A Primer on Fundamental/Macro Analysis
Don’t panic, the
headline was correct, and no, I have not lost my mind. Let me
explain. I think it safe to say that most, if not all traders are technically
inclined. Frankly, given the short-term nature of trading, fundamentals simply
to not have an opportunity to be relevant. Regardless of the quality of ones
research, the market may simply choose to ignore it during the time of your
trade. While FX is certainly no different from a trading standpoint, technicals
take precedence, sound fundamentals do play a role and do matter. The nice
thing about FX is that you can employ two types of trades that take their cues
from both technical and fundamental analysis:
1. Long-term
trades (several weeks to months): these primarily take a top down analysis
approach and use technicals as the final confirmation
2. Swing
trades (several hours to several days): driven primarily by technicals with
fundamentals as a back-drop
So what are some of the macro factors that one
needs to take into consideration?
– Interest rate differentials
– Balance of trade
– Budget deficits/surplus
– Projections on future economic growth
– Statistical relationships between economic
numbers and their implications going forward
– Merger and acquisition activity between
countries
Let’s illustrate this by looking at some current
data regarding the Euro (EUR) and how we might be able to gain an edge in
determining future price direction.
It is no surprise that the Euro has been on a
tear versus the Dollar for the last year, and at this point, trying to isolate a
point to go short would be pure folly in my opinion. Nonetheless, future data
will provide clues as to when some change in direction may occur. Remember,
when you can attach a story to chart pattern, the level of conviction of that
trade will be far greater.
The number one concern for any country or in this
case “collection” of countries with an appreciating currency is how adversely it
will affect the export market. To date, the rapid acceleration in global
economic growth as mitigated the rise in the Euro. In fact, from a trade
weighted basis, the Euro is only mildly overvalued. What is a concern going
forward however is the speed at which the EUR may appreciate. This is where
statistical analysis comes into play. A 10% increase in the trade weighted EUR
tightens financial conditions by 100 bp’s (1%). If this happens in a swift
manner, it would be difficult for monetary policy to be responsive enough. The
result, by some estimates, would be a decrease in GDP 18 months out of
0.5-1.5%. Since the market is forward looking, this type of scenario offers
opportunities for traders looking to capitalize.
This is illustrated by a
simple model where we estimate the influence of the $ and the ISM index (two
proxies for the world environment) on the European PMI. A one point increase in
the ISM index typically boosts the PMI by +0.25 after a few months. A
1%appreciation of the EUR/$ tends to dampen the PMI by .0.18 after some delay.
Using these rules of thumb, we can assess the contributions of the $ and the ISM
on Euroland business confidence.
Since its trough
in June 2003, the negative influence of the decline in the dollar has been more
than offset by the rise in the ISM index (see graph). Their combined impact has
helped boost the PMI index by 1 point. In other words, external factors have not
yet weighed on the Euroland recovery and they will continue to provide some
boost at least until mid-2004.
Source: Goldman Sachs
^next^
By this broad based analysis it becomes obvious
that the Euro, not monetary policy, is the potential party crasher of a
sustained economic activity. As long as the economic recovery continues,
monetary policy should stay the course. However, if the PMI drops below 50,
that may change.
This analysis has zero transferability today to a
viable trading strategy, and in fact, may never. It is only through the
constant monitoring of such data that one will eventually be presented with a
situations where the analysis synchs up with present day price action, however,
it is at that point where significant opportunities exist.
This type of analysis does require time and
effort, and for many it may be viewed as rather in-depth and boring. It is my
goal going forward to use this column and the forthcoming FX Service as a way to
keep you abreast of such potential developments so that you do not have to do
the research required. Most importantly, do not lose sight of the original
intent of this column, HVT. I have said it many times recently, but it bears
repeating, HVT is facing changing market conditions (lack of volatility). No
longer is one one required to man the decks after the morning session, you
either make it happen then, or you wait till the next day. The extra time and
realities of this pushed me to FX early in 2003, it was the best thing I had
done in many years. It has been interesting, but more importantly it has been
profitable, and is the ideal compliment to HVT, I now have the best of both
worlds.
Below are some charts the illustrate some trades
that I did last week. Notice the duration of these trades? Certainly not the
type of trade that requires you to be tied to your monitors. Set a stop loss,
and then manage the position.
I trust that this article was helpful and not too
“academic”, however, my experience has taught me that a solid understanding of
both macro and technicals will serve you well. As mentioned earlier in the
column, the addition of FX to my daily HVT has rounded me out just fine, I trust
you will draw the same conclusions.
I encourage you to send any comments or questions
to me regarding any of the material I mention regarding FX.
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