Expectation and Sentiment
Fundamental and technical factors are
undeniably essential in determining foreign exchange dynamics. There are,
however, two additional factors that are paramount to understanding short term
movements in the market. These are expectations and sentiment. They may sound
similar, but remain distinct.
Expectations are formed ahead of the
release of economic statistics and financial data. Solely paying attention to
the figures released does not suffice in grasping the future course of a
currency.
If, for example, US GDP came out at
7.0% from 5% in the previous quarter, then the dollar may not necessarily move
as you would expect it to. If market forecasts had expected an 8% growth, then
the 7.0% reading might come as a disappointment, thus causing a very different
market reaction from the one you were expecting had you not been aware of the
forecast.
Nonetheless, expectations could be
superseded by market sentiment. This is the prevailing market attitude vis-à-vis
an exchange rate; which could be a result of the overall economic assessment
towards the country in question, general market emphasis, or other exogenous
factors. Using the above example on US GDP; even if the resulting figure of 7.0%
undershot forecasts by a full percentage point, markets may show no reaction. A
possible reason is that sentiment could be dollar positive regardless of the
actual and forecasted figures. This might be due to solid US asset markets, or
poor fundamentals in the counter currency (euro, yen or sterling).
A term that is commonly interchanged
with "sentiment" is "psychology". During the first two months of 2000, the euro
underwent fierce selling pressure against the dollar despite persistently
improving fundamentals in the Euro zone. That is because market psychology had
decidedly favored US dollar assets due to continuous signs of non-inflationary
growth, and sentiment that further increases in US interest rates will work in
the advantage of US yield differentials, without derailing the economic
expansion.
