the appearance of continued prosperity have on financial markets;
this also is known as the boom-bust cycle. When economies
are strong, such as that of the United States in the 1990s and from
2003 through 2007, it creates the expectation that strong economic
growth will continue. As is often the case in economics
and markets, the seeds for the downturn were created by
overoptimism during the upturn, as stocks were bid up to unreasonably
inflated valuations in the late 1990s, followed by the
same phenomenon in real estate in the 2000s. “Chicken today,
feathers tomorrow,” as the old saying goes. That means, “Don’t
worry about tomorrow; get what you want today.” This is a classic
behavioral mannerism of many young adults during the first
half of their employment cycle. For many, it does not make fundamental
sense to drive a large motor vehicle that gets poor gas
mileage or to take on a large home and mortgage in anticipation
of a promotion and monetary raise the next year.
More often than not, this leveraging of the future to get more
of a good thing in the present leads consumers to tip over
financially. The newspapers were full of these types of stories
in 2007 and early 2008, and they projected economic slowdowns
after extended periods of excess. The fact that many
people have excessive debt is projected to weigh on consumer
spending and therefore on business spending. The drying up
of consumer spending can affect a country’s currency, and
when the behavior is collective, the whole global marketplace
can feel the pinch. Excessive consumer spending without the
earnings to pay for it leads to a downward spiral brought on
by debt and unsound economic decisions made by countries’
primary consumers.
On a microeconomic level individuals are responsible for their
own finances, but on a macroeconomic level people look to governing
bodies for help in a financial crisis. This is what happened
in the second half of 2008 and the beginning of 2009. Governments
embarked on a policy of notching down interest rates so
that they could attempt to borrow their way out of trouble by
lending to and buying into industries and companies hurt by
the uncertainty and fear created by falling stock prices and anemic
consumer and business spending. As of this writing, the jury
is still out on this strategy of governments keeping businesses
and industries afloat to ensure both employment and a tax base
and stabilize corporate securities markets. The thing to remember
as traders is that we do not attempt to anticipate the effects
of this strategy in the financial marketplace. We let the market
tell us how it interprets these actions by seeing which signals are
proving profitable, the buy triggers or the sell triggers. We do
know this, though: The volatility created by economic uncertainty
is a feeding bell for professional traders.
There are many nuances in the fundamental valuations of
stocks, other financial instruments, and currencies, and we’ve
taken a look at the major ones. As we’ve seen, there are four
important factors in the pricing process for financial markets:
1. Current business conditions, meaning income and cash on
hand for companies
2. Interest rates, in which differentials between countries can
create market momentum
3. Inflation, in which the concern is whether inflation is
growing or ebbing
4. Individual spending habits, which are defined as housing
and disposable income
The bottom line in business and market valuations nearly
always is determined by fundamental developments. Fundamentals
are the why of price action. There is no doubt about
the role a country or region’s capital flows and trade flows play
in determining currency prices.
Source: Mastering the Currency Market: Forex Strategies for High and Low Volatility Markets
