Fundamental Definitions

Fundamental definitions

Note: These definitions are for those that are new to the market and or want to understand fundamental data, we hope you can study and use these to the best of your advantage allowing you to profit within the financial markets.

PMI

Is an estimate of the Manufacturing Purchasing Managers Index for a country, based on about 85% to 90% of the total PMI survey responses each month.

Its purpose is to provide an accurate advance indication of the final PMI data. Because flash PMIs are among the first economic indicator released for each month and provide evidence of changing economic conditions ahead of comparable government statistics, they can have a significant effect on the currency markets. Any reading of the index above 50 indicates improving conditions, while readings below 50 indicate a deteriorating economic circumstance.

PMIs use a monthly questionnaire survey of selected companies which provide an advance indication of the performance of the private sector. It achieves this result by tracking changes in variables such as output, new orders, and prices across the manufacturing, construction, retail and service sectors.

The release of flash PMI information is a leading indicator since it comes before the collection of data from all surveys. However, it will still indicate the general trend of the industry. IHS Markit Economics reports the Manufacturing PMI in the United States.

GDP

Gross Domestic Product:

Is usually measured quarterly and is a measurement of the total amount of economic activity in each economy over a specified period. The percentage change in GDP is looked at as the primary growth rate from one period to the next. If GDP in the first quarter is reported as +0.5% it means the economy expanded 0.5 percent relative to the fourth quarters output. These reports typically come out midway through each quarter. The market's economic outlook will be heavily influenced by what the GDP reports indicate. Better than expected growth may be looked at by the banks for higher interest rates while slow or steady growth may suggest the easing of monetary policy. Exports play an especially important roll in factoring a country’s GDP. GDP rises when the value of a country’s foreign exports exceed the value of their foreign imports. In essence, if a country is selling more to foreign nations than their regular consumers are buying products that originated from abroad, a country’s GDP will get higher.

How does this effect currency pairs?

Firstly, when a country’s GDP rises, its currency’s worth also rises. It works the same way in the other direction, too. When a country’s GDP falls, its currency also weakens. When a country’s GDP dips, it means the nation’s economic growth is slowing down or stabilising. However, when a country’s GDP drops to negative numbers, that's bad news. It means the economy is actually shrinking - there's loss of productivity and purchasing and, as a result, a loss of jobs. In other words, it likely means the nation is experiencing a recession. As a result, there’s usually a fairly large incentive to keep a country’s GDP on a positive growth trajectory. Secondly, investors and international corporations use GDP to inform many of their investment decisions. Investors usually prefer putting their money in countries that indicate high GDP growth rates. Because investment usually strengthens the currency of that country, GDP has an indirect influence over it through affecting investment decisions. Thirdly, most national central banks, including the US Federal Reserve, also take GDP growth rates into consideration when deciding whether or not they should change interest rates.

Bank Interest Rate Decisions

Play an integral role for the foreign exchange market as anticipation and changing circumstances play a role for future rates. It's not just the current level of interest rates that matter, when it comes to currencies and interest rates, forex markets are focused more on the direction of the future interest rate moves than they are on the current levels because they're already priced in by the markets, so even though a currency has a low interest rate, market expectations of higher interest rates in the future will cause the currency to appreciate. Factors in Currency Values Generally, higher interest rates increase the value of a country's currency. Higher interest rates tend to attract foreign investment, increasing the demand for and value of the home country's currency. Conversely, lower interest rates tend to be unattractive for foreign investment and decrease the currency's relative value. This simple occurrence is complicated by a host of other factors that impact currency value and exchange rates. One of the primary complicating factors is the relationship that exists between higher interest rates and inflation. If a country can achieve a successful balance of increased interest rates without an accompanying increase in inflation, its currency's value and exchange rate are more likely to rise. Although interest rates can be a major factor influencing currency value and exchange rates, the final determination of a currency's exchange rate with other currencies is the result of a number of interrelated elements that reflect the overall financial condition of a country with respect to other nations. Interest rates alone do not determine the value of a currency. Two other factors—political and economic stability and the demand for a country's goods and services, are often of greater importance. Factors such as a country's balance of trade between imports and exports can be a crucial factor in determining currency value. That is because greater demand for a country's products means greater demand for the country's currency as well. Favourable numbers, such as the gross domestic product (GDP) and balance of trade are also key figures that analysts and investors consider in assessing a given currency. Another important factor is a country's level of debt. High levels of debt, while manageable for shorter time periods, eventually lead to higher inflation rates and may ultimately trigger an official devaluation of a country's currency.

Monetary Policy:

Consists of management of money supply and interest rates, aimed at achieving macroeconomic objectives such as controlling inflation, consumption, growth, and liquidity. These are achieved by actions such as modifying the interest rate, buying or selling government bonds, regulating foreign exchange rates, and changing the amount of money banks are required to maintain as reserves.

