Chris Lori - Understanding Global Fundamentals

Understanding Global Fundamentals Forexmentor.
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Written by: Chris Lori
Copyright © 2006 Currex Investment Services Inc., All rights reserved

Publication Date: January, 2006
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Topics:
1. Understanding Global Fundamentals
2. The Fundamentals
3. Economic Reports
4. Sample Weekly "Quick View" Calendar
5. ForexMentor© Econoday Calendar Overview
6. Fundamentals Affecting U.S. Dollar
7. Fundamentals Affecting EUR
8. Fundamentals Affecting JPY
9. Fundamentals Affecting GBP
10. Fundamentals Affecting CHF
11. Commodity Currencies
12. Central Bank Intervention and Bank Trading Insights - BOJ
13. Glossary of Non-U.S. Economic Indicators
Copyright© 2006 Currex Investment Services Inc. - Written by Chris Lori 1

Understanding Global Fundamentals Forexmentor.com
Introduction
This guide and economic calendar will be a reference to understand the basic factors that
are specific drivers of the major currency pairs. It is important for any serious trader to
grow their understanding of the many scenarios that may influence the market.
Although technical analysts primarily use price and time factors to discern their trading
decisions, it is also important to understand the weight of global fundamental factors on
the market movements.
Your Econoday economic calendar contains every key economic report that will occur in
the US. In addition, this supplementary guide will provide you with the significant market
moving reports from the countries of the most highly traded currency pairs Europe,
Japan, UK, Switzerland, Australia and Canada
Foreign exchange traders should acquire a basic knowledge on the fundamentals

impacting the global currency markets and understand the general trends in foreign
exchange values. It is also important to grasp the forces behind the short-term
fluctuations in currency cross valuations caused by the economic data, which play a
critical role in shaping overall market sentiment and shifting momentum over the short,
medium and long term.
The Fundamentals
The two primary approaches to analyzing the foreign exchange markets are technical
analysis and fundamental analysis.
Fundamental analysis can take the following considerations into account, an array of
economic theories, an evaluation and perception of the global and domestic political
environment and developments, monetary and fiscal policies, as well as key economic
data to analyze their affect on a currency's supply and demand.
Fundamental factors will include things such as; Central Bank actions, political
developments and geopolitical events, economic data, which represent fundamental

factors, for example; trade balance, GDP, inflation, etc. Collectively, these factors play a
key role in the pricing of one nations currency versus another.
The Effects of Exchange Rate Changes

An exchange rate is the price of one foreign currency in terms of another currency.
Foreign exchange rates are of particular concern to governments because changes in FX
rates affect the value of products and financial instruments. As a result, unexpected or
large changes can affect the health of nations’ markets and financial systems. Exchange
rate changes also impact nations’ international investment flows, as well as export and
import prices. These factors, in turn, can influence inflation and economic growth.
For example, suppose the price of the Japanese yen moves from 120 yen per dollar to 110
yen per dollar over the course of a few weeks. In market parlance, the yen is
"strengthening," or becoming more expensive, against the dollar. If the new exchange
rate persists, it will lead to several related effects. First, Japanese exports to the United
States will become more expensive. Over time, this might cause export volumes to the
United States to decline, which, in turn, might lead to job losses in Japan. Also, the higher
U.S. import prices might be an inflationary influence in the United States. Finally, U.S.
exports to Japan will become less expensive, which might lead to an increase in U.S.
exports and a boost to U.S. employment.
Interest rate differentials between countries are one of the main factors that influence
exchange rates. Money tends to flow into investments in countries with relatively high
real (that is, inflation-adjusted) interest rates, increasing the demand for the currencies of
these countries and, thereby, their value in the FX market.
Economic Reports
An Economic Report may also be termed a “Fundamental Announcement,” “Economic
Release,” “Economic Data,” or “Fundy’s”, as slang.
An Economic Indicator is a country’s (or zone’s) release of statistical data in what we

title an “Economic Report” that reflects changes to economic conditions over a period of
time. In simple terms, it is any economic statistic, such as Unemployment, GDP, or
Inflation rate, which indicate how well/poorly the economy is doing or may do in the
future.
A country is like a company. Companies report earnings and detailed financial

information that may reflect their value, as well; they are subject to market perception
based on who presides over the company, possible joint ventures as well as any
questionable activity the company may be engaged in. Similarly, countries report
economic statistics and are also subject to geopolitical dynamics and global perception of
their value.
The release of these reports may materially affect the opinions of traders regarding the
relative merits and demerits of that country’s currency. The data released by these reports
is assimilated rapidly and acts as a catalyst to cause bonds, stocks and currencies to be
immediately, and often dramatically, re-priced.
Economic Reports comment on the perceived phase of the business cycle. Financial
markets “move” when the latest economic news indicates that earlier perceptions and
assumptions about the current strength of the economy are not quire correct. Since
financial instruments are priced according to market participant’s perceptions of the
relative strength of the economy, changes in perception lead immediately to re-pricing.
Global financial markets create a perceived value of a countries currency based partly on
the statistics of these economic indicators, which reflect economic activity for a specified
period (Monthly, Quarterly, Yearly) concerning factors such as; the current employment
rate, how much retail buying has occurred, the production capacity of the manufacturing
plants, how many homes have been built and purchased, inflation, and more to be
discussed later.
The following are an example of "Market Moving" Economic Indicators in the United
States.
• Consumer Price Index - CPI

• Durable Goods Orders
• Employment Situation
• FOMC Meeting Announcement - Typically pertaining to Interest Rates
• GDP
• Housing Starts
• Industrial Production & Capacity Utilization
• International Trade Balance
• ISM Manufacturing Index
• Personal Income & Outlays • Producer Price Index - PPI .
• Retail Sales
• *University of Michigan Sentiment (Sentiment Survey)
There are many other key indicators, as well. Complete definitions and an overview of
why investors care about the specific data item can be found in the Econoday Economic
Calendar.

International Economic Calendar Sample:
Below is a sample of an economic report for a one-week period. This sample weekly
calendar is taken from a website and can be used as a quick reference for the week ahead.
As the column titles indicate, the calendar shows the time, location, and description of the
report. For further detail on the description of the report you can refer to the
ForexMentor© Econoday Economic Calendar. The sample calendar below also issues the
previous outcome for the same report and the forecast for the report that is due. On this
particular example, because this was printed after the reports were issued, we can view
the outcome of the report under the "Actual" subtitle.


