Forex News

April 2014 14

Key Indicators That Make Financial Markets Tick

Financial indicators - Teletrade There are certain economic indicators that traders should monitor in order to evaluate the strength of a country’s economic performance and thus its currency. Economic indicators and reports are released by governments and independent bodies that collect and analyse the relevant figures, providing the market with an indication of the situation of the economy. Traders pay close attention to the latest results of each report, as they have a direct effect on the value of a country’s currency.

As a serious Forex trader, it is essential to keep track of the pulse of the economy by looking at major indicators. This article will look at some of the most significant economic indicators and reports that traders around the world observe.

Gross Domestic Product

The gross domestic product (GDP) is the broadest indicator of a country’s economic output and growth. It is an aggregate measure of the total economic production, representing the market value of all goods and services produced by the economy during the period measured. GDP includes private consumption, government spending, businesses spending on capital and foreign trade balance, measured as total exports minus total imports.

GDP can be presented in nominal and real values. The basic difference between nominal and real values is that real values are adjusted for inflation, whereas nominal values are not. Consequently, nominal GDP may often reported higher than real GDP. Taking inflation level into consideration is very important when assessing if the economy is really improving or declining, when making comparisons between different time periods.

Real GDP is the one indicator that says the most about the health of the economy and the advance release of the report is almost always moving the markets. It is bar far the most discussed and closely-monitored indicator by policy makers, economists and traders.

Interest Rates

Central banks around the world have a benchmark interest rate. The interest rate within an economy is considered as the guide for the rate at which the central bank and other commercial banks lend each other funds in order to fulfill their operational needs. Commercial lending rates are also affected by the interest rate and it is this connection of short-term rates to the commercial rates that makes interest rate policy so crucial for central banks.

The central bank may rise interest rates during periods of high inflation in an attempt to decrease consumer spending in order to bring growth back to a more controllable level. If economy needs a boost as a result of deflation, central banks may lower interest rates to attract more consumer lending. Consequently, consumer spending will increase, as consumers will have access to less costly loans.

Forex traders monitor the changes in interest rates, as they tend to seek out currencies that provide higher returns. If interest rates rise for a specific currency, traders will increase their holding on that currency to profit on the higher return. The subsequent increase in demand for the currency could cause it to appreciate compared to other currencies.

Employment

Another crucial indicator of the health of an economy is employment. As consumers account for approximately 70-80% of a country’s economic activity, the status of the labour market is of vital significance to the general strength of the economy. If employment is declining, domestic consumption could fall, as fewer people will be able to buy non-essential goods. If employment trends upwards, then spending and economic activity will rise, thus leading to a stronger currency. The key principal is that more people working, means more income, which might lead to higher personal consumption that affects positively the gross domestic product.

On the first Friday of each month, the U.S. Bureau of Labor Statistics releases its unemployment and non-farm payroll reports. These reports show the existing unemployment rate and the total number of paid workers, as well as how many jobs have been added or lost by the U.S. economy, respectively. Another important indication of employment is the weekly jobless claims report that shows the number of first-time filings for unemployment benefits nationwide. Investors eagerly look forward to these reports, as they often result in some of the largest one-day movements in financial markets.

Inflation

The mandate of all central banks is to stimulate economic growth and price stability in the country’s economy. Price stability is gauged as the rate of inflation. High inflation results in an increased discount rate and consequent lower projected value. Deflation is also risky, as reduced income means possible dismissals for companies, as they cannot retain their full personnel. Forex traders closely monitor monthly inflation reports in order to determine the future course of monetary policies among large economies.

An important report to look at is the Consumer Price Index (CPI). The CPI gauges the fluctuations in consumer prices and determines to what level life is becoming pricier for the average consumer. A CPI that is rising month after month could be an indication that inflation is corroding purchasing power to the point that the central bank is likely to increase interest rates to curtail spending. A rise in interest rates may result in the rise in demand for a currency, as the probability for a higher yield renders the currency more attractive to traders.

Another important indicator is the Producer Price Index (PPI). PPI rate fluctuations gauge the change in inflation rates for producer goods. In general, if the producer goods prices rise considerably, it is likely that companies will ultimately pass the price increases on to consumers. Moreover, increasing PPI could signal a surge in interest rates in order to fight inflation.

Consumer Activity

Changes in consumer activity directly affect corporate profits and stock prices. One of the most prominent methods to assess consumer activity is to measure consumer confidence. There are various ways of measuring consumer confidence, which are all designed to evaluate how consumers feel about the economic outlook in the months to come. The rule of thumb is that when people feel more confident, they are more likely to purchase non-essential goods and vice versa. Due to the fact that markets are future oriented, there is a tendency for stock prices to mirror the future sentiments of consumers today.

One of the main indicators of consumer activity is retail sales. Retail sales report calculates the total receipts from a diverse sample of retail shops in a country. The specific report is highly regarded as a timely indicator of general consumer spending patterns, adjusted according to seasonal variables. Moreover, it is used to forecast the performance of other lagging indicators and to evaluate the current direction of the performance of the economy. Retail sales revisions often cause high volatility in financial markets.

Another important indicator of consumer activity is the housing market. Traders monitor monthly releases regarding this market, such as housing starts, building permits, housing completions and new home sales to assess the level of activity in the housing market. By looking at a variety of housing reports, investors can comprehend whether or not people are willing to conduct large purchases. Moreover, individuals purchasing new homes tend to spend money on other goods, such as furniture, home appliances and garden supplies. It is notable, that the housing market is the first to show signs of stagnation, after rate hikes by central banks. This is due to the fact that increasing mortgage rates may be enough for homebuilders to slow down on new housing starts.

Keep track of major indicators

Understanding the relationship between the performance of an economy and its currency value, can allow a Forex trader to assess the demand and a possible rise or decline in the value of a currency pair. Here are some best practices to help you keep in line with the economic indicators that affect a currency:

  • Regularly consult an economic calendar that lists the indicators and when they are due to be released. Also, anticipate future indicators, as markets often move in expectation of a particular indicator to be released at a later stage.
  • Be aware of the economic indicators that get most of the market’s attention at any given time. Such indicators affect the largest price and volume movements.
  • Keep track of the market forecasts for the data and focus on whether the forecasts are met. Occasionally, there is important difference between the market expectations and the actual figures.
  • Do not trade too quickly on the data released. Often figures are revised and things can change quickly. Pay attention to these revisions, as they may help you react more accurately to future reports.
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