Lesson 40 – Economic Indicators, A Guide for Forex Traders
After our previous lesson on Fundamental analysis, you’ll now be coming across a lot of economic indicators during your research on the latest developments of the markets. Examples might include, GDP, CPI, employment rates, etc.
Getting the information is good, but understanding what they are and how it affects markets is better. So that’s why we’re here today to explain what they mean and their impact on the value of a currency.
In this lesson, we’ll break down the main economic indicators that you will come across one by one and how the markets react to them.
Gross Domestic Product GDP
Starting with one of the biggest indicators of economic performance, GDP. You definitely will have heard of this term at some point in your life.
Gross Domestic Product is a way to measure the annual market value of the flow of goods and services in a country. This is used to determine how healthy a country is performing economically overall.
Economists even use it to determine what stage of the business cycle a country is in at any point in time. For example, if they see two consecutive months of negative GDP, then you know that a country is in a recession.
The moment you see a month with a positive GDP change, then the depression is deemed to be over.
Due to how good GDP is as an indicator of economic health, it becomes a good indicator of market sentiment around the currency of that country.
For example, if a country is in a recession then there is a very good chance that its currency will depreciate (fall in value). So it’s definitely something to be aware of and how it will affect your currency pairs.
But, you should note that it takes a very long time to compile the information that goes into calculating GDP.
Therefore, by the time that GDP headline is released, most of its component data has already been made public. So usually, it doesn’t affect markets too much.
However, is the resulting GDP is far away from previous expectations, maybe due to some unexpected shock or development, then that can definitely shock markets and cause some volatility.
Non-farm payroll NFP
Non-farm payroll, or NFP, is a big economic indicator used for the United States economy. Since the USD is the most traded currency in the world, it’s very likely you will be trading with it sometime in the future.
NFP records the total number of paid workers in the U.S. excluding government employees, farm employees, private household employees, and nonprofit organization employees.
For the U.S. it is one of the most important economic indicators and news on the NFP generally always affects markets.
The higher the number is, the better shape the U.S. economy is in.
Usually, it is released on the first Friday over every month at 8:30 am EST, and you’ll definitely want to keep tabs on that date.
This because, even in the days leading up to its release, the market becomes more volatile as people wait and guess in anticipation of what the number might end up being.
There may be rough expectations about what the NFP number will be, but of course, expectations won’t always be correct, and the market will shift a lot if the number is far away from expectations.
So be aware of this figure and the associated volatility in the days surrounding its monthly release date.
Consumer Price Index CPI
Consumer Price Index, or CPI, measures the average price of a specific basket of goods or a service, to estimate the general cost of goods and services in a country.
Changes in the CPI are used to monitor the rate of inflation, which is extremely important when it comes to currency trading as inflation directly hits the value of a currency.
The rate of inflation basically shows how fast prices are rising or falling in an economy. This number is often released on a monthly basis by countries like the UK or U.S., so it’s important to check these dates for the country of whichever currency you are trading.
If the released number align with the expected inflation rates, then this is good for the economy and the currency might strengthen, but if it doe not align with expectations, then the currency might lose in value.
Employment figures are one of the most important indicators that signal how strong an economy and its government policies are performing.
The lower the percentage of unemployed, the better it is for the economy.
There are a lot of different indicators you can pay attention to when it comes to employment statistics. One example would be the NFP that we mentioned before, but general employment and unemployment numbers are important for each country.
These numbers can be found in the Employment Monthly Report that displays the employment and unemployment rates (shown as a percentage of the total available labour force). This is made public once a month, so make sure to keep an eye on those dates.
Retail sales is a measurement of how much people are spending on goods that are sold in stores. It keeps track of payments made in supermarkets, high street shops, hardware shops, etc.
It is a great measurement to track the strength of consumer spending and thus, how an economy is performing. This is because consumer spending is essentially is biggest driver of money flow. If that weakens, then so too does the entire economy.
To see things in more practical terms and its effect on currencies, if consumer spending is high, then profits of those companies in that country will be high, which means share prices will be high, attracting more and more investors who will want to invest in those companies using that currency.
This means that currency will rise in value because of the increased demand for investment.
Interest Rates & Central Banks
Changes in the interest rate is one of the biggest events that drastically shift the value of a currency in a country. This is because it affects so many groups and investments, that a change in the interest rate will always create a huge uproar in the forex markets.
Most countries of the major currencies have their central bank meet every month to discuss what to do that is best for the economy, such as changing the interest rate or implementing quantitative easing. This is done to manipulate their economy to get into a better position than before.
Because it’s not completely random and is done to better help the economy, a lot of speculation and guessing will happen in the market, and thus the value of the currency will shift towards expectations in the days leading up to the central bank meeting.
But of course, expectations are not always correct and nobody has a magic 8-ball to predict exactly what the central bank will decide.
Unless you have some sort of inside information, then it’s best to minimize or avoid trading during these periods. This is because the moment the announcement is released, computer-based trading in the markets will react much faster than you will, and the risk of you being on the wrong side of a trade may be very high.
So that was that for this lesson and Chapter on Economics for Forex Traders. In the next chapter, we will deal with how to “Start Trading”.