Financial and Sociopolitical Factors

 tags:-Political Events and Crises,foreign exchange,The Role of Financial Factors

The Role of Financial Factors

Financial factors are vital to fundamental analysis. Changes in a government's monetary or fiscal policies are bound to generate changes in the economy, and these will be reflected in the exchange rates. Financial factors should be triggered only by economic factors. When governments focus on different aspects of the economy or have additional international responsibilities, financial factors may have priority over economic factors. This was painfully true in the case of the European Monetary System in the early 1990s. The realities of the marketplace revealed the underlying artificiality of this approach. Using the interest rates independently from the real economic environment translated into a very expensive strategy.

Because foreign exchange, by definition, consists of simultaneous transactions in two currencies, then it follows that the market must focus on two respective interest rates as well. This is the interest rate differential, a basic factor in the markets. Traders react when the interest rate differential changes, not simply when the interest rates themselves change. For example, if all the G-5 countries decided to simultaneously lower their interest rates by 0.5 percent, the move would be neutral for foreign exchange, because the interest rate differentials would also be neutral.

Of course, most of the time the discount rates are cut unilaterally, a move that generates changes in both the interest differential and the exchange rate. Traders approach the interest rates like any other factor, trading on expectations and facts. For example, if rumor says that a discount rate will be cut, the respective currency will be sold before the fact. Once the cut occurs, it is quite possible that the currency will be bought back, or the other way around. An unexpected change in interest rates is likely to trigger a sharp currency move. "Buy on the rumor, sell on the fact...".

Other factors affecting the trading decision are the time lag between the rumor and the fact, the reasons behind the interest rate change, and the perceived importance of the change. The market generally prices in a discount rate change that was delayed. Since it is a fait accompli, it is neutral to the market. If the discount rate was changed for political rather than economic reasons, what is a common practice in the European Monetary System, the markets are likely to go against the central banks, sticking to the real fundamentals rather than the political ones. This happened in both September 1992 and the summer of 1993, when the European central bankslost unprecedented amounts of money trying to prop up their currencies, despite having high interest rates. The market perceived those interest rates as artificially high and, therefore, aggressively sold the respective currencies.

Finally, traders deal on the perceived importance of a change in the interest rate differential.

Political Events and Crises

Political events generally take place over a period of time, but political crises strike suddenly. They are almost always, by definition, unexpected. Currency traders have a knack for responding to crises. Speed is essential; shooting from the hip is the only fighting option. The traders' reflexes tak over. Without fast action, traders can be left out in the cold. There is no timefor analysis, and only a split second, at best, to act. As volume drops dramatically, trading is hindered by a crisis. Prices dry out quickly, and sometimes the spreads between bid and offer jump from 5 pips to 100 pips. Getting back to the market is difficult.

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Economic Indicators part two

tags"Producer Price Index (PPI),Consumer Price Index (CPI),Gross National Product Implicit Deflator,Personal Income,CRB index,Leading Indicators,Employment Indicators,Auto Sales,Consumer Spending Indicators,Employment Cost Index (ECI),Merchandise Trade Balance,JoC,Gross Domestic Product Implicit,Producer Price Index (PPI)

didn't  see part one so you go here

Producer price index is compiled from most sectors of the economy, such as manufacturing, mining, and agriculture. The sample used to calculate the index contains about 3400 commodities. The weights used for the calculation of the index for some of the most important groups are: food - 24 percent; fuel - 7 percent; autos - 7 percent; and clothing - 6 percent. Unlike the CPI, the PPI does not include imported goods, services, or taxes.

Consumer Price Index (CPI)

Consumer price index reflects the average change in retail prices for a fixed market basket of goods and services. The CPI data is compiled from asample of prices for food, shelter, clothing, fuel, transportation, and medical services that people purchase on daily basis. The weights attached for the calculation of the index to the most important groups are: housing - 38 percent; food - 19 percent; fuel - 8 percent; and autos - 7 percent.

The two indexes, PPI and CPI, are instrumental in helping traders measure inflationary activity, although the Federal Reserve takes the position that the indexes overstate the strength of inflation.

Gross National Product Implicit Deflator

Gross national product implicit deflator is calculated by dividing the current dollar GNP figure by the constant dollar GNP figure.

Gross Domestic Product Implicit

Gross domestic product implicit deflator is calculated by dividing the current dollar GDP figure by the constant dollar GDP figure.

Both the GNP and GDP implicit deflators are released quarterly, along with the respective GNP and GDP figures. The implicit deflators are generally regarded as the most significant measure of inflation.

