For the longest time, the performance of a country’s financial and capital markets has been touted as an indicator of economic health. On the other hand, foreign investors’ participation in the local financial and capital market can be taken as a sign of confidence in the local economy. Therefore, monitoring foreign securities purchases can be used as a gauge of investors’ confidence in the local economy.
Understanding Foreign Securities Purchases
Foreign securities purchases measure the involvement of foreigners in the domestic financial and capital markets. It includes the value of local bonds, stocks, and money-market assets bought by foreigners over a particular period.
The financial market is considered the backbone of any economy. Every sector of the economy is interconnected with the financial market, not just by transactions. Companies, businesses, and governments use the financial and capital markets as a source of funds. Through IPOs, companies can raise funds that will be used for business expansions. Governments issue bonds and treasury bills in the money markets, which are used to fund government expenditures. In the secondary markets, however, these financial assets’ prices tend to reflect investors’ sentiments.
Therefore, foreign investors’ level of participation in the local financial markets can be used as a leading indicator of economic sentiment.
Using Foreign Securities Purchases in Analysis
Primarily, the data of foreign securities purchases shows foreign interest in the domestic economy. This data has various applications to government agencies, investors, and even forex traders.
The stock and money markets are driven by sentiment. The basics of how the financial market works is that; you buy a financial asset when prices are low and sell when prices are high. For example, in the stock markets, the price of a company’s stock is tied to its financial performance. So, when its performance is well, the share price will rise, and when the performance is deteriorating, the share price will fall. Another critical factor that drives the fluctuation in share price is a sentiment about the company’s performance.
When traders anticipate that the company will have a windfall – either increased demand for its core products or the launch of a new product line – the share price will rise. The rise in the share price is driven by the fundamental laws of demand and supply. The price will rise when there is an increased demand from investors to buy the shares, which means that those buying exceed the number of those selling. The price will fall when investors are selling the shares, which increases its supply relative to those demanding to purchase it.
Using this aspect of the stock markets, when foreign investors flood the domestic market to purchase shares, it means that they anticipate that the companies will perform better soon. As we have explained, a better financial performance by a company could result from increased demand for its products or expansion in business operations.
Since the stock market is forward-looking, increased buying activity can be interpreted as a vote of confidence that economic conditions are going to improve. Let’s take the example of the S&P 500. On October 19, 2020, the index closed just above 3400 from lows of 2237 on March 23, 2020, at the height of the Coronavirus pandemic.
Therefore, a rebound in the stock markets can be taken as a sign that investor confidence is increasing and improving economic conditions.
Source: St. Louis FRED
However, note that there is a disconnect between the GDP and the performance of the stock market. Most people tend to make the mistake of assuming that the growth of the stock market is synonymous to an increase in the GDP. While this might be true in some cases, it is purely coincidental, because the stock market is only one component of the economy. While the economy’s growth tends to encompass all aspects ranging from the growth of the labor market to household consumption, the stock market is majorly a reflection of corporate profits. For example, while the S&P 500 recovered from March to October 2020, the GDP was on a steady fall.
Source: St. Louis FRED
The other way foreign securities purchases can be used for analysis is through the purchases in the money markets, especially government bonds and treasury bills. When foreigners swam the domestic market to purchase government securities, it can be taken as a sign that the domestic economy is offering better returns compared to other international economies.
Furthermore, increased foreigner participation in the domestic money markets can be taken as a sign that the local economy is regarded as a safe heaven. It is a vote of confidence that the domestic economy is stable and comparatively less volatile, which means that their investments will receive a steady return and no chances of an outright loss of capital.
Impact on Currency
As a leading indicator of economic sentiment, foreign securities purchase data can show what investors think about economic recoveries. When the foreign securities purchases increase in times of economic recessions or slump, it can be taken as a vote of confidence by the investors that the economy will rebound in the near term. The logic behind this is that no one would want to invest in an economy bound to fall or one that has no signs of recovery. In such an instance, the currency will appreciate.
Similarly, the local currency will appreciate relative to others since an increase in foreign securities purchases implies that the domestic economy offers better returns. These higher returns could be a direct result of higher interest rates. Higher interest rates mean that the local currency will appreciate.
Conversely, when the foreign securities purchases data is on a decline, it shows that investors are fleeing the domestic economy. They can either get better returns on investment in other economies or believe that the local economy is headed for rough times. In this case, the local currency will depreciate relative to others.
Sources of Data
Statistics Canada collates and publishes foreign securities purchases data in Canada. The data published is of the prior two months. A more in-depth and historical review of the foreign securities purchases in Canada is available at Trading Economics.
How Foreign Securities Purchases Data Release Affects Forex Price Charts
For this analysis, we will focus on the August 17, 2020, release of the foreign securities purchases data at 8.30 AM EST. The data can be accessed from Investing.com. Moderate volatility is expected when the data is released.
In June 2020, Canada’s net foreign securities purchases were -13.52 billion compared to 22.39 billion in May 2020.
Let’s see what impact this release had on the CAD.
GBP/CAD: Before Foreign Securities Purchases Release on October 17, 2020, Just Before 8.30 AM EST
From the above 5-minute GBP/CAD chart, the pair was trading in a steady downtrend before the release of the data. The 20-period MA was steeply falling with candles forming further below it. This trend shows that the CAD was strong during this period.
GBP/CAD: After Foreign Securities Purchases Release on October 17, 2020, at 8.30 AM EST
The pair formed a long 5-minute candle upon the release of the data. As expected, the negative net foreign securities purchases in Canada resulted in the weakening of the CAD. Subsequently, the pair traded adopted a subdued uptrend with the 20-period MA slightly rising and candles forming just above it.
The foreign securities purchases data is a moderate-impact economic indicator. Since it only serves to show investor confidence in the economy, it does not result in high volatility when released. Cheers!