The Fundamental Analysis of Foreign Exchange

Elementary theory

Interest rate

If the trend of the market rate is unclear, then any news which is related to the interest rate could influence the trend of the exchange rate. Generally, if a country raised its interest rate, this country's currency could relatively become strong, because the investors would transfer their properties into these countries in order to expect for a higher return rate in the future. But, if the interest rate is too high, it is bad news for the stock market, the investor would transfer their fund out of the country's stock market which will cause the currency price to drop. It is knowledge to judge strength is much stronger, this is decided according to the overall economic environment before the change of the interest rate. The most important economic indicators that could influence the interest rate are the consumer price index, the buyer price index and the gross national product, these indicators could the reference for various countries' central bank (BOE, FED, ECB, BOJ) before deciding the interest rate.


International trade

According to a country's trading balance, Forex traders could refer the difference between the import and export of a country, when a country's import is bigger than the exportation, there will be a trade deficit, and this usually is not good news. Take US as the example, in order to pay import debts, the government must sell its currency in order to buy another's currency to pay the debts, because the outflow of the currency could cause the U.S dollar to depreciate. If, balance show that the export ratio increases, US dollar can flow back to its homeland cause the U.S dollar to become strong. According to economical point of view, trade deficit may not be all negative but if the trade deficit is bigger than the market expectation, it could create a reverse side effect.


Purchasing (PPP)

This purchasing theory stipulated that, the exchange rate is decided by the identical group commodity relative price. For example, let's use hamburger as a classical case, if a hamburger in U.S is worth 2.00 U.S dollar each, but in Britain the value is 1.00 British pounds, according to the purchasing theory, the exchange rate certainly is 2 US dollar equals to1 British pound. If is in vogue the market exchange rate is 1.7 US dollars to each British pound, then the British pound has depreciated, but US dollar is has appreciated. This theory supposition these two currencies finally to 2:1 relational change.

The purchasing theory main drawback lies in its assumption that the commodity can be traded freely, and does not count transaction cost and customs duty, quota and payment of taxes. Another drawback is it only suitable for the commodity, actually it has neglected the service, but service has the extremely remarkable value disparity space. Moreover, besides the difference between the inflation rate and the interest rate difference, but there are also certain factors that could affect the exchange rate, for instance: Economical digital issue/report, property market as well as political situation development. Before 1990s, the purchasing theory is lack of fact to support its effectiveness. After 1990's, this theory is only suitable for long period (3 - 5 years). In during the span cycle, the price finally closes up to the fair price.

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