ForexMentor© Econoday Economic Calendar

Contents
Please review the contents table of the calendar in detail so you know what is available to
you. To take in all of the information and understand its value to your trading potential
may be a little overwhelming at first, but you will eventually get the feel for what is of
greater and lesser importance to keep your eye on and when.

By-The-Month Calendar
The "By The Month Calendar" view is handy to quickly identify which days of the month
where increased or decreased volatility may prevail. Start by highlighting the days on
which there is one or more market moving economic reports. Rather than memorizing the
US market movers, the calendar has highlighted them in bold green for you. If you want
details of the report and want to know why investors care, simply go to the "Market
Movers" section in appendix A. Trading days that have multiple data reports coming out
can become very volatile. The question is also timing, of course. The market will know in
advance what reports are due and what time and date they will be announced, so it may
begin to price in an expectation several days before the news. When this occurs, you will
see the market trend in anticipation of the news. This price behavior is why you want to
identify what data and news is coming out in advance. It helps you get into "sync" with
the market and understand why price may be behaving in the manner that it is. So when
you see a favorable set up on the technical side, this reference will help you make more
sense of it and will ultimately help you determine i£ when and where to enter and manage
your trade. •
In addition, mark off the significant bank holidays for the countries that move the most
foreign exchange transactions, i.e. USA, Europe, Japan, UK. Most others are not
significant enough to have any consequential change in the daily liquidity and
movements of the market. When a country is on bank holiday, than you can expect poor
liquidity and possibly choppy and less desirable price action for the day.
Month end can be a period of less predictable market action. Pay particular attention
quarter end, Double and Triple Witching:
Triple Witching Hour Definition (Investorwords.com)
The final hour of the stock market trading session on the third Friday of March, June,
September, and December, when option contracts and futures contracts expire on market
indexes used by program traders. The simultaneous expirations often set off heavy
trading of options, futures and the underlying stocks, which can cause large fluctuations
in the value of their underlying stocks.
You may want to use the monthly view to note other important days like taking your
sweetheart to a fine restaurant, a trip to the zoo or a ride down a bobsled track, so your
they don't think trading is your new mate.

By-The-Day Calendar

One full page is sectioned for a daily view. Conveniently, one the daily view page you
can also reference a full list of economic reports for the week and, on the same page,
there is a "quick view" of the calendar month and calendar year forward showing the
important bank holidays.
The Market Moving reports are noted in bold green in the daily and weekly view on the
page. The multi time zone reference is handy, because it enables you to see the time in
each time zone when the report will occur. This is helpful, because we may access
alternative informational materials (i.e. bank reports, daily summaries) that reference
their local time zone. It helps to train the mind to understand where peak market activity
is in relation to one another.

Glossary
Each of the terms used in the calendar can be found in the glossary. The market moving
indicators can be found both, in the glossary, as well as in their own section named
"Market Moving Indicators" where additional detail is provided on the indicator along
with an explanation of "Why Investors Care."

Market Moving Indicators

Just as the indicators are titled, there are approximately twelve indicators that can have a
significant immediate impact on market liquidity and volatility. Traders are advised to
pay close attention to the time of release of market movers. It is advisable to properly
manage existing positions, or avoid having exposure at the time of the event, altogether.
The market changes its view of what data is important as domestic economics constantly
adjust.
The relative importances of specific economic releases also tend to evolve and change
with time. In 1992, the trade balance was the number one market moving US economic
release on a when tracking the reaction 20 minutes following the event, while non-farm
payrolls (and unemployment data) was the third. In 2004, the two indicators were
shuffled with non-farm payrolls being the biggest market mover for the dollar and the
trade balance ranking third. It is a natural occurrence as the market shifts its attention to
different economic sectors and data due to economic changes, for example; trade balance
becomes important when a country is operating at insurmountable deficits and
accumulating massive debt. Likewise, employment data becomes important when a
country seems to have difficulty stimulating jobs, thus the market will focus on the
employment situation.
Now, into 2006, the market is not what it was at the time of the evaluation above.
It is the shifts in what is important to the market participants that traders must identify in
order to take advantage of medium and longer term trading opportunities. Understanding
when the market places more or less value on a particular piece of data will have your
hand on the pulse of the market as participants change their flavor of the month. For
example, the "Employment Situation" (non-farm payrolls/unemployment) has
experienced shifts of importance in relation to other market stimuli. There have been
periods when the market would definitively consolidate prior to an Unemployment
announcement while traders waited with great anticipation which direction their favorite
currency cross would take following the report. This environment was friendly for traders
to use a simple strategy of placing a buy or sell entry above or below the consolidation
and potentially make a nice sum of money.
This technique was soon washed out when several things changed. First, brokers
withdrew their promise to guarantee fills, which left any such speculators exposed to
potentially large gaps that could generate nice losses resulting from the reaction to the
report. In addition, the perceived significance and market reaction to the report has
changed materially. It is common for the market to react in a panic of indecisiveness
while positions within a large range get wiped out and are taken or "locked-in" to losses.
Trading into the report of a top market mover is a form of gambling and is more an art of
guesswork, rather than calculated skillful trading.


International Organizations
As a serious trader, you will hear buzz words of notable international organizations that
play an integral role in global markets. Details about these organizations are contained
within the calendar on page A29. Take the time to understand who these organizations
are and what purpose they serve.

