihttp://www.fxstreet.com/education/glossary/fadehttp://www.fxstreet.com/education/glossary/reserve-currencyhttp://www.fxstreet.com/education/learning-center/unit-2/chapter-2/economical-indicators-related/#cpihttp://www.fxstreet.com/education/learning-center/unit-2/chapter-2/economical-indicators-related/#ppihttp://www.fxstreet.com/education/learning-center/unit-2/chapter-2/economical-indicators-related/#gdphttp://www.fxstreet.com/education/learning-center/unit-2/chapter-2/economical-indicators-related/#rsaleshttp://www.fxstreet.com/education/learning-center/unit-2/chapter-2/economical-indicators-related/#pincomehttp://www.fxstreet.com/education/learning-center/unit-2/chapter-2/economical-indicators-related/#tbalancehttp://www.fxstreet.com/education/learning-center/unit-2/chapter-2/economical-indicators-related/#ismhttp://www.fxstreet.com/education/learning-center/unit-2/chapter-2/economical-indicators-related/#pfihttp://www.fxstreet.com/education/learning-center/unit-2/chapter-2/economical-indicators-related/#gsihttp://www.fxstreet.com/education/glossary/fade


13/32

The trader has to be fle!ible enough to watch an indicator with a completely different set of criteria

from time to time.

/onsumer %rice Index 3/%I4

'efinition: The (7# is a consumer-level inde! designed to measure pure price change of a fi!edmarket basket of goods and services, representative of the purchases of a typical urban consumer.

(7# is classified among the economy-wide indicators which are the broadest measures of productive

activity and record the result for an entire economy.

The /ore /%I is calculated in the same manner as the (7# but it e!cludes items with

high volatility such as energy and food which are vulnerable to price shocks , leading to a distortion in

the (7# calculation.

5hy does it matter) #t is considered to be one of the most effective indicators revealing the current

state of inflation in an economy. The inflation rate, which is the rate at which prices of goods and

services change, is determined by the economy's need for money and by the supply of money. #n

order to determine whether the money supply is great enough to meet the needs of the economy, we

need to know the inflation rate. #nflation data is also needed to monitor the effectiveness of

a monetary policy in its effort to promote ma!imal economic growth.
http://www.fxstreet.com/education/glossary/volatilityhttp://www.fxstreet.com/education/glossary/price-shockhttp://www.fxstreet.com/education/glossary/price-shockhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/supplyhttp://www.fxstreet.com/education/glossary/supplyhttp://www.fxstreet.com/education/glossary/money-supplyhttp://www.fxstreet.com/education/glossary/money-supplyhttp://www.fxstreet.com/education/glossary/money-supplyhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/monetary-policyhttp://www.fxstreet.com/education/glossary/monetary-policyhttp://www.fxstreet.com/education/glossary/volatilityhttp://www.fxstreet.com/education/glossary/price-shockhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/supplyhttp://www.fxstreet.com/education/glossary/money-supplyhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/monetary-policy


14/32

=conomic growth has to be understood in a cycle made of inflation and interest rates . +rowth

typically creates higher wages and full employment, which increases the aggregate demand .

)hen inflation begins to escalate too fast, it deteriorates asset values and it affects savings - people

are unable to save money because of higher prices. #n order to control inflation in periods of

economical e!pansion, the &ederal Leserve /that is the U monetary authority0 will adjust interest

rates to cool off the economy. "igher interest rates curb e!pansion as it makes growth more

e!pensive reflecting the fact that the cost of money is higher.

)hen inflation is low and growth is also falling, the &ederal Leserve can lower interest rates in order

to stimulate growth.

The inflation rate is determined by the general price increases of consumer goods and services over

time. The best way to measure it is using an inde! which reduces the prices that consumers spend

in one year to a simple number that can be easily compared to other years. 6ased on a starting

inde! value of 5 , if the (7# for the current period is, let's say, 55G, the indication is that it now costs5GA more to buy the basket of goods today than it was when the inde! was first established /in

5HB4-BG0. 6y comparing the monthly (7# data, you can easily detect changes in consumer's buying

power from month to month.

