Fundamentals of Economy
To determine the true health of economy, we should look at the most important fundamental variables and try to compare them. These variables will change year to year as international trade dynamics evolve and central bankers and investors redirect their fixations. Most investors look at three key variables: monetary indicators, economic indicators, and sentiment. Interest rates reflect how much you get paid for holding a currency, which is why rates drive the Forex Market.
Interest rates are set by a combination of central banks decisions (which set short term rates) and the bond market developments (which determine longer term rates). If interest rates are going up it tends to suggest the economy is in a growth spurt. (Thus central bankers are inclined to ward off inflationary pressures with higher rates. ) The currency tends to appreciate as a result. If interest rates are neutral or going down, it typically means growth is slowing (as bond markets bring long term rates down in the expectation that central bankers will offer more lax monetary policy), and the currency tends to depreciate as a result.
Economic Indicators can be broken down as follows: Leading indicators, corporate sector, manufacturing, unemployment and inflation. The reason you should care about economic indicators is because they drive the interest rate outlook. Remember, a growing economy can offer a higher yield. Leading Indicators are those that tend to change before the wider economy changes. They should give your fundamental analysis a forward-looking bias since they are the best gauge for what is shaping the economy. While there are many leading indicators, the US housing market is an excellent example.
Building and buying a new home usually suggest extensive outlays (homes need to be constructed, financed and furnished), thus developments in the housing market usually precede developments in linked industries. While the consumer is a key to the economy, the corporate sector is also important. If companies are making money, they are more likely to invest, expand and employ. Attracting the attention of politicians, central bankers, and investors, job creation acts as the backbone of a healthy economy.
Assuring US consumers of a healthy job outlook loosens the wallets of a consumer-driven economy. By loosening their wallets, new jobs create difficulties for central bankers who look for signs of tightness in the labor market that create inflationary pressure. Inflation is the result of a growing economy since businesses will increase their prices when consumers buy more. Central bankers weigh both inflation and economic growth when setting short-term interest rates. If they think inflation is above their comfort level, they will raise interest rates and vice versa.
Inflation is affected by supply as well. This sort of price pressure is most commonly seen in the cost for food and energy, making the prices paid for these goods less controllable and volatile. Conclusion The currency market is a living, breathing market driven by the choices of individuals. Sentiment drives the market by setting the tone you can attribute to an economy. Since the consumer is the backbone of the economy, reports suggesting consumer confidence give clues to consumer spending habits.