Fundamental analysis

Fundamental analysis

  • Fundamental analysis
  • Official discount rate
  • FOMC and Meeting
  • Inflation
  • Budgetary deficit
  • Economic indicators
  • Trade balance
  • Consumer price index (CPI)
  • Producer price index (PPI)
  • GDP - Gross domestic product
  • Unemployment rate
  • Non-farm payroll
  • Elections
  • Dynamics of prices of oil and energy sources
  • Stock market indices
  • Summary to fundamental analysis

  • Fundamental analysis

    Fundamental analysis studies reasons of price changes at the macroeconomic level and represents analysis of economic and political conditions in countries or separate industries. With the help of fundamental analysis influence of various events on currency, raw material or stock markets is estimated. The school of fundamental analysis appeared together with development of applied economic science. Knowledge of macroeconomic life of society and its influence on price dynamics of different commodities was taken as the basis. Generally. all fundamental factors are estimated from two points of view:

    • how this news will influence the official discount rate of this or that country;
    • what are current conditions of the national economy;

    Background data for fundamental analysis are supplied via information channels in the form of news. News may be divided in unexpected and planned (anticipated). Unexpected news include news of political (government dismissals, coups, wars, etc.) and natural origin (various natural disasters and climatic events). The market is severely affected by wars. As a rule, the currency of the country, on which territory military activities take place, is getting cheaper. Natural disasters also lead to a fall of the national currency, since finances are required for recovery, which may give rise to inflation. Anticipated news include meetings of commissions of central banks of different countries, where discount rates are discussed and changed, and issue of economical indicators. Economic conditions of the country are assessed by many indicators. Let us review influence of the most important of them.

    ODR or official discount rate is one of the hey regulators of national monetary policy. ODR usually indicates at which rate the central bank issues credits to other banks. Besides ODR, Lombard rate and REPO rate are often used. Increase of ODR usually leads to tightening of monetary policy of the state and slowdown of the national economy growth, but it also causes increased foreign investments to the national economy. Thus, in the short-term outlook, ODR increase causes the national currency growth, but in the long-term outlook high rates hinder economic development of the country and leads to a fall of the national currency exchange rate.

    Heads of central banks of the leading countries have regular meetings to discuss issues of economy regulation. Such meetings are called FOMC (Federal Open Market Committee), if the it is presided by the head of FED (Central Reserve System of the United States of America) or Meeting, if the meeting takes place on a neutral territory. The main issues of this meeting include:

    • change of ODR;
    • change of bank reserve rate;
    • mutual crediting of the coalition countries;

    FOMC or Meeting are held approximately once in two weeks, and many things in the financial world depend on results of their decisions. Thus, increase of ODR by 0.25% USD may lead to USD growth by 100 pips and more within 10-15 minutes.

    Dates and results of FOMC meetings have wide publicity in business press, the Internet, and you also can find links to information resources at our site.

    Inflation is devaluation of paper money due to its emission in quantities, exceeding demands of commodity turnover, accompanied by increase of commodity prices and reduction of actual wages. Besides that, price increase is caused by credit appreciation. High inflation adversely affects economy, since high interest rates reduce production efficiency and determine redistribution of capital from production to intermediaries. With low inflation or the absence thereof, interests of intermediaries suffer. Financial institutions suffer from low interest rates. Inflation level should be optimal. With such a level, stable high production efficiency is observed, and intermediaries still can derive profits.

    Budgetary deficit is the state budget surplus. High budgetary deficit leads to the national depth growth and can cause inflation acceleration. Budgetary deficit level may be regulated by two methods. First - increase of revenues. It can be achieved by increase of tax receipts, which will impose burden on taxpayers. Excessively high taxes adversely affect production and stimulate development of black economy. The second method is reduction of production costs at the expense of social programs. This leads to increased social tension and produces a general negative effect.

    Economic indicators provide the most complete idea of the current situation in the national economy, but require extensive experience and practice. Let us review some of them and estimate their effect on price dynamics.

    Trade balance is the difference between export and import of commodities. If the amount of prices of exported commodities exceeds the amount of prices of imported commodities, trade balance is positive; if import exceeds export, trade balance is negative. Positive balance, as well as reduction of negative balance, lead to increase of the national currency value.

    Consumer price index shows change of price level for commodities of the consumer goods basket. CPI growth may lead to interest rate increase, which consequently cause increase of the national currency exchange rate.

    Producer price index shows change of price level for industrial goods. Its effect on the exchange rate is similar with CPI.

    Gross domestic product is one of the basic indicators, showing the current situation in the national economy. GDP = consumption + government expenditures + investments + export + import. GDP has a profound effect on the market. Its growth leads to increase of the national currency exchange rate.

    Unemployment is a social-economic phenomenon, when a part of the population cannot find jobs. High unemployment level contributes to social tension, reduction of the middle class and lowering of the net mass of actual income of the population. With a low level of unemployment, workers lose motivation for conscientious work and interests of employers suffer.

    Unemployment growth, as a rule, is accompanied with a fall of the national currency rate. However, for each country there is an officially permissible level of effective unemployment.

    This indicator shows quantity of new jobs, excluding the agricultural sector of economy. Increase of this indicator characterizes employment growth and leads to growth of the currency rate.

    Parliamentary, presidential and other elections also influence on currency rates. Change of rates depends on pre-election promises of candidates and historical preferences of winning political parties.

    The market is influenced by dynamics of prices of oil and energy sources. As a rule, when oil prices grow, currencies of energy-dependent countries (Japan, Germany, Switzerland) are depreciated. American dollar in such cases goes up, as a rule.

    Stock market indices represent average cost of stocks (or cost of a share portfolio) of the largest national companies or biggest companies of an industry, selected according to certain parameters. For example:

    • S&P (S&P-500, Standard & Poors) - chares of the biggest US companies;
    • DJIA (DJIA-24, Dow Jones Industrial Average) - cost of elite shares of the United States of America, Including General Motors, General Electric, Motorola, etc.
    • DAX (DAX-30, XETRA DAX) - larges production companies of Germany;
    • CAC - French Stock Index;
    • FTSE (FTSE -500) - UK Stock Index;
    • Nikkei-225 - index of 225 leading companies of Japan;
    • TANKAN, TOPIX etc;

    Stock indices show the current situation at stock exchanges, which, therefore, influence the national currency rate. Growth of the stock market increases the national currency rate, since it reflects favorable conditions in the corporate sector and vice versa - a fall of indices moves quotations down. Growth of prices of state bonds (T-bills, T-bonds) leads to increase of the national currency value.

    In conclusion, it needs to say that fundamental analysis facilitates determination of the main market trend. However, for determination of a concrete moment of transaction it is not sufficient, and methods of technical analysis should be used.

    *  This article has been prepared and written by the specialists of analytics department of the Company Larson& HolzIT Ltd: Fundamental analysis
    All rights reserved.
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