Fundamental Factors Affecting the USD

Federal Reserve Bank
The US Central Bank has full control over setting monetary policy with the objective of
achieving maximum non-inflationary growth. The fed controls the three tools of
monetary policy - Open Market Operations, the Discount Rate, and Reserve
Requirements. For more details on these items, visit www, federalreserve.gov/fomc/
Federal Open Market Committee (FOMC)
The primary responsibility of the FOMC is to make decisions on monetary policy, which
include interest rate announcements 8 or more times per year.
The position as Chairman is being passed from Alan Greenspan to Board of Governors
member, Ben Bernanke.
10-Year Treasury Note
The 10-Year Treasury Note is a bond that matures in more than 10 years. It is often
referred to as the "long bond." The 10 Year Treasury Note has become the benchmark for
long-term interest rates. It is considered the most important indicator that fuels a market
expectation for inflation, which ripples into the financial markets as participants attempt
to position themselves accordingly. It is common for the USD to strengthen when 10-
Year Treasury yields increase, because investors seek higher yields for safety capital.
For a basic understanding, bond prices and yields move in opposite directions. So if you
read or hear of bond prices going up, this means that bond yields have dropped and vise
versa. Bond prices/yields will move with the markets anticipation of interest rate
expectations.
3-Month Eurodollar Deposits
A USD held by a foreign institution outside the U.S., usually a bank in Europe, often as a
result of payments made to overseas companies for merchandise.
A more generalized global definition would be that a Eurodollar deposits are bank
accounts deposited in a country other than the country of the currency. For example; USD
accounts deposited outside of USA are named "Eurodollar," or Japanese Yen accounts
deposited outside Japan are called "Euroyen," Euros held outside Eurozone would be
called EuroEuro deposits,
The interest rate differentials among the Eurodollar deposits can help determine currency
valuations as holders of cash gravitate toward the higher interest paying security.
US Treasury
The US Treasury has the responsibility of issuing government debt and making decisions
on the fiscal budget, has no involvement in monetary policy.
Treasury Secretary is John Snow. When the Secretary makes well crafted or offhanded
comments about the dollar, it can have a notable influence on the currency's valuation.
US Economic Data/Indicators - Market Movers
The markets moving economic indicators in the US are:
• Consumer Price Index - CPI

• Durable Goods Orders
• Employment Situation
• FOMC Meeting Announcement - Typically pertaining to Interest Rates
• GDP
• Housing Starts
• Industrial Production & Capacity Utilization
• International Trade Balance
• ISM Manufacturing Index
• Personal Income & Outlays
• Producer Price Index - PPI
• Retail Sales
• Consumer Confidence
• *University of Michigan Sentiment Survey
Stock Market
The major indices for the US equity markets are:

1. Dow Jones Industrials
2. S&P500
3. NASDAQ
The movement of the US dollar has moved in and out of correlation with the Dow over
the past few years. Recently there has bee a low correlation between the movement in US
equities and the USD.

Fed Funds Rate Futures Contract
Fed Funds Rate Futures Contracts can impact both equity and currency markets.
These are contracts, bought and sold on the Chicago Board of Trade, used by speculators who
want to gamble on interest rates and, to a lesser extent, by money managers who want to hedge or
offset interest-rate risk in their funds.
The prices of these contracts reflect investors' collective wisdom about where short-term interest
rates are going. For example, if the US economy has a string of strong employment data, the
market could begin to speculate on an increase in interest rates and the futures contracts could
reflect this forecast.
The Fed Funds Rate could also lead to speculation on the interest rate of the 3-month Eurodollar
Futures Contract.
Double Deficit
The US economy is deemed to have a "Double Deficit" (aka "twin deficit") if it has a Current
Account deficit and a Fiscal (Budget) Deficit. In effect, the economy is giving claims on
domestic assets to foreigners in exchange for foreign-made goods. Many economists claim that
persistent double deficits will lead to currency devaluation/depreciation that can be severe and
sudden.
Current Account: The term current account usually refers to the current account of the balance
of payments (BOP) and contains the import and export items of goods and services as well as
transfer payments including net investment income. The current account is often presented
alongside the capital account and financial account of the BOP which contains data about short
and long-term capital flows. Long-term capital flows are also known as foreign direct investment
(FD1). Often, the capital account and the financial account are both referred to as the capital
account. The BOP balances by means of a balancing account which allows for changes in official
reserve assets.
When it is talked about most, the current account will be either in large surplus (export receipts
exceeding import payments) or substantial deficit (import payments exceeding export receipts).
Generally it is a significant current account deficit (rather than a surplus) that is perceived to be a
problem requiring action, but the current (trading) and capital (largely financial) accounts are
inter-rclatcd and a persistent capital surplus can (by raising the exchange rate above the level it
would otherwise reach) cause a current account deficit.

Key Drivers of Current Account: The items in the current account (e.g. perhaps especially
imports and exports of goods) are sensitive to international price differentials (the differences
between the prices of goods in different countries), to the rise and decline of industries (e.g the
emergence of the Japanese automobile industry 20 years ago, and the decline of the US
steel industry at the same time), and to differential economic growth rates (e.g. with a
country being likely to experience a deteriorating current account balance if its economy
is growing more rapidly than other countries).
The theory of purchasing power parity deals with the relationships between price levels
(and changes of price levels) in competing countries, and is relevant in any discussion of
the stability and likely trajectory of a current account balance, because the price pressures
that may be operating will find their expression primarily (though not exclusively) in the
traded goods area (within the current account).
Fiscal Deficit: occurs when an entity (often a government) spends more money than it
takes in. The opposite is a budget surplus.
The size of a governmental budget deficit is often an important political issue as well as
one of economic policy. Fiscal conservatives denounce deficit spending and advocate
balanced budgets.
An accumulated deficit over several years (or centuries) is referred to as the government
debt. Often, a certain part of spending is dedicated to paying of debt with certain
maturity, which can be refinanced by issuing new government bonds. That is, a fiscal
deficit leads to an increase in an entity's debt to others.

