Foundations on Forex - Introduction. Interest rates and GDP [part 1]

The type of analysis of currency pairs (and not only them) we choose, largely answers the question, what kind of investor are we. There is a relationship saying that the longer the investment horizon we choose, the more fundamental analysis is our ally. Shouldn't mid-term and short-term traders nevertheless worry too much about ignorance of economic factors? On the one hand, the golden rule of intraday trading is not to play when publishing data. However, I think that the general knowledge of basic macroeconomic factors is extremely useful to the majority, even to capture a longer sentiment or mood prevailing on a given asset.

What data to choose?

Let's start with the fact that there are really many participants on the currency market. They are daily flooded with information from various agencies, institutes, portals, blogs and colleagues' reports. It is extremely difficult, especially at the beginning of your trader's career, to filter out relevant information and translate into transaction signals, or assess their direct impact on a given currency pair. Is there good advice or a ready solution? One could say in answer to this question that it is experience. The second way (if you do not have too much of the first one) is to use information filters. Daily digging up piles of information that are completely unrelated to our investment will not make any sense. We currently have a large number of various economic calendars available on the web. It is worth setting and filtering them so as to observe relevant publications about the instrument on which we trade and those that are in close correlation with it.

Investors from the smallest to the largest evaluate the weight differently and react differently to publications. The issue of emotion and psychology on the market is creeping in, while in this article we will focus only on the "technical" aspects of investing in foundations. Returning, therefore, to the heart of information acquisition, investors guided by a long-term strategy, e.g. assuming an increase in their position in emerging markets, based on data will create forecasts and possibly revise their investment policy. The long-term investor (as evidenced by surveys conducted on individual investors in the US) very quickly withdraws from the market when the political / geopolitical situation in the region changes.

On the other side of the barricade are the interbank market dealers who, after publication of the data, try to quickly assess the situation (the strength of the publication's impact, the relevance of the data). They mainly care about quick opening of position and using possible move.

What did the market expect?

This is one of the basic questions that we should ask ourselves after publishing the information. Similar to data evaluation issues. Was this information positive or negative? Many long-term investors recommend the use of zero-one strategies in their decision-making process. In this case, you can use a simple formula to compare data with recent data (reference point), which should be exactly the equivalent of new. It is worth, especially at the beginning of your path with foundations, to focus on one indicator rather than look for its correlation or relationships with others. Therefore, for example, when analyzing inflation, we should separate "the most fashionable" indicators in a given period. A good example would be inflation, which is usually higher in the first months of the year due to the largest number of price increases. Therefore, focusing on "intermediate" indicators (and their increase / decrease) does not make the slightest sense, since we know that the increase in inflation in the first quarter is natural.

The seasonality of data is also an important issue. Unemployment is the best example. The employment rate can (and does) significantly change over the years. This is due to the increased / reduced demand for seasonal workers. Therefore, larger fluctuations in individual data should be considered more broadly, on the basis of looking for reasons for this rather than another state of affairs.

Below we will focus on the main fundamental indicators and their impact on currency pairs.

Gross National Product and Gross National

GNP is the income received by the citizens of a given country in their own country and abroad. It excludes those incomes that were obtained in Poland by foreigners due to the help of the factors of production they manage. GDP is similar with the difference that it covers income achieved by both Poles and foreigners achieved only in the geographical area of ​​Poland.

How does it affect currency pairs?

• GDP / GNP growth - increase of the national currency
• Fall of GDP / GNP - fall of the national currency

It is worth noting that the increase in GNP usually means good economic condition, an increase in industrial production, or inflows of foreign investment. The latter together with increased exports cause demand for the national currency by foreign recipients. GNP largely depends on the government's fiscal and monetary policy. Therefore, there are two dependencies here:

• in fiscal policy - higher government purchases -> higher GNP -> increase in interest rates -> decrease in investments
• in monetary policy - higher money supply -> lower interest rate -> higher investments and exports -> higher incomes and GNP

Interest rates

The interest rate is a very general concept. The nominal interest rate is nothing other than the rate measured in monetary units, while we have in mind the profitability of any instrument, e.g. treasury bills, deposit, government bonds. A real interest rate will be more useful to assess its impact on the currency, which, in contrast to the nominal, is expressed in purchasing power. We get rid of the first inflation rate.

We have a really large amount of interest rates. Given our backyard, the basic rates published by the NBP will be: rediscount bill, lombard loan, reserve requirement, foreign currency deposits, minimum 28-day yield and open market operations. Is there a general relationship to assess the impact of each of these rates? In part, yes. There is a general relationship saying that:

• interest rate increase -> capital inflow -> high currency supply -> domestic currency increase
• decrease of the interest rate -> outflow of capital -> reduced supply of the currency -> decrease of the national currency

In the assessment of rates, some caution and prioritization in terms of significance of impact on the market should be taken. It is important to go back to previous (not one or two) publications and evaluate the trend prevailing on this indicator. If high interest rates were offered or your forecasts indicate that they will be offered in the future for a long time, this indicates a high level of state debt. In the event of large uncertainties in world trade or the impending financial collapse, this will mean the outflow of a large proportion of the capital invested there. The currency of this country will weaken.

There may also be such a situation that low or falling interest rates will trigger the appreciation of the domestic currency against foreign ones, due to the inflow of capital and investments in debt securities.

The subject of fundamental analysis of the basic factors shaping exchange rates is really extensive. The analysis of foundations by most analysts is treated in a detail-to-general manner. This means that when assessing economic indicators, we should contribute to the creation of a certain economic scenario and forecasts, gradually successive indicators, analyzing their impact on each other. At the beginning, analyzing historical data and drawing conclusions about the formation of prices of individual currency pairs can be a great help. It should be remembered that the market in various periods is quite specific. I am referring to a certain "priority" of events, where often political events cause greater reactions on currencies than the publication of inflation data on an annual basis.