Demystifying Forex Trading: Fundamental Analysis March 11, 2024
In the world of financial markets, the Forex market stands out as the largest, most liquid, and most volatile, attracting many participants eager to engage in trading. Thus, identifying the appropriate Forex trading style and analysis method in such a complex economic environment becomes particularly crucial.
The two main methods of Forex trading analysis are Fundamental Analysis and Technical Analysis. This article will primarily focus on Fundamental Analysis.
What is Forex?
Forex, or FX, short for foreign exchange, refers to the global marketplace where currencies are traded against each other. The FX pair is always displayed in the format of GBP/USD, with the base currency (GBP) listed first, followed by the quote currency (USD).
Singapore is the third-largest Forex centre globally after London and New York, and the largest in Asia Pacific. Based on official data from MAS (the Monetary Authority of Singapore), Singapore’s foreign exchange (FX) average daily trading volumes (ADTV) rose to US$864 billion in October 2023, significantly increasing by 134% over the past decade [1].
Source: Singapore Foreign Exchange Market Committee (SFEMC) Semi-Annual Survey of Singapore FX Volume
How does Fundamental Analysis work for Forex?
Forex Trading analysis involves evaluating various factors to predict currency movements, aiming to profit from buying or selling FX pairs at opportune moments in the foreign exchange market.
Fundamental analysis delves into the economic conditions of the countries in FX pairs and the global economic l, scrutinising essential economic indicators and conditions. Key indicators include Gross domestic product (GDP) growth, varied indices and rates, policy, and significant events.
Here are some examples of key indicators that countries pay close attention to:
A Key Economic Indicator – Interest Rates
Interest rates, set by a country’s central bank through monetary policies, play a crucial role in determining currency valuations in the Forex market and stand as a fundamental indicator.
Understanding interest rate differentials is crucial in Forex trading. When a country’s interest rates are higher than another, investors are attracted to invest in that country’s currency or assets to earn a better return on their investment. This elevates the desirability of that country’s currency, prompting capital inflows, which are likely to bolster demand for the currency and foster its appreciation in the Forex market.
Take for example, the scenario following the Federal Reserve’s decision on 16 March 2022 to increase the federal funds rate to 5.5%. In contrast, Japan’s interest rate remained at -0.1%, and China’s at 3.45%. This situation led to a widening gap between the interest rates of the USD compared to those of the JPY and CNY, making the USD more attractive to investors seeking higher returns, which in turn, could lead to an appreciation of the USD in the Forex market.
Source: U.S. Dollar / Japanese Yen, TradingView
Source: Interest rate in U.S., China and Japan, TradingView
As a result, USD/JPY and USD/CNY have been on an uptrend, indicating a continuous appreciation of the USD.
Source: U.S. Dollar / Chinese Yuan, TradingView
An Exciting 48-hour in the United States:
Event: ADP National Employment Report
Time: 7:15 am Eastern Standard Time (EST), 31 January 2024
Automatic Data Processing Inc. released the ADP National Employment Report on 31 Jan 2024, two days ahead of government data. This report, a reliable forecaster of the government’s non-farm payroll report, indicated that private employers added 107,000 jobs in January. This figure is considerably lower than December’s 164,000 jobs and below the anticipated 145,000. The hiring slowdown from 2023 extended into January, with wage pressure continuing to ease. Notably, the pay premium for those changing jobs dropped to a new low last month [2]. The release of this data saw the US dollar start a downtrend.
From top to bottom: USD/JPY, USD/SGD, USD/CAD, USD/CHF, USD/CNH.
From top to bottom: EUR/USD, AUD/USD, GBP/USD.
Source: TradingView
Event: Federal Open Market Committee (FOMC) Meeting
Time: 2:00 pm EST, 31 January 2024
In the US, the Federal Reserve’s interest rate meetings, held approximately eight times annually, are crucial economic events. The FOMC, which dictates the federal funds rate, also publishes the Summary of Economic Projections quarterly, outlining expectations for GDP growth, unemployment, inflation, and interest rates.
Source: Summary of Economic Projections on Federal Reserve System [3]
The FOMC meeting on 31 January 2024 concluded with indications that a rate cut in March was unlikely. Following this announcement, the US dollar rebounded, showing an uptrend trend.
Event: Non-farm payrolls
Time: 8:30 am EST, 2 February 2024
The U.S. Bureau of Labor Statistics released the US Employment Situation Summary for January 2024 at 8:30 am on 2 February. The report showed an impressive increase in non-farm payrolls by 353,000 month-on-month, far exceeding the Dow Jones estimate of 185,000. With the unemployment rate holding steady at 3.7%, against a forecast of 3.8%, and a significant 0.6% rise in average hourly earnings—double the expected rate—the labor market demonstrated robust performance. Annually, wages increased by 4.5%, notably above the 4.1% projection, indicating significant income growth for workers, which could bolster consumer spending and overall economic expansion [4].
From top to bottom: USD/JPY, USD/SGD, USD/CAD, USD/CHF, USD/CNH, EUR/USD, AUD/USD, GBP/USD.
Source: TradingView
This exciting 48-hour example illustrates how various fundamental factors can influence currency movements in the Forex market.
Conclusion
Fundamental analysis is a powerful tool in Forex trading, enabling traders and investors to understand the underlying drivers of currency movements. By analysing economic data, central bank policies, and geopolitical events, market participants can make informed decisions and capitalise on trading opportunities in the Forex market. Nonetheless, successful Forex trading requires the combining of fundamental analysis with sound risk management practices along with a disciplined trading approach to ensure long-term success.
Reference:
- [1] https://www.mas.gov.sg/development/foreign-exchange
- [2] https://adpemploymentreport.com/
- [3] https://www.federalreserve.gov/monetarypolicy/fomccalendars.htm
- [4] https://www.bls.gov/news.release/pdf/empsit.pdf
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About the author
Wenxuan
Management Associate
Wenxuan, holds a Master's degree in Applied Finance from SMU, and dual Bachelor's degrees in Mathematical Finance and Electronic Science and Technology from Xiamen University. With a profound belief in the synergy between mathematics and finance, she perceives this fusion as instrumental in enhancing analytical capabilities and refining investment strategies and endeavours to leverage this interdisciplinary expertise for financial analysis and investment decisions.
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