EUR/USD
The Eurozone
There are 12 members in the Eurozone: Austria, Belgium, Finland, France, Germany,
Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal, and Spain.
The European Central Bank The primary objective of the ECB's monetary policy is to
maintain price stability. The ECB aims at inflation rates of below, but close to, 2% over
the medium term.
Harmonised Index of Consumer Prices (HICP)

The index of consumer prices whose statistical methodology has been harmonised across
countries. The HICP was developed by the European Commission (Eurostat) in close
liaison with the national statistical institutes and the ECB and, formerly, the European
Monetary Institute (EMI). The HICP is the measure of prices used by the ECB to define
price stability in quantitative terms.
In other words, it is an inflation indicator used by the European Central Bank. New prices
of products are added to the HICP only after these products have become significant in
the market. Every month, each country publishes a report containing data about the
HICP. ECB targets 2% inflation. ECB Council meets every other Thursday to announce
interest rates.
ECB President: Jean Claude Trichet. He may deliver well-scripted comments that could
heavily influence currency moves.
Interest Rates

The Governing Council of the ECB sets the key interest rates. The three key interest rates
for the euro area:
1. The interest rate on the main refinancing operations (MRO), which provide the
bulk of liquidity to the banking system. The Eurosystem may execute its tenders in the
form of fixed rate or variable rate tenders. Since 27 June 2000 the MRO have been
conducted as variable rate tenders with a minimum bid rate. The difference between this,
the refinancing rate, and the US Fed Funds rate is a good indicator for the EUR/USD
movements.
2. The rate on the deposit facility, which banks may use to make overnight deposits
with the Eurosystem.
3. The rate on the marginal lending facility, which offers overnight credit to banks
from the Eurosystem.
3-Month Eurodeposit (Euribor)
Euro Interbank Offered Rate (Euribor) is the rate at which a prime bank is willing to lend
funds in euro to another prime bank. Remember, Eurodollar deposits are bank accounts
deposited in a country other than the country of the currency. So, Euros deposited in
banks outside Eurozone are called "EuroEuros." The interest rate set on 3-month Euribor
deposites held in banks ourtisde Eurozone. Traders will compare the interest rate
differential between the Eurodollar rates to help estimate currency cross rates.
10-Year Government Bonds
As we established with the USD 10-Ycar Treasury Note, similarly, the German 10-Year
Bund is normally used as a lead for the Eurobond market and interest rates. The market
closely observes the interest rate differential between the US and Eurozone, which can
drive EUR/USD exchange rates. So, if we see a rise in USD interest rates and a
stabilization or fall in Eurozone interest rates, reflected in German 10-Year Bund yields,
than we could speculate that the EUR/USD cross could fall (USD rally). Interest rate
differentials is commonly related to comparative growth outlooks for the two regions.
Economic Data/Indicators - Market Movers
• GDP
• HICP - Inflation
• Purchasing Managers Index - PMI, manufacturing and services
• Unemployment

• Industrial Production
• Current Account and portfolio flows
Within the Eurozone, there are also some national reports that can impact the market
• Germany's IFO and ZEW economic sentiment surveys are indicators of business
confidence. Reports out of Germany tend to have more impact on the EUR
exchange rate than other Eurozone members.
3-Month Euro Futures Contract (Euribor)
The contract typically indicates what the market expects of the 3-Month EuroEuro
Deposits (Euribor) to be priced in the future. Do you remember the reference to 3-Month
Eurodollar Deposits earlier in this document? The difference between the Eurodollar and
the EuroEuro contract can offer a hint for EUR/USD expectations.
Political and Psychological Factors
Political or psychological factors clearly have an influence on exchange rates. Global

political concerns are factored into the exchange rates; such as, Swiss francs which are
known as a refuge or safe haven currency while the dollar moves (cither up or down)
whenever there is a political crisis anywhere in the world. For example, the EUR/USD
cross rate may trade within a comparative value to the USD/CHF, but when political
instability as a result of war and terrorism heighten, then and increase in the value of CHF
often unfolds.
The EUR is the primary beneficiary to most negative news and events coming out of, or
aimed at, the US, such as; Presidential elections, oil price, terrorism, war, deficits, trade
balance, etc. Alternatively, if there is a string of positive news out of Eurozone, but the
EUR/USD continues to fall, there are underlying factors that are weighing heavily on
EUR in opposition to the positive economic data, which is negative for the EUR/USD
cross.

USD/JPY
Ministry of Finance
The Ministry has long been regarded as the most powerful ministry in the Japanese
government and has control over foreign exchange policy. After various financial
scandals revealed in the 1990s, however, the Ministry lost its power over banking
supervision to a newly-established Financial Services Agency. It also lost its control over
monetary policy conducted by the Bank of Japan.

In financial markets, the Ministry is famous for its active foreign exchange policy. Its top
civil servant on the international side, Vice Minister of Finance for International Affairs,
is often quoted in the markets. Former Vice Minister Eisuke Sakakibara was known as
"Mr Yen", whereas his successors Haruhiko Kuroda and Zembei Mizoguchi were often
referred to as "Mr Asian Currency" and "Mr Dollar", respectively.
More than any other currency, the Ministry of Finance in Japan has influence over the
movement of their own currency through various means of intervention. The market
moving figureheads are the Finance Minister and the Vice-minister for International
Affairs.
Monetary policy
Monetary policy is the process of managing a nation's money supply to achieve specific
goals— such as constraining inflation, achieving full employment or economic growth.
Monetary policy can involve changing certain interest rates, either directly or indirectly
through open market operations, and setting reserve requirements.
Monetary policy is the regulation, availability, and cost of credit, while fiscal policy deals
with government expenditures, taxes, and debt. Through management of these areas, the
Ministry of Finance regulated the allocation of resources in the economy, affected the
distribution of income and wealth among the citizenry, stabilized the level of economic
activities, and promoted economic growth and welfare. Monetary policy is under the
control of the Bank of Japan.
Interest Rates
Since the Bank of Japan Law of 1997 took effect in April 1998 the Bank of Japan (BoJ)
has control over monetary policy. The BoJ's Policy Board in its Monetary Policy
Meetings makes decisions on interest rates. The BoJ's official interest rate is the discount
rate and the Overnight Call Rate is the key short-term interbank rate, which is controlled
by the BoJ's open market operations. The call rate is a guide to trigger monetary policy
changes, which can impact currency valuations.
Japanese Government bonds (JGBs)
Government bonds are the bonds issued by the government, which is responsible for
interest and principal payments. Interest is paid every six months, and principal payments
are secured at maturity. The issues of the bonds are used to stimulate the system by
providing liquidity.
In Japan, similar to our discussion with EUR and USD, the yield on the 10-Year JGB
offers a good indication of long-term interest rates. Again, foreign exchange traders will
closely observe the differential between the yield on the US 10-Year Treasury Note in
comparison to the yield on the 10-Year JGB yield. Thus, if the US 10-Year Treasury
Note rises versus a stable or falling 10-Year JGB yield, this could be reflected in the
foreign exchange rates with a boost to the USD/JPY cross.
JPY Economic Data/Indicators - Market Movers
• GDP
• BoJ's Quarterly Tankan Survey - Business sentiment survey and expectations • PMI
• Unemployment
• Tertiary Sector Industries Survey
• Industrial Production
• International Trade
• Money Supply
GBP/USD
Bank of England (BoE)
It performs all the recognized functions of a central bank - to maintain price stability, and
subject to that, to support the economic policy of Her Majesty's Government (Bank of
England Act 1998) in order to promote economic growth and employment goals. It has a