Most central banks function under legislative mandates that focus on two objectives:

Promoting price stability and Restraining inflation

Quantitive Easing

Is a form of unconventional monetary policy in which a central bank purchases longer-term securities from the open market in order to increase the money supply and encourage lending and investment. Buying these securities adds new money to the economy, and also serves to lower interest rates by bidding up fixed-income securities. It also greatly expands the central bank's balance sheet which in doing can achieve their legal mandates.

Fiscal Policy

Is the means by which a government adjusts its spending levels and tax rates to monitor and influence a nation's economy. It is the sister strategy to monetary policy through which a central bank influences a nation's money supply. World governments can influence macroeconomic productivity levels by increasing or decreasing tax levels and public spending. This influence, in turn, curbs inflation (generally considered to be healthy when between 2% and 3%), increases employment, and maintains a healthy value of money. Fiscal policy plays a very important role in managing a country's economy.

What is the unemployment rate?

It is a lagging indicator, meaning that it generally rises or falls in the wake of changing economic conditions, rather than anticipating them. When the economy is in poor shape and jobs are scarce, the unemployment rate can be expected to rise. When the economy is growing at a healthy rate and jobs are relatively plentiful, it can be expected to fall. The data measures unemployed individuals seeking work as a percentage of the civilian labour force. Increases int this rate can be interpreted as weakness in the country's economy overall while declines in the rate are considered a positive sign for the job market and the overall economy.Calculating the Unemployment Rate The official unemployment rate is known as U-3, To calculate the unemployment rate, the number of unemployed people is divided by the number of people in the labor force, which consists of all employed and unemployed people. The ratio is expressed as a percentage:

u3= unemployed/labour force x 100

What is the U-6 Rate?

The U-6 rate is the unemployment rate that includes discouraged workers who have quit looking for a job and part-time workers who are seeking full-time employment. The U-6 rate is considered by many economists to be the most revealing measure of a country’s unemployment situation since it covers the percentage of the labor force that is unemployed, underemployed and discouraged.

Impact On Currencies:

When the unemployment rates for each country are lower than expected for this will tend to appreciate each of the currencies because traders believe that the economy is doing good which could lead to higher interest rates from the bank respectively. On the other hand, greater than expected unemployment rates could weaken currencies as it is expected to lead to lower interest rates due to the banks having a concern over the overall economy. This provides added volatility when trading as large entities react to the data releases and enter the markets.

NFP - Non Farm Payrolls:

Is an economic event held monthly in order to measure statistics of new payrolls added by private and government entities in the U.S. The monthly statistic is tracked by the Bureau of Labor Statistics (BLS) and reported to the public on a monthly basis through the closely followed “Employment Situation” report. Like its name, non-farm payrolls exclude the hiring of farm workers within the agricultural industry. In addition to farm workers, non-farm payrolls data also excludes some government workers, private households, proprietors, and non-profit employees. According to the BLS, non-farm employee classifications account for approximately 80% of U.S. business sectors contributing to gross domestic product (GDP). While this represents a significant majority of the U.S. labor force there are some notable exclusions in addition to farm workers:

Government workers:

Government is a key part of the “Employment Situation” report each month but there are some government workers who are excluded. The government category covers civilian employees. However, it excludes military employees and employees of government-appointed officials. Employees of the Central Intelligence Agency, National Security Agency, National Imagery and Mapping Agency, and the Defence Intelligence Agency are also excluded.

Private households:

Private household employees and domestic household workers are excluded.

Proprietors:

Proprietors are generally unincorporated business owners. This includes sole proprietors and self-employed workers that operate without a registered business incorporation (e.g.: without limited liability corporation or partnership status).

Non-profit employees:

Though quite large, the non-profit sector is not included for consideration in the non-farm payroll statistics.

Analysing the Monthly Report

The most important payroll statistic that is analysed from the report is the non farm payroll and the unemployment rate, these are the biggest things to take from the “Employment Situation” report but economists and policymakers use all of the available data for assessing the current state of the economy and forecasting future levels of economic activity. The going wisdom among economists is that the U.S needs to add around 200,000 jobs each month just to offset population growth and keep the unemployment rate steady. The report contains many valuable insights into the labor force that have a direct impact on the economy as well as the stock market, the value of the U.S. dollar, the value of Treasuries, and the price of Gold. Why is the number of jobs important?

The non-farm payrolls report (NFP) is treated as an economic indicator for people employed during the previous month, and the number being released will have a direct impact on the markets.

the difference between the actual non-farm data and expected figures will determine the overall impact on the market. If the non-farm payroll is expanding, this is a good indication that the economy is growing, and vice versa. However, if increases in non-farm payroll occur at a fast rate, this may lead to an increase in inflation. In Forex, the level of actual non-farm payroll compared to payroll estimates is taken very seriously. If the actual data comes in lower than economists' estimates, forex traders will usually sell U.S. dollars in anticipation of a weakening currency. The opposite is true when the data is higher than economists' expectations, If the jobs report beats expectations, the US dollar will strengthen. The prior two months NFP changes are also revised and those revisions will colour the market's interpretation of the current report.

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