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Fundamental News Drives the Forex Market
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Traders who are new to forex can take comfort in knowing that analyzing and forecasting exchange rate movements does not rely solely on macro economic factors, the “big picture” issues. These are concepts for which in formation is readily available but that are not so intuitively grasped by the masses. Currency traders who are looking to capture big moves in ex change-rate movement definitely should focus on the fundamentals and the understanding of what drives interest rate differentials between various countries. The currency pairs are traded especially when attempting to assess the value of currencies.

Traders need to be aware of several key elements and events that can cause currency values to move. For one, the adjusting of interest rates by central banks is a major factor that moves markets. These decisions are based on many concerns, such as international trade flows, investment flows, the health of individual country's economies, and inflation worries. The opposite concern, as has been the case for Japan for over a decade, is deflation. These are the same factors that can and do influence moves on the stock and bond markets.

Our civilization has evolved into a very complex international capital istic environment. Some governments intercede to help benefit their economies through government support programs, as had been the case in China . China had artificially supported its currency, the yuan, to move in re lationship with the U.S. dollar. Then we have multinational conglomerate corporations, whose money flow needs can and do influence short-term price swings in currencies. Throughout these developments, it has become increasingly difficult to target one single effect on the value of a currency in the short term, especially one weighted against the U.S. dollar. Take for ex ample what happens in an economic business cycle. Money flow moves where there are better opportunities either from the perspective of attrac tiveness on rate of return or from a safety issue in uncertain times. Huge in vestment funds can move money to higher-yielding interest-earning instruments, namely bonds, or to foreign stocks. When major hedge funds see better opportunities from one country to another, they have the re sources to move quickly with limited restrictions. These shifts in trading strategies also cause short-term moves in currency values.

Historically, when we see signs of economic changes taking place, money flows in the equity markets move from one sector to another as the economic business cycle goes into an expansion mode, then into a con traction, and then back into an expansion mode. Foreign investors may wish to take part in these changes as well, therefore increasing capital flows to the United States , which will have a short-term supportive boost for the dollar. As of the middle of October 2006, what we were possibly en tering would have been considered an early-stage economic contraction. There were many factors at play that would lead to that conclusion. For starters, the Federal reserve had raised interest rates by 0.25 percent 17 consecutive times over a two-year period, bringing the federal funds rate to 5.25 percent. It concluded its interest-rate-hiking campaign based on con cerns that it might choke off liquidity, bringing more risks to economic growth than the risks of inflation. That was a pretty good tip-off that the economic expansion phase just might moderate. As a result of increased in terest rates, even the housing market turned south, as we discussed previ ously (see Figures 1.1 and 1.2). We had been in a longer-than-normal economic expansion period, starting from early 2003 through mid-2006. With this said, it was at the time considered a “long in the tooth” recovery (lasting more than 40 months), especially after the economic contraction period that followed 9/11/01 .

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