Page 90 - DMGT549_INTERNATIONAL_FINANCIAL_MANAGEMENT

Unit 6: Economic Fundamentals and Foreign Exchange Risk Exposure

Notes

Notes The U.S. trade deficit of the past decades has slowed down the overall GNP.

Did u know? GNP can be approached in two ways: flow of product and flow of cost.

Industrial Production

Industrial production consists of the total output of a nation’s plants, utilities, and mines. From
a fundamental point of view, it is an important economic indicator that reflects the strength of
the economy, and by extrapolation, the strength of a specific currency. Therefore, foreign exchange
traders use this economic indicator as a potential trading signal.

Capacity Utilization

Capacity utilization consists of total industrial output divided by total production capability.
The term refers to the maximum level of output a plant can generate under normal business
conditions. In general, capacity utilization is not a major economic indicator for the foreign
exchange market.
However, there are instances when its economic implications are useful for fundamental analysis.
A “normal” figure for a steady economy is 81.5 percent. If the figure reads 85 percent or more,
the data suggests that the industrial production is overheating, that the economy is close to full
capacity.
High capacity utilization rates precede inflation, and expectation in the foreign exchange market
is that the central bank will raise interest rates in order to avoid or fight inflation.

Factory Orders

Factory orders refer to the total of durable and nondurable goods orders. Nondurable goods
consist of food, clothing, light industrial products, and products designed for the maintenance of
durable goods. Durable goods orders are discussed separately. The factory orders indicator has
limited significance for foreign exchange traders.

Durable Goods Orders

Durable goods orders consist of products with a life span of more than three years. Examples of
durable goods are autos, appliances, furniture, jewelry, and toys. They are divided into four
major categories: primary metals, machinery, electrical machinery, and transportation.
In order to eliminate the volatility pertinent to large military orders, the indicator includes a
breakdown of the orders between defense and nondefense.

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Caution This data is fairly important to foreign exchange markets because it gives a good
indication of consumer confidence. Because durable goods cost more than nondurables, a
high number in this indicator shows consumers’ propensity to spend. Therefore, a good
figure is generally bullish for the domestic currency.

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