Using economic indicators can be quite difficult, as traders become overwhelmed with a variety of information that can lead to overanalyzing the market and even be counterproductive. To avoid information overload, traders should focus on the major economic indicators that affect the market.
What are economic indicators?
Economic indicators represent the various economic activities of a particular country or region. They provide valuable information about the current activities of the business, as well as the prospects for the development of the entire economy.
Let's first look at how indicators are classified according to the business cycle. The business cycle is a very important concept in the modern economy. It represents fluctuations in overall economic activity with periodic ups and downs. For example, a contraction in economic activity that results in negative gross domestic product growth in two consecutive quarters is considered a recession.
Economic indicators are usually classified in several ways. The main types of economic indicators are leading, coinciding and lagging indicators.
Economic indicators that predict future changes in economic activity are called leading indicators. Indicators that change simultaneously with changes in economic activity are called coinciding. Finally, indicators that confirm that there has been a change in economic activity are called lagging indicators.
Unfortunately, for traders, there is no single set of major economic indicators that can successfully predict the entire future level of economic activity, as well as directly indicate changes in exchange rates.
In this article, I will talk about the main economic indicators that affect the market and make it possible to predict future changes in currency prices. Traders should use a reliable economic calendar and prepare for increased market volatility at the time these reports are released.
Employment reports
The employment situation is one of the most important indicators of fundamental analysis, which every trader should carefully monitor. Job creation can tell a lot about the overall health of an economy. This is closely related to future consumer spending, and for the US economy, consumer spending makes up the largest share of GDP at about 70%. The employment report is also a leading economic indicator and can tell a lot about future economic growth.
The US Bureau of Labor Statistics releases the employment report on the first Friday of every month at 8:30 am ET. Most professional and institutional traders take this report into account as it is usually the most volatile market event.
The US Employment Report includes a number of labor indicators that are released simultaneously: non-farm payroll data, average hourly earnings and the unemployment rate. The impact of a growing number of non-agricultural jobs can be easily reversed if average hourly earnings fall short of expectations.
A fall in the unemployment rate is usually accompanied by increased pressure for higher wages as fewer people can meet the demand of companies and hiring managers.
Non-Farm Payrolls Report
Among the employment indicators, the NFP and the US dollar have the biggest impact on the markets. The number of non-agricultural jobs includes all jobs other than self-employment, agricultural jobs, and jobs in the military and intelligence service.
NFP shows how companies and hiring managers see the current and upcoming economic situation. Positive numbers in the report are generally good for the US dollar, while negative non-farm payrolls send the dollar down. The fundamental aspect of the reports is mainly due to the impact of short-term interest rates. Strong employment reports suggest economic growth going forward, increasing the likelihood of a restrictive monetary policy that pushes demand for US dollar assets relative to foreign assets.
As noted earlier, traders should also pay attention to other labor indicators on the employment report in order to form a clear understanding of the potential impact of these economic indicators on the market.
The unemployment rate is also closely related to the inflation rate. The reason for this is that an increase in household income often creates inflationary pressure in the economy.
inflation rate
The rate of inflation is also an important driver of the market. Inflation shows the change in the prices of goods and services over a certain period of time. Like the employment report, it is one of the most popular and important economic indicators for traders.
Central banks like the Federal Reserve target a certain level of inflation to keep the economy healthy and growing. The Fed's inflation target is about 2% for the US economy. While a certain level of inflation is normal, deflation or extremely high inflation can cause recessions and recessions.
Traders and economists prefer the hidden price deflators contained in the gross domestic product report to get a picture of inflationary pressures in the economy. More frequent reports are the Consumer Price Index (CPI) and the Producer Price Index (PPI).
Like employment statistics, the US Bureau of Labor Statistics also publishes CPI and PPI reports. Both reports are released around the middle of the month at 8:30 AM ET for the previous month's data. In this case, CPI is usually one business day before PPI. Among the planned indicators of economic news on inflation, the CPI report has a slight advantage over the PPI report, as it shows price changes at the consumer level.
The Consumer Price Index (CPI) measures the change in the price of a basket of several hundred goods and services. The basket shows typical household spending on a monthly basis, and the weight of each item in the basket reflects a percentage of total household spending.
The CPI report also contains sub-indices that track changes in the price of energy and all goods and services except food and energy.
As you can see in the chart above, the Core CPI report is much less volatile than the CPI report for all commodities. Therefore, it can serve as a valuable substitute for CPI across all commodities during periods when extreme fluctuations in oil prices distort actual inflationary performance in the economy.
The publication of an inflation report often causes great resonance in the financial markets. Its importance is even clearer as central banks target a certain level of inflation and adjust their monetary policy to meet this target. Rising inflation as a result of positive economic conditions often requires monetary tightening to cool the economy, leading to currency appreciation.