monopoly on the issue of banknotes in England and Wales; it is both the Government's
banker and the bankers' bank; it manages the country's foreign exchange and gold
reserves.
BoE also acts as Central Bank for Northern Ireland (UK).
Monetary Policy
The Monetary Policy Committee (MPC) is a committee of the Bank of England, which
meets every month to decide the official interest rate in the United Kingdom.
The BoE previously had an inflation target of 2.5% gauged offthe Retail Prices Index
excluding mortgages, but now uses the same indicator as European Central Bank, the
Harmonized Index of Consumer Prices (HICP), which UK authorities call CPI, because
of exclusion of housing costs. The adjusted inflation target now used is 1.75% to 2.0%
using HICP/CPI
As an FX trader, just keep your eye on CPI and watch the inflation figures as they come
out to see how the market reacts to figures versus expectations in the rate announcements.
Interest Rates
The primary interest rate instrument of the Bank of England (BoE) is the Minimum
Lending Rate (MLR) base rate. Usually in the first week of each month, the MLR is sent
out to give an indication on monetary policy changes. Any changes will often have an
impact on GBP currency rate crosses.
As listed in previous crosses, likewise, the interest rate on 3-month Eurosterling Deposits
held in banks outside the UK may contribute the cross valuation. As well, the difference
between the 3-month Eurosterling Deposits and the 3-month Eurosterling futures contract
can offer a sign of expectations of the GBP/USD expectations.
Gilts
As we have seen in other national regions, with each country having government
bonds/securities, UK government bonds arc the gilt-edged securities, aka "Gilts."
Similarly, the yield differential between the yield on 10-year Gilts and the yield on
10year US Treasury note will have an impact on the GBP/USD cross valuation. If you are
trading EUR/GBP, the yield differential between German Bunds and Gilts may have
impact on the noted cross.
•••

Currently, a lurking issue in the UK is the "If, How, and/or When the UK will make a
move towards EMU. Naturally, there are a number of issues that will have to be managed
for such a movement to come to fruition. To name a few; Interest rate differentials
between Eurozone and UK and its impact on industry, is it better or worse for UK, impact
on financial services industry, and the compatibility of economic structures and flexibility
to deal with them manageably.
There is a high correlation between GBP/USD and EUR/USD cross movements. Some
considerations for this effect are a result of increasing trade between the UK and the
Eurozone, because 2/3's of UK exports go to the Eurozone. To convert to a single
currency with a trade partner (Eurozone) may optimize the flow of trade. Further, the
market may be pricing in the possibility of the UK joining EMU.
GBP Important Economic Indicators
• GDP
• Claimant Unemployment
• Average earnings
• RPI - X/HICP
• Retail Sales
• PPI
• CIPS - Purchasing managers survey
• Balance of Payments
• Housing prices
• BoE Quarterly Inflation Report
USD/CHF
The Swiss National Bank (SNB) holds maximum independence in setting monetary and
exchange rate policy aimed at maintaining price stability. The SNB considers price
stability to be achieved with an annual inflation (CPI) rate of less than 2%. The SNB
bases its monetary policy decisions on a medium-term (three year) inflation forecast.

Switzerland maintains a stable economy with low unemployment, a highly skilled labor
force, and a per capita GDP larger than that of the big Western European economies. The
Swiss in recent years have brought their economic practices largely into conformity with
the EU's to enhance their international competitiveness. Switzerland remains a safe haven
for investors, because it has maintained a degree of bank secrecy and has kept up the
franc's long-term external value. Reflecting the anemic economic conditions of Europe,
GDP growth dropped in 2001 to about 0.8%, to 0.2% in 2002, and to -0.3% in 2003, with
a small rise to 1.8% in 2004. Even so, unemployment has remained at less than half the
EU average.
Interest Rates
The SNB issues changes to monetary policy with adjustment in the discount rate.
Changes in the discount rate can have a considerable impact on the currency.
As we have discussed with Euroeuro, Eurosterling and Euroyen 3-month deposits, the
3month Euroswissfranc Deposits interest rates can forecast speculative change, as traders
price in an expectation of shifting interest rate differentials.
CHF Important Economic Indicators
Swiss economic reports have little impact on the valuation of its currency against other
currencies. It is typically the cross currency that can impact the CHF. As with other
countries, the primary reports that impact the country are: CPI, Unemployment, Balance
of Payments, GDP, Industrial Production, MMI and Money Supply.
The correlation between the USD/CHF and the EUR/USD is one of the strongest in the
currency markets. This is due to the central proximity of the country to the Eurozone and
the statistic that 61% of Switzerland's exports go into the Eurozone.
In addition, it is relevant to note that Switzerland has the strongest Trade Balance as a
percentage of GDP in comparison to Japan, Eurozone, UK and US.
Commodity Currencies AUD and CAD

AUD
The Australian dollar is labeled a "Commodity Currency," because its valuation is tied to
the prices and demand of commodities, such as; Gold, Copper, Nickel, Coal and Wool,
which make up approximately 2/3's of total Australian exports. Hence, as prices of these
commodities increases with global demand, so does the dollar value versus other crosses.
Note the parallel between the price of gold and the increase in the AUD/USD exchange
rate.
In addition, Aussie offered high short term yields in 2004/05 compared to other major
currencies, which inspires flows into the currency and pushing up the valuation. The
favorable yields should keep the currency strong against the majors.
CAD
The fact that Canada is a substantial bordering nation to the world's largest economy has
created the largest bilateral trade between two nations. Nearly 80% of Canada's exports
go into the US making Canada's economy largely dependent on the US. As a result, under
relatively ordinary conditions, the Canadian dollar would fare better than other currencies
against positive US economic news.
The Canadian dollar is considered a "Commodity Currency" as commodities make up

about half of Canada's exports. The Canadian dollar responds favorably to a rise in
commodity prices in mining and energy, petroleum, in particular. The Canadian dollar
has seen a significant increase against the majors in 2005 resulting largely from the
increase in Oil prices. Canada has the world's second largest oil reserves in Alberta's oil
sands, but until oil has held above $35 p/b it has not been economically viable to produce.
$50 dollar oil has created a new wealth for Canada as reflected in the movement of its
currency against all others. Even while the USD has rallied against the majors, CAD has
continued to strengthen against the USD.
Central Bank Intervention

The following article from the Bank of Japan offers a thorough explanation on the
process of FX intervention. It will also offer some insight into the operations of bank
foreign exchange dealers.