%cceleration or deceleration of inflation , as signaled by the rate of change of the (7#, can indicate

that a change in monetary policy may be appropriate.

% (7# that continues to trend upwards month over month could be a signal that inflation is eroding

buying power to the point that the central bank will raise interest rates to curb spending. %s a result,

an increase in interest rates may lead to an increase in demand for the currency as its

higher interest rates make the currency more attractive for global investors, as we have seen in the

above real interest rate differential model.

This is the normal cycle , but is it always like this* Unfortunately not. There are several limitations

when dealing with (7#. ne is the basket of goods being highly subjective and different from country

to country. %nother one is the fact that core (7# number e!clude goods that consumers have to

purchase anyway such as energy and food. This means that inflation may not be really a result of

economical growth.

The cycle we described above breaks down when the economy e!periences dramatic price

increases or decreases. il, for instance, is many times related to those price shocks as seen in thepast. &or this reason, oil prices act as a leading indicator for (7#.

#n any case, in times when there are concerns about inflation , the (7# gains in importance despite its

limitations. %s with other indicators - even technical ones - don't worry too much about its handicaps

and try to e!tract the valuable information it contains. Understanding (7# can be translated in trade

opportunities and guidance in managing their overall risk . #t is not because of its inherent value but
http://www.fxstreet.com/education/glossary/cyclehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/aggregate-demandhttp://www.fxstreet.com/education/glossary/aggregate-demandhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/periodhttp://www.fxstreet.com/education/glossary/periodhttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/periodhttp://www.fxstreet.com/education/glossary/periodhttp://www.fxstreet.com/education/glossary/periodhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/monetary-policyhttp://www.fxstreet.com/education/glossary/monetary-policyhttp://www.fxstreet.com/education/glossary/trendhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/central-bankhttp://www.fxstreet.com/education/glossary/central-bankhttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/demandhttp://www.fxstreet.com/education/glossary/demandhttp://www.fxstreet.com/education/glossary/demandhttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/real-interest-ratehttp://www.fxstreet.com/education/glossary/real-interest-ratehttp://www.fxstreet.com/education/glossary/cyclehttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/cyclehttp://www.fxstreet.com/education/glossary/price-shockhttp://www.fxstreet.com/education/glossary/leading-indicatorhttp://www.fxstreet.com/education/glossary/leading-indicatorhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/riskhttp://www.fxstreet.com/education/glossary/riskhttp://www.fxstreet.com/education/glossary/cyclehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/aggregate-demandhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/periodhttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/periodhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/monetary-policyhttp://www.fxstreet.com/education/glossary/trendhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/central-bankhttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/demandhttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/real-interest-ratehttp://www.fxstreet.com/education/glossary/cyclehttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/cyclehttp://www.fxstreet.com/education/glossary/price-shockhttp://www.fxstreet.com/education/glossary/leading-indicatorhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/risk


15/32

because of the attention that traders pay to it that (7# is relevant. pecially important for traders and

analysts are the developing trends in (7# results and the breaking points between inflationary and

deflationary periods .

*eleased by: U Department of @aborM 6ureau of @abor tatistics . @ook for , as it is the most popular measure of inflation .

#re&uency: (7# results are published on a monthly basis. +enerally available the second week of

the month immediately following the month for which data is being released. #t's always released

after the 7roducer 7rice #nde!.

1ote also that in the U % most indicators are published on certain weekdays, rather than on a

monthly date.%roducer %rice Index 3%%I4

'efinition: The 77# is not as widely used as the (7#, but it is still considered to be a good indicator

of inflation . +enerally, the 77# is also collected by governments and it's considered to be among the

most authoritative statistics.

