Major Economic Indicators That Drive the Forex Market

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Financial_Economic_newsThe forex markets are quite efficient, and many believe that all the available information is priced into every currency pair.  When new information becomes available the value of a currency pair will move to reflect the new equilibrium created by traders. Information that changes the value of a currency pair, can come in many forms, but the most pertinent are economic indicators that help drive the currency market.

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Major Forex economic indicators typically come in the form of economic news releases that are disseminated daily.  Most the major economic events that are released are reported by sovereign governments throughout the globe.  Additionally, there are several economic data points that are released by private organizations that can move the market.   

How to Economic Releases Effect the Forex Markets

By using economic data, investors can measure the performance of an economy.  The stronger the data, the more likely growth will rise.  The reverse is also true, which is that generally weaker economic data, foretells a slowing of growth.  What traders’ attempt, when trading economic data is to measure how economic indicators are perceived relative to expectations.

Before nearly every economic release, what the market generally prices in is the median expectation reflected by analysts and economists. The known variable are the expectations, and the unknown is the actual release. Since currency pairs can move significantly based on new data, traders are always trying to anticipate where the actual figures will come in upon release.

Changes to economic data will typically filter down to potential changes to interest rates by a central bank.  US economic announcements are heavily watched as they will influence the perceptions of market participants which help drive interest rates and other monetary policy by the Fed.

Why are Interest Rates Important to the Currency Markets?

While a central bank controls the short end of the interest rate curve with instruments such as overnight rates, where banks lend to one another, the longer ends of the curve are driven by market participants. 

Interest rate levels of one currency relative to the interest rate levels of another currency are a major driving force behind the movements in the forex market.  The interest rate differential is the difference between the levels of two sovereign currencies.  If you own the currency with a higher interest rate, you will be receiving a payment for holding your currency.  If you own the currency with the lower yielding interest rate, you will need to pay to hold the currency pair.  The interest rates of each country are embedded into the forward rates that you will pay or receive if you transact beyond the spot rate which is 2-business days.

Generally, the higher yield currency attracts investors, driving up the value of the currency pair.  Therefore, many traders track the interest rate differential and pay attention to forex economic news as it will move the forex markets.  The interest rate differential is used to calculate the forward points which are added (or subtracted) to the spot rate to generate the forward rate.

Using an Economic CalendarEconomic_Calandar_Forex

One of the best ways to track fx fundamental news events is to use an economic calendar.  This tool is essential to monitoring financial events and determining the forecasted number of a news release relative to the actual data release. 

A forex economic calendar allows both novice and experienced traders to stay informed about potential price moves that can occur due to fundamental news reports.  An economic calendar will focus on economic events, and it will also show you when there are central bank meetings, political elections as well as bond auctions. 

There are many ways to use a financial calendar. Since you know when events are going to take place, you can manage your risk and initiate positions based on future events.  For example, if you are holding an EUR/USD position and the ECB is planning to meet the following week, you will be forewarned that an event might occur that could generate significant volatility.  If you plan on initiating a position, this type of information is invaluable.

Political events and votes can generate significant volatility.  For example, following the Brexit vote on June 23, 2016, the pound tumbled, but if you were not aware that it was going to occur, you could have lost a significant amount of money due to being uninformed.  Finding a financial calendar that has political information as well as economic data is crucial. 

Additionally, it is imperative that you have a financial calendar that has central bank information.  Nothing will move a currency pair like a surprise change in monetary policy.  But it’s not just the actual announcement you need to be aware of, you also want to know what most analysts or economists believe the central bank will do prior to the event.

There are a plethora of great financial calendars, on reputable websites such as Reuters, Bloomberg and Forex Factory. If you want to customize one, you can enter the information yourself on a spreadsheet to make sure you are capturing all the information that you deem crucial to your trading decisions.

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Major Economic Indicators

While central bank meetings and political events generate volatility occasionally, scheduled monthly economic data consistently provides the backdrop for trading opportunities for the fundamental trader. There are several data points including employment, inflation, and manufacturing that are considered major market-moving economic indicators.

Employment Reports

One of the most watched economic indicators is the United States employment report, the NFP report, which is released on the first Friday of every month unless the first Friday is the first day of the month and then the release is pushed back to the second Friday.

Additionally, if the first Friday is a holiday, the government will push the report back to the second Friday of the month.

There are two reports released by the Department of Labor which make up the employment report. There is the non-farm payroll report, which is a report that counts the number of employees added via a corporate survey, and there is the employment rate report, which is a household survey report.

Both reports cover the same survey period.  The corporate report shows all the employees added or subtracted from businesses that are a specific size, while the household report, surveys a certain number of homes. 

The Non-farm payroll report is the most widely viewed report and generally the most important for currency traders.  The unemployment rate shows the percent of the population that are looking for work.  It also has a sub-component that tells you the number of people that were hired and fired during the survey period.