Outline of the Bank of Japan's Foreign Exchange Intervention Operations
I. Introduction
Since the introduction of a floating exchange rate system in February 1973, the Japanese
economy has experienced large fluctuations in foreign exchange rates, with the yen on a
long rising trend. In order to mitigate the negative influence of such fluctuations on the
Japanese economy, foreign exchange market interventions (hereafter "foreign exchange
interventions" or simply "interventions") have been conducted from time to time.
Although, these interventions have occasionally been reported in newspapers and other
news media, the actual operational procedures seem not to be well understood. This
article will therefore briefly explain the basics of foreign exchange intervention, focusing
on the practical side.
The next section begins with the definition of foreign exchange intervention and goes on
to outline its legal status. Section III explains the operation of intervention, including the
decision-making procedures. The last section deals with the funding and foreign
exchange reserve management that accompany foreign exchange intervention.
II. What Is Foreign Exchange Intervention?
A. Definition and the Legal Status of Intervention
Foreign exchange intervention is defined generally as foreign exchange transactions

conducted by the monetary authorities with the aim of influencing exchange rates. In
Japan, the Minister of Finance is legally authorized to conduct intervention as a means to
achieve foreign exchange rate stability.1 The Bank of Japan, as the agent of the Minister
of Finance, executes foreign exchange intervention operations in accordance with the
directions of the Minister of Finance. The expression "Bank of Japan Intervention," often
used in newspapers and other news media, might therefore be misleading (for an
international comparison of foreign exchange intervention systems, please refer to the
appendix).
1
The Foreign Exchange and Foreign Trade Law stipulates that the "Minister of
Finance shall endeavor to stabilize the external value of the yen through foreign exchange
trading and other measures" (Article 7, Section 3).
2
The Bank of Japan Law stipulates that the Bank buy and sell foreign exchange
"as the agent of the government......,when its purpose is to stabilize the exchange rate of
the national currency" (Article 40, Section 2). The Foreign Exchange Fund Special
Account Law stipulates that the Minister of Finance may entrust operations involving the
Foreign Exchange Fund that are stipulated in the Article 5 to the Bank of Japan (Article
6, Section 1).

B. Types of Foreign Exchange Intervention
Foreign exchange interventions arc usually conducted in the Tokyo market. However, as
most of the trading shifts to European markets after around 5:00 p.m. JST and then to the
New York market, in cases where it is considered necessary to intervene during these
hours, the Bank of Japan, as the agent of the Minister of Finance, requests foreign
monetary authorities to conduct interventions on behalf of the Bank ("entrustment
intervention"). The final decision to use this method is made by the Minister of Finance.
The Minister also determines the details of the intervention including the amount,
currency pair, and method of intervention. The funds necessary for intervention come
from the Foreign Exchange Fund Special Account (explained later) irrespective of the
market where the interventions are conducted.3 Similarly, when foreign monetary
authorities need to intervene in the Tokyo market, the Bank can conduct interventions on
their behalf upon request ("reverse-entrustment intervention").4
There are cases where two or more monetary authorities implement intervention jointly
by using their own funds at the same time or in succession. This is called "coordinated
intervention."
** 3Entrustment intervention" means intervention that is conducted in overseas

markets with funds of the Japanese authorities. It is different from the intervention that
is conducted in overseas markets with funds of respective foreign monetary authorities.
4
The funds of foreign monetary authorities are used in this kind of intervention.
C. Purpose of Foreign Exchange Intervention
The Foreign Exchange and Foreign Trade Law stipulates that the Minister of Finance
shall endeavor to stabilize the external value of the yen by taking necessary measures
including foreign exchange transactions.
III. Operational Procedures of Foreign Exchange Intervention
The Bank of Japan conducts foreign exchange intervention operations as the agent of the
Minister of Finance, as mentioned earlier. The sections engaged in and responsible for
intervention operations are the Foreign Exchange Division of the Financial Markets
Department (hereafter BOJ Forex Division) and the Planning and Coordination Division
of the International Department.1
1
Before the reorganization of May 2000, as a result of which dealers moved to the
Financial Markets Department from the International Department, the former Foreign
Exchange Division of the International Department had sole responsibility for the

operation. In view of the ever-closer linkages between domestic and foreign financial
markets and the increasingly active cross-border flow of funds, it is expected that both
monitoring and analytical ability will be greatly enhanced by the reorganization.
A. Collecting Information
The BOJ Forex Division closely monitors and analyzes developments in foreign
exchange markets day and night through frequent contact with market participants, the
Bank's overseas offices, and foreign central banks, as well as utilizing the services of
information vendors. In addition, the Forex Division carries out research on
developments in the areas that relate to the foreign exchange markets, such as
developments in overseas securities and stock markets and commodity prices.
Information gathered in these ways is passed to the Policy Board and other related
sections in the Bank as one of the factors on which a judgment of the state of financial
and business activities in the Japanese economy is based.6 As the agent of the Minister of
Finance, the BOJ Forex Division reports such information every day also to the Foreign
Exchange and Money Market Division of the International Bureau of the Ministry of
Finance (hereafter MOF Forex Division), which is in charge of foreign exchange
intervention in the Ministry.
6
The Bank of Japan provides the public with information on the foreign exchange market
through pre-recorded telephone services. This information includes the highest and
lowest values as well as turnover, and is revised every hour. (+81-3-3279-2256, Japanese
only).