This indicator measures and reflects the change of manufacturersN cost of raw materials and semi-

finished goods retrieving data from production and manufacturing firms across several sectors

/manufacturing, agriculture, mining and utilities 0. The 77# is also a basket of various

inde!es covering a wide range of areas affecting domestic producers. @ike the (onsumer 7rice

#nde!, the 77# compares the current price inde! to a base value of 5 O this means that a 77# value

of 55; is 5;A higher than the original base .
http://www.fxstreet.com/education/glossary/trendhttp://www.fxstreet.com/education/glossary/periodhttp://www.bls.gov/news.release/cpi.toc.htmhttp://www.bls.gov/news.release/cpi.toc.htmhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/utilitieshttp://www.fxstreet.com/education/glossary/utilitieshttp://www.fxstreet.com/education/glossary/coverhttp://www.fxstreet.com/education/glossary/rangehttp://www.fxstreet.com/education/glossary/basehttp://www.fxstreet.com/education/glossary/basehttp://www.fxstreet.com/education/glossary/basehttp://www.fxstreet.com/education/glossary/basehttp://www.fxstreet.com/education/glossary/trendhttp://www.fxstreet.com/education/glossary/periodhttp://www.bls.gov/news.release/cpi.toc.htmhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/utilitieshttp://www.fxstreet.com/education/glossary/coverhttp://www.fxstreet.com/education/glossary/rangehttp://www.fxstreet.com/education/glossary/basehttp://www.fxstreet.com/education/glossary/base


16/32

#n order to avoid distortions on the 77# figures, the (ore 77# e!cludes volatile items such as energy

and food. % sudden spike or fall in oil prices or other une!pected event is not reflected in the data

released.

5hy does it matter) The 77#, while not as strong as the (7# in detecting inflation - because 77#includes goods being produced -, can be used as a leading indicator to forecast future (7# releases.

The 77# inde! printing higher figures suggests an e!panding economy with reasonable assurances

of continued employment for those working in the manufacturing sector. %n increasing 77# value

could also indicate an interest rate hike intended to fight inflation .

&or &ore! traders and followers of the real interest differential model, a rise in interest rates means

an increase in the demand for the currency as investors can e!pect increased returns. 6ut concerns

over increasing inflation , specially in the U , may outweigh benefits of a high interest rate /see the

monetary model of e!change rate determination in the previous section 0. o overall, the effect of 77#

on the U D is moderate in comparison to other markets.

?ou should also note that the 77# report is the first of the inflation -based reports available each

month. #t will usually receive close scrutiny as traders look for signs of inflation or deflation that could

impact on the (7# released shortly after.

&or the long-term trader the 77# and (7# numbers are used to track price pressures that can help to

anticipate inflationary conse$uences in the near future.

The short-term trader, in turn, will not be so much interested in forecasting interest rate changes, but

rather use the 77# as leading indicator to estimate the (7# result since this indicator has ultimately

more impact on the market. #f you follow this approach, don't forget to spot for oil prices as they alsowill impact on the (7# inde!.

*eleased by: U Department of @aborM 6ureau of @abor tatistics .

#re&uency: #t is released in the second full week of every month, covering the previous month's

data.6ross 'omestic %roduct 3 6'% 4
http://www.fxstreet.com/education/glossary/volatilehttp://www.fxstreet.com/education/glossary/spikehttp://www.fxstreet.com/education/glossary/spikehttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/leading-indicatorhttp://www.fxstreet.com/education/glossary/leading-indicatorhttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/interest-differentialhttp://www.fxstreet.com/education/glossary/interest-differentialhttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/demandhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/learning-center/unit-2/chapter-2/basic-theories-of-fundamental-analysis/http://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/deflationhttp://www.fxstreet.com/education/glossary/deflationhttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/leading-indicatorhttp://www.fxstreet.com/education/glossary/leading-indicatorhttp://www.bls.gov/news.release/ppi.toc.htmhttp://www.bls.gov/news.release/ppi.toc.htmhttp://www.fxstreet.com/education/glossary/coverhttp://www.fxstreet.com/education/glossary/coverhttp://www.fxstreet.com/education/glossary/coverhttp://www.fxstreet.com/education/glossary/gdphttp://www.fxstreet.com/education/glossary/volatilehttp://www.fxstreet.com/education/glossary/spikehttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/leading-indicatorhttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/interest-differentialhttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/demandhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/exchange-ratehttp://www.fxstreet.com/education/learning-center/unit-2/chapter-2/basic-theories-of-fundamental-analysis/http://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/deflationhttp://www.fxstreet.com/education/glossary/interest-ratehttp://www.fxstreet.com/education/glossary/leading-indicatorhttp://www.bls.gov/news.release/ppi.toc.htmhttp://www.fxstreet.com/education/glossary/coverhttp://www.fxstreet.com/education/glossary/gdp