On the other hand, falling inflation rates call for looser monetary policy to drive inflation and avoid negative deflationary conditions. Japan, which boomed in the 1970s and 1980s, fell into deflation in the 1990s and 2000s. This period in modern Japanese history is often referred to as the "Lost Decade of Japan".
Traders may also try to predict CPI figures to gain an edge in the market. Rising prices for materials and goods increase the cost of final products as prices for inputs rise. This is called cost-pumping inflation and can give an indication of which direction the inflation rate is heading. The Producer Price Index can also be useful in this regard.
The Producer Price Index (PPI) tracks the price changes of about 3,000 items at different stages of production. The components of the PPI, also referred to as the wholesale price index, are weighted according to their share in the gross domestic product. Unlike CPI, PPI covers prices up to retail level determination and includes raw materials and intermediate goods.
Since the producer price index is released at least one day before the consumer price index, traders can analyze inflation performance in the manufacturing process and determine this impact on the retail sector. It should also be remembered that the producer price index does not include changes in the prices of services, which is a significant factor influencing US GDP.
Because the PPI includes the price of raw materials, which are very weather sensitive, their price can fluctuate significantly and create very volatile PPI readings that are very different from CPI readings. However, both indicators show a high positive correlation over time and are used as a reliable means of analysis in financial markets.
Retail sales
Another economic indicator to watch on the forex economic calendar is the retail sales report.
The Retail Sales Report is an estimate of the value of sales for the retail sector and is released by the US Department of Commerce approximately two weeks after the end of the month at 8:30 AM ET.
The retail sales report is another key economic indicator for the market and can have a significant impact on exchange rates. The reason for this is that retail sales represent personal consumption, which in turn has the largest share of gross domestic product (GDP).
Since the retail sales data is released on a monthly basis, this may provide clues as to what to expect from the quarterly GDP report. An increase in retail sales usually means an increase in company profits, which can lead to more investment and an increase in demand for the dollar, which will lead to an increase in the value of the US dollar. Higher-than-expected retail sales are usually positive for the US dollar, while lower-than-expected retail sales often push the currency down.
To get an idea of how much shoppers are spending, some analysts go to malls and monitor shopper behavior, or count occupied parking lots in front of malls on weekends. Holiday sales tend to stimulate retail sales and can also provide insight into consumer spending.
If people feel confident in their financial well-being and in their jobs, this will be reflected in their spending behavior. Therefore, it is important to track sales reports for Christmas, Thanksgiving, Easter and other holidays as they can provide valuable insight into the state of the economy compared to previous retail sales data.
Gross domestic product
Among all economic indicators, gross domestic product (GDP) is the most obvious indicator of a country's economic health. It is the sum of the market value of all finished goods and services produced in a country during a given period of time. For example, all cars that Toyota manufactures in the United States count toward US GDP. Ownership of resources does not affect the value of GDP if all goods and services are produced within the country's borders.
The Bureau of Economic Analysis reports on GDP quarterly. Each report goes through three stages: a preliminary report, another preliminary report, and a final report.
The Preliminary Report, which is the first report to hit the news feed, has the biggest impact on the currency markets. This report is published approximately one month after the end of the reporting quarter - for example, for the first three months of the year, the preliminary report is published in April.
After the Bureau of Economic Analysis makes the necessary adjustments and refines the preliminary report, the next preliminary report is published approximately one month after the preliminary report. The final report is published one month after the last preliminary report and represents the final revision of the GDP for the reporting quarter.
The GDP report is calculated using the total expenditure method:
GDP = C + I + G + (X - M)
- Where C is personal consumption.
- I - domestic investment.
- G - government spending and investment.
- (X - M) - net export of goods and services.
The share of each component does not vary much from period to period, and personal consumption occupies the largest share in US GDP - about 70%.
When trading the GDP report, traders should pay particular attention to the preliminary report as it is the most dynamic release of all the GDP reports. The impact on the foreign exchange market is positive for the national currency when GDP grows more than expected, and negative if it does not exceed market expectations.
The correlation between the GDP report and the US dollar is shown in the following chart.
Recently, the impact of the GDP report on the foreign exchange market has slightly decreased. The reason for this is the frequency of its release. Being a quarterly release, traders try to predict the GDP report by tracking leading indicators such as personal consumption and housing market data.
However, GDP remains the most important indicator that provides valuable information about the overall economic condition of the country.
Conclusion
Labor force statistics, inflation reports, retail sales and GDP reports are among the main group of key economic indicators that have a strong impact on the foreign exchange market. Both labor force data and retail sales are key indicators of future economic conditions against which GDP growth rates can be projected. They are widely used by traders to analyze the potential impact on exchange rates.
While trading economic fundamentals can be difficult, with a little practice and experience, traders can use macro strategies in addition to technical analysis in order to gain a statistical edge in the market.