B. Foreign Exchange Intervention Decision-Making
When foreign exchange rate developments are regarded as too volatile, the MOF Forex
Division gets in touch with the BOJ Forex Division on the hot line, and is supplied with
the background information on the volatile movements and other relevant information for
making decision on intervention.
If the Minister of Finance decides to conduct intervention based on such information, the
MOF Forex Division gives the BOJ Forex Division specific directions for the
intervention. The Minister of Finance determines the details taking into consideration
various factors in the foreign exchange markets in order to maximize the effectiveness
and efficiency of the intervention. The BOJ Forex Division continues to monitor the
market developments in parallel with the intervention and provides the MOF Forex
Division with information, such as market reactions to it. There are cases where the
method of intervention is modified based on the Bank's report.
C. Settlement
Once a dealer of the Bank reaches agreement on the terms of a transaction and makes a
contract with the counterparty, the back office takes care of the remainder of the business.
The back office in the Planning and Coordination Division of the Bank's International
Department is responsible for confirming the terms of contracts made by dealers in the
front office and also for carrying out the transactions (i.e., settlement).
Confirmation is done by matching the terms of contracts with the counterparties over the
telephone or by SWIFT,7 based on the contract records kept by the dealers. Having
confirmed the contract, the back office proceeds to settlement. Settlement for an
intervention is made, in principle, through the authorities' accounts at the central bank
whose currency is the subject of the intervention.
7
Abbreviation for The Society for Worldwide Interbank Financial Telecommunication, a
data telecommunication system for transmitting messages relating to international
banking transactions. The headquarters of the system is located in Brussels, and the Bank
of Japan has been a member since 1987.
IV. Financing and Investment of Funds for Foreign Exchange Intervention

This section will briefly explain how interventions are financed as well as the basic policy
for the investment of foreign exchange reserves, which have been accumulated partly as a
result of interventions.
Intervention by the Bank of Japan as the agent of the Minister of Finance is conducted by the
account of the Japanese Government, which is called the Foreign Exchange Fund Special
Account (hereafter FEFSA).8 This fund consists of foreign currency funds and yen funds.
In case of U.S. dollar buying/yen selling intervention, for example, the yen funds to be sold are
raised by issuing Financing Bills (FBs). In the event of U.S. dollar selling/yen buying
intervention, U.S. dollar funds held in the FEFSA are used for buying the yen in the markets.
The Japanese Government holds large amounts of foreign currencies in the FEFSA, partly
as a result of foreign currency buying/yen selling interventions in past yen appreciation
phases. The Minister of Finance makes decisions on investments of these currencies
paying careful attention to liquidity and safety. Most of these funds have been invested in
securities issued by the authorities of major industrial countries, which are almost
immune from liquidity risk. The back office also plays a role in the implementation of
such foreign currency funds investment.
8
The FEFSA system consists of two elements: the Foreign Exchange Fund and the
narrowly defined Foreign Exchange Fund Special Account. The former is a fund
prepared for foreign exchange trading by the Government. Purchases/sales of foreign
exchange by this fund are not recorded as the revenues/expenses of the Government. In
the latter, results of trading such as (1) profits/losses arising from foreign exchange
trading and (2) payment/receipt of interest arising from fund-raising/investment
accompanying foreign exchange intervention are recorded as the revenues/expenses of
the Government.

APPENDIX
Systems of Foreign Exchange Intervention Abroad
United States Euro Area United Kingdom
Authority Government (Treasury European Central Bank Government (the

for Department) and Federal (ECB) Intervention should Treasury) and Bank of
Intervention Reserve Board (FRB) — be consistent with the England — Intervention
Government has priority general orientations by BOE is restricted to
with regard to the formulated by ECOFIN. occasions when it is
decision. The general orientations necessary to attain the
arc formulated after monetary policy objective.
consulting the ECB, or on
a recommendation from
the ECB and "shall be
without prejudice to the
primary objective of the
ESCB to maintain price
stability."
Operation of Federal Reserve Bank of ECB BOE
intervention New York

Funds for Government (Foreign ECB Government (Foreign

intervention Exchange Stabilization Exchange Operation
Fund) and FRB (usually, Account) and BOE. The
each finances half of the Treasury is planning to
amount used for disclose intervention on a
intervention). Intervention monthly and quarterly
results are reported to the basis on its Web site.
Congress every quarter
(also published in Federal
Reserve Bulletin).
A Day in the Life of the Bank of Japan's Foreign Exchange Dealers
-- Written by Masafiimi Yamamoto, Foreign Exchange Division
Foreign exchange dealers are, in general, very early birds, and dealers at the Bank of
Japan are no exception. We start work before 7:00 a.m. JST when morning trading in the
Sydney market in Australia, which starts two hours earlier, peaks out. Our first job is to
get ready for the morning market reports meeting by gathering, sorting, and analyzing
information. We first check the previous day's developments in the New York and
European foreign exchange markets, and then make our own forecasts for the day by
listing up bull and bear factors as well as by exchanging views with market participants.
Information we gather ranges over various areas such as economic indicators, statements
by high officials, political events, holidays, and rumors circulating in the market. All
kinds of media are utilized, including paper media (newspapers, fax news services,
magazines), on-line media (computer on-line services, e-mail communication), and voice
(telephone conversations). As the volume of information is tremendous, and there is both
useful and useless information, we have to screen it and formulate our own view.
There is no time for rest even after the morning meeting. Recently, the improvement in
on-line communication media has made it easy for anyone to obtain global information
on a real-time basis, dramatically increasing the efficiency of information gathering.
However, as the whole market reacts simultaneously even to trivial news, we have to be
alert at all times. It is often the case that foreign exchange rates fluctuate abruptly due to
unexpected factors. This means that the market has to be analyzed from the standpoints of
various areas such as macroeconomic analysis, time-series analysis (which requires
sophisticated econometric methods), historical studies, political analysis, and even
astrology. Thus, we have to keep on obtaining and analyzing information throughout the
day.
Although electronic media have become so popular and useful that we are not able to live
without them, conversations over the phone with market participants are still vital for
monitoring the markets. Market participants' views occasionally differ significantly and it
is often the case that subtle changes in their sentiment gradually grow to a strong trend in
exchange rates. Frequent contacts with market participants are the most effective way to
remain sensitive to market developments. Communication with market participants is
also an important channel for providing them with accurate information on the Bank's
monetary policy stance and on the statements of the Bank's officials and thus helps to
prevent market reaction arising from misunderstanding.
We look most active when we are conducting intervention. The Bank of Japan, as the
agent of the Minister of Finance, conducts foreign exchange transactions (i.e.,
intervention) in order to stabilize the yen's value. This is stipulated in laws such as the
"Foreign Exchange Fund Special Account Law" and the "Bank of Japan Law."
Specifically, the Foreign Exchange Division is the operational unit of intervention. When
a large fluctuation in the yen is expected to have significant negative effects on the
economy, the hot line connected to the Ministry of Finance rings. Several dealers and
back-up staff members are quickly on standby, and the tension builds up in the dealing
room. When intervention is decided, the room is thrown into an uproar as the dealers and
the chief dealer shout their orders and directions.
After 5:00 p.m. JST, the majority of trading shifts to the European market, and usually,
the Bank's representative offices in Europe and the United States take over the task of
monitoring. It is not until then that we arc released from the high tension that started in
the early morning. However, when the exchange rates show too much volatility, we
cannot close our business even after the Tokyo market closes. It is not uncommon that we
continue monitoring during European and U.S. trading time by contacting dealers in
overseas markets and people in charge of monitoring foreign exchange markets at foreign
central banks. When the Bank of Japan requests foreign central banks to conduct
interventions on behalf of the Bank, senior officials of the Bank play the roles of liaison
and broker between the Minister of Finance and the foreign central banks. When this
happens, work often continues till dawn.
Example of Intervention Transaction:
Total amount of foreign exchange intervention operations for the period from January
through March 2004: ¥ 14,831.4 billion