Commodity Research Bureau's Futures Index (CRB index)

The Commodity Research Bureau's Futures Index makes watching for inflationary trends easier. The CRB Index consists of the equally weighted futures prices of 21 commodities. The components of the CRB Index are:

• precious metals: gold, silver, platinum;
• industrials: crude oil, heating oil, unleaded gas, lumber, copper, and cotton;
• grains: corn, wheat, soybeans, soy meal, soy oil;
• livestock and meat: cattle, hogs, and pork bellies;
• imports: coffee, cocoa, sugar;
• miscellaneous: orange juice.

The preponderance of food commodities makes the CRB Index less reliable in terms of general inflation. Nevertheless, the index is a popular tool that has proved quite reliable since the late 1980s.

The “Journal of commerce” Industrial Price Index (JoC)

The “Journal of commerce” industrial price index consists of the prices of 18 industrial materials and supplies processed in the initial stages of manufacturing, building, and energy production. It is more sensitive than other indexes, as it was designed to signal changes in inflation prior to the other price indexes.

Merchandise Trade Balance

is one of the most important economic indicators. Its value may trigger long-lasting changes in monetary and foreign policies. The trade balance consists of the net difference between the exports and imports of a certain economy. The data includes six categories:

1. food;
2. raw materials and industrial supplies;
3. consumer goods;
4. autos;
5. capital goods;
6. other merchandise.

Employment Indicators

The employment rate is an economic indicator with significance in multiple areas. The rate of employment, naturally, measures the soundness of an economy. (See Figure 4.2.) The unemployment rate is a lagging economic indicator. It is an important feature to remember, especially in times of economic recession. Whereas people focus on the health and recovery of the job sector, employment is the last economic indicator to rebound. When economic contraction causes jobs to be cut, it takes time to generate psychological confidence in economic recovery at the managerial level before new positions are added. At individual levels, the improvement of the job outlook may be clouded when new positions are added in small companies and thus not fully reflected in the data. The employment reports are significant to the financial markets in general and to foreign exchange in particular. In foreign exchange, the data is truly affective in periods of economic transitio recovery and contraction. The reason for the indicators' importance in extreme economic situations lies in the picture they paint of the health of the economy and in the degree of maturity of a business cycle. A decreasing unemployment figure signals a maturing cycle, whereas the opposite is true for an increasing unemployment indicator.

Figure 4.2. The U.S. unemployment rate.

Employment Cost Index (ECI)

Employment cost index measures wages and inflation and provides the most comprehensive analysis of worker compensation, including wages, salaries, and fringe benefits. The ECI is one of the Fed's favorite quarterly economic statistics.

Consumer Spending Indicators

Retail sales is a significant consumer spending indicator for foreign exchange traders, as it shows the strength of consumer demand as well as consumer confidence. component in the calculation of other economic indicators, such as GNP and GDP.

Generally, the most commonly used employment figure is not the monthly unemployment rate, which is released as a percentage, but the nonfarm payroll rate. The rate figure is calculated as the ratio of the difference between the total labor force and the employed labor force, divided
by the total labor force. The data is more complex, though, and it generates more information. In foreign exchange, the standard indicators monitored by traders are the unemployment rate, manufacturing payrolls, nonfarm payrolls, average earnings, and average workweek. Generally, the most significant employment data are manufacturing and nonfarm payrolls, followed by the unemployment rate.

Auto Sales

Despite the importance of the auto industry in terms of both production and sales, the level of auto sales is not an economic indicator widely followed by foreign exchange traders. The American automakers experienced a long, steady market share loss, only to start rebounding in the early 1990s. But car manufacturing has become increasingly internationalized, with American cars being assembled outside the United States and Japanese and German cars assembled within the United States. Because of their confusing nature, auto sales figures cannot easily be used in foreign exchange analysis.

Leading Indicators

The leading indicators consist of the following economic indicators:

• average workweek of production workers in manufacturing;
• average weekly claims for state unemployment;
• new orders for consumer goods and materials (adjusted for inflation);
• vendor performance (companies receiving slower deliveries from suppliers);
• contracts and orders for plant and equipment (adjusted for inflation);
• new building permits issued;
• change in manufacturers' unfilled orders, durable goods;
• change in sensitive materials prices.

Personal Income

is the income received by individuals, nonprofit institutions, and private trust funds. Components of this indicator include wages and salaries, rental income, dividends, interest earnings, and transfer payments (Social Security, state unemployment insurance, and veterans' benefits). The wages and salaries reflect the underlying economic conditions.

This indicator is vital for the sales sector. Without an adequate personal income and a propensity to purchase, consumer purchases of durable and nondurable goods are limited.

For the Forex traders, personal income is not significant.

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