From the April 01, 2011 issue of Futures Magazine • Subscribe!

Top five forex fundamentals

2. Employment: While the Federal Reserve in the United States has a dual mandate to stabilize prices and to promote full employment, that is not necessarily the case for other central banks. "Interest rates are directly controlled by central banks, but employment and economic growth aren’t necessarily under their control," Boyd says.

Employment numbers are a factor for two reasons. First, employment directly affects consumer spending. Second, that consumer spending affects inflation, which plays into central bank decisions on interest rates.

"As employment increases, you can expect consumer spending in the country to increase a bit. That’s going to increase your domestic demand and help with employment [further]. If it gets to the point where inflation is a concern, that’s when you’ll see central banks stepping in and raising interest rates to ease spending," Boyd says.

Consequently, employment can have an immediate effect on currencies while potentially providing a forecast of what a central bank may do.

3. Economic growth and trade: A lot of reports and outlooks factor into a country’s expectations for economic growth. While interest rates and employment numbers can point to those expectations, other reports also provide insight into where a country’s economy is headed.

"You can look at GDP, consumer price index, anything that shows inflation or growth. All those things add to the story," Boyd says. "If manufacturers are increasing their inventory, you can take that as a sign that they expect business to pick up in the [near future]."

According to Regan, earnings are an early indicator for an economy. "As soon as you start to see earnings improve, you know the economy likely is soon to follow," he says.

There are a number of reports that show these growth expectations, but some carry more weight than others. Boyd says the housing sector is one of the most important for determining future direction because the lag time is so great. "As houses come into play now, they’re not actually hitting the market for six months to a year. It definitely gives you some insight into where that sector thinks things are going," he says.

Trade is a key factor for many countries’ economies and although there are benefits to having a strong currency, a rising currency means that the cost of that country’s goods are rising against its competitors.

Central banks often will manage/manipulate their currency by selling it after it rises to an unacceptable level. China has longed pegged its yuan — much to the consternation of the last few U.S. administrations — to the value of the U.S. dollar, ensuring the cost of their goods do not rise relative to the dollar. And while the Japanese yen floats, the Japanese central bank periodically in the past has sold the yen when it became too strong relative to other currencies.

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