Mar 5,2004 ¥ 1,244.6 billion the US dollar (bought)

the Japanese yen (sold)
Glossary of Non-U.S. Economic Indicators

CBI Surveys
Britain's largest organization of business employers publishes surveys assessing the
manufacturing and services sectors.
HICP
The Harmonized Index of Consumer Prices (HICP) provides a common measurement of
inflation that facilitates carrying out international comparisons. It is obtained as a result
of homogenizing the most significant methodological aspects of each one of the
Consumer Price Indices from each one of the member states of the European Union (EU)
to make them comparable.
The HICP of each country covers the divisions that exceed one per thousand of the total
expense of the national shopping basket.
IFO
German business climate survey of construction, wholesaling and retailing.

Tankan Survey
Japan's chief business survey, compiled quarterly by the bank of Japan. Consists of
manufacturing and non-manufacturing firms.
ZEW Indicator
Indicator of Economic Sentiment: Germany's leading indicator on the overall economy.
Comprised of the opinions of 350 financial experts.
References:
MG Financial Group and Forexnews.com Daily FX Investopedia Wilkipedia Bank of

Japan
-end-

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Chris Lori - Understanding Global Fundamentals

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Understanding Global Fundamentals Forexmentor.

Copyright © 2006 Currex Investment Services Inc., All rights reserved

Copyright© 2006 Currex Investment Services Inc. - Written by Chris Lori 1

Foreign exchange traders should acquire a basic knowledge on the fundamentals

Copyright© 2006 Currex Investment Services Inc. - Written by Chris Lori 2

The Effects of Exchange Rate Changes

An Economic Indicator is a country’s (or zone’s) release of statistical data in what we

A country is like a company. Companies report earnings and detailed financial

• Consumer Price Index - CPI

Copyright© 2006 Currex Investment Services Inc. - Written by Chris Lori 4

International Economic Calendar Sample:

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Copyright© 2006 Currex Investment Services Inc. - Written by Chris Lori 6

ForexMentor© Econoday Economic Calendar

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Triple Witching Hour Definition (Investorwords.com)

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Copyright© 2006 Currex Investment Services Inc. - Written by Chris Lori 9

Copyright© 2006 Currex Investment Services Inc. - Written by Chris Lori 10

Copyright© 2006 Currex Investment Services Inc. - Written by Chris Lori 11

Market Moving Indicators

Copyright© 2006 Currex Investment Services Inc. - Written by Chris Lori 12

Copyright© 2006 Currex Investment Services Inc. - Written by Chris Lori 13

Copyright© 2006 Currex Investment Services Inc. - Written by Chris Lori 14

Fundamental Factors Affecting the USD

Federal Open Market Committee (FOMC)

10-Year Treasury Note

3-Month Eurodollar Deposits

US Economic Data/Indicators - Market Movers

The markets moving economic indicators in the US are:

• Consumer Price Index - CPI

The major indices for the US equity markets are:

Copyright© 2006 Currex Investment Services Inc. - Written by Chris Lori 16

Fed Funds Rate Futures Contract

Copyright© 2006 Currex Investment Services Inc. - Written by Chris Lori 17

Copyright© 2006 Currex Investment Services Inc. - Written by Chris Lori 18

Harmonised Index of Consumer Prices (HICP)

Copyright© 2006 Currex Investment Services Inc. - Written by Chris Lori 19

3-Month Eurodeposit (Euribor)

10-Year Government Bonds

Economic Data/Indicators - Market Movers

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3-Month Euro Futures Contract (Euribor)

Political and Psychological Factors

Political or psychological factors clearly have an influence on exchange rates. Global

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Copyright© 2006 Currex Investment Services Inc. - Written by Chris Lori 22

Japanese Government bonds (JGBs)

JPY Economic Data/Indicators - Market Movers

Copyright© 2006 Currex Investment Services Inc. - Written by Chris Lori 24

BoE also acts as Central Bank for Northern Ireland (UK).

Copyright© 2006 Currex Investment Services Inc. - Written by Chris Lori 25

GBP Important Economic Indicators

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CHF Important Economic Indicators

Commodity Currencies AUD and CAD

Copyright© 2006 Currex Investment Services Inc. - Written by Chris Lori 27

The Canadian dollar is considered a "Commodity Currency" as commodities make up

Central Bank Intervention

Copyright© 2006 Currex Investment Services Inc. - Written by Chris Lori 28

Outline of the Bank of Japan's Foreign Exchange Intervention Operations

II. What Is Foreign Exchange Intervention?

A. Definition and the Legal Status of Intervention

Foreign exchange intervention is defined generally as foreign exchange transactions