Using fundamentals in practice.
The euro appeared at the beginning of 2000 as the single currency of 12 union countries, and up to 2019, the number of the regions in the Eurozone increased to 19. All these economies (especially small ones) are closely intertwined, and therefore any news from Germany, France, Italy or Greece is capable of setting the single currency in motion.
Let us clarify that the Eurozone implies a closer level of integration and coordination than the European Union, which includes 29 countries. In the Eurozone countries, they have not only the common currency but also the common monetary policy from the European Central Bank.
Although at the moment not all the EU countries have accepted EUR, the main aim of the single region’s development is the euro circulation.
However, the Eurozone debt crisis, reaching its peak in 2011, undermined these plans. There are still global doubts that such a wide range of economies, from Germany to Greece, with radically opposing views on fiscal policy, can continue to use the common currency. In particular, the share of the euro in the world central banks reserves has fallen sharply, despite the fact that more than 35% of all global world trade operations are held in euro.
In addition, the euro has become much more vulnerable to political news from Italy and Greece - countries with a heightened debt burden, whose governments used to conflict with the EU officials. All this causes the euro “Sell” trades on fears of the EU split.
We also recall how badly the economy of Spain, Portugal, and Italy suffered during the financial crisis of 2008. In addition, Greece has repeatedly written off debts, and the Italian bonds were regarded by investors as speculative investments only. Even in such a tense situation, the euro survived. Despite very wide fluctuations, its course to the US Dollar turned out to be close to the levels that we saw at the very beginning of the history of the cash circulation of the single currency.
In addition, the transparency of the ECB actions makes the fundamental analysis rather predictable: with some experience, you will learn how to interpret the statements of Central Bank representatives and understand what effect they have on the pair's fluctuations.
First of all, pay attention to the ECB and the Fed monetary policy decisions. In both cases, parliamentarians meet every 6 weeks to make a decision on the interest rates changes, as well as to refresh the economic estimates. As a rule, the official language is trying to be “smoothed” and “combed”. It may seem to a novice trader that there have been expressed just simple obvious things, but the experienced observers know how to “translate” all the statements on the “human language” and compare the previous speech content with the current one.
An important source of euro volatility is the comment of the head of ECB during a press conference that is usually held 45 minutes after the release.
Since 2019, the Fed also began to organize additional speeches 30 minutes after the current data and the publication of the economic forecast.
Markets respond to any changes in the expectations. So, the most influential information is often contained in comments and explanations. Central banks call such a policy the “management of expectations”.
So, what is going on in these press conferences?
Usually, the journalists from all over the world ask the head of the ECB about the current economic situation in Eurozone, the future plans of the Central bank and any changes in the national monetary policy.
The most accurate and timely information can be obtained if you watch the live broadcast on the official ECB website. Pay attention to the Christine Lagarde and Jerome Powell statements, and how they affect the EURUSD rate. Try to notice this correlation by yourself, in real-time.
During the press conference, the reaction of the market can be very unexpected and substantial. Remember that there is a human behind each trade on the financial market, and people are used to being subject to emotions, fears, and expectations. Very often, after a reassessment of all that has been said by the ECB representatives, markets experience corrections or hikes.
Inflation is another important influence on the euro. In fact, the ECB is committed to keeping this indicator at 2%, or even below it.
The main thing that you should remember after studying this lesson is that trading in the Forex market is affected by changes in interest rates and the actions of central banks to achieve the target level of inflation.
When the actual EU inflation or even its forecasts deviate from the target of 2%, it affects the interest rates and tone of the ECB statements. In particular, the euro “Buy” trades are intensified when the Central Bank raises the rates or warns about such a possibility. On the contrary, the euro falls under pressure in case of an actual reduction in rates or hints of readiness to take such a step.
Why does the ECB set rates at all?
The regulator needs to find a balance between the level of the growth/fall in inflation and the level of the increase/decrease in the interest rates. By the way, have you ever wondered why world analysts usually talk and write about “the interest rates” in the plural, and not about “the interest rate”?
Not many traders know that at each meeting the European Central Bank determines three interest rates. We will not go into details but you should know that this process is versatile and affects different areas of the national economy.
For example, the ECB controls inflation, based on the Harmonized Consumer Price Index, which is published m/m (preliminary estimate is released on the last working day of the month, and the final estimate is usually published in the middle of the next month). Significant deviations from the forecasts occur rarely but when they do, they lead to strong changes in the euro rate in pairs with all currencies on the market.
Traders monitor both general inflation indicators and the Core CPI, the calculation of which excludes fluctuations in food and energies prices. However, there are some differences in approaches between the Fed and the ECB. The European Central Bank publishes a general inflation rate, while the Fed pays close attention to the core consumer price index.
Like interest rates, inflation is a defining indicator for the currency exchange rates but markets are rarely surprised since analysts have learned how to assess the general trends accurately on the basis of the other data.
Also, any changes in the business index (PMI) have a particular impact on the euro. It is believed that the purchasing managers can provide the most up-to-date information on orders, output and inflation trends. Periodic reports reflect their answers to questions about whether the activity has increased or decreased compared with the previous period. Values below 50 indicate a decline in the business activity, while indicators above this mark reflect the growth. It is equally important for traders to pay attention to how the fact correlates with the forecasts. As we remember, the reassessment of expectations is a driving force on the markets.
The EU PMIs are calculated for the manufacturing and service industries. In addition, Markit (the company that conducts these surveys) separately calculates indices for the large EU countries, which also attracts close attention from market participants.
While the service sector is a priority for the US and UK, both indicators have an equal influence on the Eurozone. Always pay attention not only to the general EU PMI but also to the national indicators in Germany and France - countries that are considered as the EU flagships.
How to use the actual PMI values in your trade?
A value below 50 indicates a reduction in business activity and may beсcome a precursor to a recession. A value above 50 reflects the growth of the regional economy. For those who trade on news, it is important to know how much the fact differs from the forecast. Values above the expectations often reinforce the “Buy” trades on euro.
The data below forecasts can cause a flurry of transactions for the sale of the single currency in pairs with the main “competitors”, as well as increase the pressure on European stocks.