17/32

'efinition: #n the U , the &ederal Leserve's primary goal is to keep a sustained growth of the

economy with full employment and stable prices. The information provided by the +D7 inde! is a

gross measure of the big economical picture. Lepresenting the monetary value of all the goods and

to signalservices produced by an economy over a specified period , the real +D7 is the most

comprehensive measure of the country's production and it is indicative of inflation pressures.

To determine the +D7 results, purchases of domestically-produced goods and services by

individuals, businesses, foreigners and government entities and the trade balance are routinely

captured. #n short, everything that is produced within the countryNs borders is counted as part of

the +D7 . &or this reason it's perhaps the broadest indicator of the well-being of an economy.The published output is available in nominal or in real terms /also called inde! form0, meaning

increases in the the results due to inflation have been removed. %nalysts and traders usually monitor

the real growth rates generated by the +D7 $uantity inde! or the real dollar value.

The nominal , current dollar, +D7 corresponds to the market value of goods and services produced

and it's calculated using today's Dollars. This makes comparisons between time periods difficult

because of the effects of inflation . The real +D7 , the inde! form, in turn, solves this problem by

converting the current information into some standard era Dollar.

The +D7 is typically lower than the consumer price inde! because investment goods /which are in

the +D7 price inde! but not the (7#0 tend to have lower rates of inflation than consumer goods and

services.

5hy does it matter) +D7 indicates the pace at which a country's economy is growing /or

shrinking0. 6y monitoring trends in the overall growth rate as well as the rate of inflation and the

unemployment rate, policy makers are able to assess whether the current stance of monetary

policy is consistent with the goal of sustained growth.
http://www.fxstreet.com/education/glossary/gdphttp://www.fxstreet.com/education/glossary/periodhttp://www.fxstreet.com/education/glossary/gdphttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/gdphttp://www.fxstreet.com/education/glossary/gdphttp://www.fxstreet.com/education/glossary/gdphttp://www.fxstreet.com/education/glossary/gdphttp://www.fxstreet.com/education/glossary/nominalhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/gdphttp://www.fxstreet.com/education/glossary/gdphttp://www.fxstreet.com/education/glossary/gdphttp://www.fxstreet.com/education/glossary/gdphttp://www.fxstreet.com/education/glossary/gdphttp://www.fxstreet.com/education/glossary/periodhttp://www.fxstreet.com/education/glossary/periodhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/gdphttp://www.fxstreet.com/education/glossary/gdphttp://www.fxstreet.com/education/glossary/gdphttp://www.fxstreet.com/education/glossary/gdphttp://www.fxstreet.com/education/glossary/gdphttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/gdphttp://www.fxstreet.com/education/glossary/trendhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/monetary-policyhttp://www.fxstreet.com/education/glossary/monetary-policyhttp://www.fxstreet.com/education/glossary/gdphttp://www.fxstreet.com/education/glossary/periodhttp://www.fxstreet.com/education/glossary/gdphttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/gdphttp://www.fxstreet.com/education/glossary/gdphttp://www.fxstreet.com/education/glossary/nominalhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/gdphttp://www.fxstreet.com/education/glossary/gdphttp://www.fxstreet.com/education/glossary/periodhttp://www.fxstreet.com/education/glossary/inflationhttp://www.fxstreet.com/education/glossary/gdphttp://www.fxstreet.com/education/glos

go to basic 1 (2. fundamental)

Documents