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Currency Trading Basics: Economic Indicators and the Market

Posted by Joseph Trevisani on Aug 21, 2013 12:06:00 PM

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Economic Indicators and their Impact on the Currency Market

Indicators

An economic indicator is information amassed and published by a government or private entity recording the activity in a particular economic sector, in a specific industry or in an entire economy.  Most indicators are statistical, but they can be anecdotal or subjective as well.  Indicators are recorded and published on a regular basis by many organizations and are used by traders to assess the strengths or weaknesses of an economy, to predict future activity, to judge central bank policy and to provide insight into the many economic variables that make up a modern industrial economy.

Types of Indicators

Economy wide indicators, such as Gross Domestic Product (GDP), Consumer Price Index (CPI), Producer Price Index (PPI) and the unemployment rate record the result for an entire economy and are the broadest measures for productive activity.   They are usually collected by governments and are among the most authoritative statistics and receive close scrutiny from the market.  

Industry and sector based statistics normally pertain to a particular industry, such as housing  or a particular economic activity, like as retail sales and are collected by both government agencies and private groups. Though the activities they track are more limited they can have a close correlation to the broader indices and can often generate considerable trading interest.  Some examples for the Unites States are Durable Goods Orders, Housing Starts, Building Permits, New Home Sales, Retails Sales, Purchasing Managers Index and the Institute for Supply Management (ISM) Survey. 

Sentiment indicators gauge business and consumer opinions on current economic conditions and their expectations and intentions for the future. Examples are the Conference Board Consumer Sentiment Index in the United States and the ZEW Survey of Economic Sentiment in Germany.

Time Frame

Most indicators are classified as leading or lagging depending on the relation of the data to past and future economic activity.

Leading indicators are those that track economic factors that usually change before the general economy and are used to predict future economic conditions.  Examples are the various Institute for Supply Management Purchasing Managers Surveys in the United States and the Markit Institute equivalents in Europe.

Lagging indicators record activity that has already taken place. They may or may not be useful in prediction.  Unemployment and GDP rates of all types are lagging indicators.

Release Schedules

Almost all statistics are released to the public on a regular basis with dates and times announced in advance.  Historical data for many series can often be obtained from the websites of the issuing organization or government.  All statistics are embargoed by the issuing agencies until the release time. 

Importance

Not all statistics on a single topic are of equal importance. Some government and central banks prefer one particular measure to another and the markets will assign that much more trading weight to the favored statistic. The European Central Bank (ECB) prefers the overall CPI number, including energy and food prices as a measure of inflation while the United States Federal Reserve prefers the core measure without energy and food charges.  Other statistics gain or lose interest over time depending on their volatility, changes in the economy or newer and better measurement techniques.  

Trading Popularity

Traders will focus on different statistics depending on what is felt to be more pertinent to current economic and market conditions.  If for instance, market focus is on GDP growth then economy wide statistics will be paramount.  If developments in a particular industry are of concern then those statistics will be uppermost in traders’ minds. 

In the past ten years several central banks in the industrial world primarily the ECB and the Bank of England (BOE), have adopted inflation targets. For those banks inflation reports have assumed the greatest importance.  For other banks, such as the United States Federal Reserve, inflation is only one of the determinants of policy, and American inflation figures play a lesser role.

Trading: Reality versus Expectation

In currency trading it is the difference between what the market expects the statistic to be and what the statistic actually is that governs market response. 

For any popular statistic forecasts are widely disseminated in the financial markets before release. These predictions are based both on past results and projections founded on evolving market and economic conditions.

These predictions form the background of trading decisions in the period leading up to the release and are part of the economic picture incorporated into the trading price.  In market parlance the forecast is said to be ‘priced into the market’.  This anticipation applies to non statistical events such as central bank rate decisions as well as statistical releases. 

For example, if expectations are for the US economy to produce 100,000 jobs in a certain month, that would indicate a rate of moderate GDP and economic growth for the United States. That level of economic activity would be tied to a level of the dollar and an expectation for Federal Reserve policy.

If the actual number came in at 20,000, that would indicate an economy much weaker than anticipated and would diminish support for the dollar and increase speculation for a more accommodative Fed policy.

Many trading positions that had been opened on the basis of the 100,000 forecast would then be closed in the aftermath of the release. It is this rapid adjustment of expectations and positions that sometimes produces the violent moves following the issue of an unexpected statistic.  

 

Joseph Trevisani

Chief Market Strategist

WorldWideMarkets

 

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