A third part of the employment report is hourly earnings, which reflect wage gains.  The Federal Reserve’s mandate is maximum employment with inflation within their targeted range. Wages along with housing make up a large component of inflation expectations, which makes the employment report the most significant economic report of the month.

Inflation Metrics 

Forex economic news traders will also focus on inflation as it is another important component of the Feds mandate for determining interest rates. The most widely watched inflation measure is the consumer price index (CPI). The CPI index reflects the value of goods and services at the consumer level during the survey period.

The Consumer Price Index is viewed as the benchmark inflation guide for the United States economy.  The CPI measures the change in the cost of a fixed basket of goods and services which would include for example: food and beverages, housing, apparel, medical care, recreation, education, transportation, electricity, haircuts, restaurants etc. The CPI is published on a monthly basis but the dates for the release change consistently, however, the time that the report is published remains static.

The CPI is an extremely important metric to follow on a regular basis.  When prices rise, this erodes the purchasing power of the consumer.  Also, if wages remain static this will also act to reduce consumer’s purchasing power, which will typically lower living standards.  Inflation plays a major role in how politicians vote and how corporate planning takes place.  The way businesses and consumers function can be directly affected by inflation. 

It is difficult to gauge pricing pressure in one specific good or service and use that as an overall barometer on inflation levels.  For example, the price of spirits may rise by 10 percent in a single month but that would not cause alarm bells if the prices of other liquid drinks were falling or remaining constant. The CPI is tracked as an index of goods in order to best determine overall trends for inflation.

A second inflation gauge that traders should watch for within their economic data calendar is the Producer Price Index or PPI. This index is used to measure wholesale inflation at the intermediate goods level. So instead of looking at what the consumer is paying for goods, the government reports what wholesalers are paying for goods.

Generally, services at the wholesale level are not measured by the Producer Price Index. The producer price index is reported every month, in the United States by the Department of Labor. 

There are also some other inflation indices that are monitored in the United States, including the personal consumption expenditures released in the personal income and spending report.  The GDP deflator is another inflation gauge which is often evaluated.

Sentiment Surveys

Sentiment surveys provide a good guide to what could eventually take place in the economy.  If you are asking manufacturers what is going on before the government reports what is going on, you would likely have some early clues as to potential trends in the market.  Most developed countries report purchasing managers reports (PMI), on a manufacturing and service level.  The surveys evaluate many sub-components which include employment, prices paid and prices received, new orders, and backlogs.

Housing_Starts_ReportHousing Reports

Housing statistics are an integral part of the U.S. economic data set.  Most individual’s wealth in the United States is wrapped up in their home. 

There are several housing-related economic indicators which are released every month including Housing Starts, Building Permits, New Homes Sales, Existing Home Sales, and Pending Home Sales.  Housing prices along with employment numbers are a strong reflection of inflation.  As housing prices rise, inflation expectations will tend to increase.  As home prices increase, homeowners will typically spend more, as they feel wealthier.

Housing starts tell investors the number of new houses that are at the beginning of the building process.   Before building a home, the contractor will need a permit, which helps forecast the number of new starts coming down the pipeline.  New home sales record the number of sales of brand new homes which are on the market for the very first time.  This number differs from the existing home sales figure, which reflects the number of homes that were sold that have been sold once before.  Lastly, pending home sales describe homes that are in contract, and could eventually be sold at a point in the future.

The employment number, the inflation gauges, as well as the housing and manufacturing numbers roll up into the Gross Domestic Product. The GDP reflects the aggregate growth in a country. As such, the GDP report is widely watched by forex traders.

Summary

Economic events can help traders gauge the strength or weakness of an economy.  These numbers are the backdrop used by central banks to determine the course of monetary policy.  Since the forex markets are highly correlated to changes in the interest rate markets, the changes reflected by economic data spills over into the currency market.

The most important information that you can garner from the release of economic data is whether the release was greater, worse or in line with expectations.  Most traders believe that all the available information is priced into a currency pair, and only new information such as economic data will significantly alter the value of a currency pair.

One of the best ways for you to follow economic data is to find a reputable financial calendar. Not only will a good calendar tell you what data points to expect each day, but it will also relay the forecasted numbers which are expected by economists. 

The key to trading these numbers is to see if what is expected is likely to play out into an actual economic figure.  Changes to the value of a currency come when the actual economic release is different from what is expected.  In these instances, the markets will move to reflect the new information. 

The economic releases that hold significant importance include the employment numbers as well as inflation reports. The U.S. employment report, typically referred to as the non-farm payroll report is one of the most anticipated report monthly. This report generally reflects the economic picture on the United States, the largest economy in the world. 

Regardless of the report, traders who are looking to trade economic data will either position ahead of a release, or wait until the dust settles to take a position once a new price range is discovered.

Download the short printable PDF version summarizing the key points of this lesson….Click Here to Download

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