In this Wiki, we will explore Specific Economic Indicators, why they are important and what traders need to know about them so that they can navigate the Forex market better.
This Wiki is part of our larger Economic data releases Wiki. Be sure to check that out HERE.
Specific Economic Indicators
Overview of Economic Specific Indicators
Economic indicators form the backbone of all trading analysis for both central banks and the traders that follow Central banks. Understanding how economic indicators work and how they impact the Forex market is an absolute must if you are thinking about applying some fundamentals and sentiment to your trading. No other place is this more true than in the Forex market.
Why are economic indicators are so important to the Forex market? Well, if economic indicators are what the Central banks use to adjust monetary policy, and if monetary policy is what big money traders are using to direct their trades, then surely it makes perfect sense for retail traders to try and get into any moves caused by central banks actions as early as possible.
Note: We have used the term risk event interchangeably to describe an economic indicator that has the potential to move the market or create risk throughout the rest of this article.
Trading with Specific Economic Indicators
So how is this done? Traders do this by analyzing specific economic indicators in order to try and work out how the central banks will react to their individual readings. Most central banks will tell the market exactly which indicators they are focussing on or concerned with. This makes the job of the much simpler in determining which indicators are important at any given time.
Forex traders are always waiting for central banks to act in a specific way rather than simply waiting to see what they did do after they already did it. This is called trading with “Market Expectations”. Traders determine market expectations by following the hints and clues from central banks about monetary policies and the economic indicators that they are following to enact those monetary policies. These hints and clues are known as forward guidance.
As you can probably imagine, once you start to get a good feel for each central bank and how they focus on each economic indicator you can look to position yourself well ahead of certain economic releases and central bank events. This is because you can get a good feel for what their next steps will be based on what the central banks themselves have said to the market in the recent past. They will almost always express how they feel the indicators have been performing and whether that performance is in line with their desired targets.
Some of the best sentiment trades are trading with the market expectations going into a scheduled event a day or two prior to the release. These are often the least stressful and most profitable trades. An example of a trade with the market expectations is when the market thinks a central bank will hike or cut its interest rate. The market will attempt to price that information into the currency in the weeks running up to the central bank announcement. These are generally the best sentiment trades with the highest reward. Waiting for the actual interest rate decision will still provide trading opportunities but that will all depend on what the central bank actually does.
If the central bank does as the market expects then the reaction could be muted or even the opposite of what you would expect to happen. This is because the smart traders that were already in will book profits causing the price to illogically go in the opposite direction.
If the central bank doesn’t do what the market expects then there will be an immediate unwinding of all the previous bets that were made in the run-up to the event.
Another example is if a central bank is focused on inflation right now then traders will obsessively track inflation related data. If they switch their focus to wage growth then traders will follow along with wage growth indicators. By doing this traders are constantly tuned in with what the central banks are presently concerned with which allows them to get a head start on what actions they might take.
Growth Domestic Product Expanded
We have already looked at GDP above. What we will do here is break it down a little more to fully cement your understanding of it. If you are a little fuzzy on the details you can go back and check out the section on GDP above.
GDP is a growth indicator. It represents the big picture of economic health in a particular nation. This obviously makes it extremely important to all central banks.
By understanding this indicator traders will also start to understand what makes up a healthy economy. This will give some insights into what makes each component of GDP tick.
The biggest thing to bear in mind about GDP is that it helps you think about how the economy behaves. Having this kind of insight when trading financial markets gives you a major advantage over that of a typical retail trader. When you have been around long enough to see how GDP related figures affect individual currencies you will start to have a natural intuition of what kind of numbers will have what type of impact on the market.
GDP represents the total production of a country. Measuring total production can be tricky, especially for larger economies that have many moving parts. However, we can try to simplify this by breaking it down into 3 ways to calculate it.
- Adding up the total spending in the economy.
- Adding up the total income earned by the economy.
- Adding up the value added at each step of production and distribution.
When analyzing GDP data the markets tend to pay particular attention to the annualized quarterly percentage changes for overall GDP and its major components. What does this mean? Most countries will release GDP data quarterly but in an annualized format. So if the U.S. quarterly GDP comes out at 2.1% this does not mean that inflation is 8.4% for the year. 8.4% would be 2.1% X 4 quarters. What 2.1% means is that all 4 GDP quarterly numbers for a year are divided by each other to come out with a 2.1% growth forecast for the entire year. This is an attempt to make the data less volatile due to seasonal fluctuations because winter and summer GDP readings can sometimes be much different.
On the other hand, there are other countries that release their GDP numbers in a quarterly format rather than in an annualized format. This means that if the next 4 quarterly numbers come out as 0.4%, 0.5%, 0.7%, and 0.5% then the annual rate of inflation as measured by GDP is 2.1% which would be acceptable for most central banks. In this case, you would simply add the 4 quarterly readings to come up with the annualized number (0.4% + 0.5% + 0.7% +0.5% = 2.1%).
Then again there are other countries that release their GDP data monthly. Some countries will release the GDP data as “Advanced or Preliminary”, “Secondary”, and “Final”. The way GDP is calculated is roughly the same but it can take some time to get to grips with how individual countries release GDP statistics.
You can get all this information by going to the Forex factory calendar and clicking on the folder icon next to the GDP event. In there it will tell you how the particular country releases its GDP data. This is probably the easiest way to get the info you need fast. Actually, you can do this for any economic indicator to get a bit more of a flavour for the economic data that is to be released.
Most traders are referring to real GDP when they talk about GDP but it is worth understanding the distinction.
Consumer Price Index (CPI)
CPI is a measure that examines the weighted average of prices of a basket of consumer goods and services such as transportation, food, and medical care. CPI is calculated by taking price changes for each item in the predetermined basket of goods and averaging them out. The goods are also weighted according to their importance. Food would have a higher weighted average than cloths would for example. You need both but you will die without food whereas you can live naked as long as you are well-fed!
Changes in CPI are used to assess price changes associated with the cost of living. This is important because we all need to buy these items to live in modern society. If prices are going up then the things you need are taking more money out of your pocket which could make your financial situation a little bit tougher.
CPI can be casually termed as inflation. Most developed nations try to keep their CPI reading between 2% to 3% over the long run.
If CPI reaches or exceeds the upper band of this range then the central bank will likely increase interest rates to balance growth and try to slow inflation down by making the costs of borrowing higher.
Conversely, if it comes in at the lower end of the range the central bank will likely cut interest rates to try and spur growth and CPI. This incentivizes people and companies to borrow and spend.
CPI readings outside of the central banks target range can be either very bullish or bearish depending on what it might lead the central bank to do. Traders will be listening out for the central banks to tell them how they feel about the current path of CPI and looking to trade in line with that outlook.
Non-Farm Payrolls (NFP)
This is one of the most famous U.S. economic figures that absolutely dominates the global FX market. If you are serious about learning economic data but don’t have a lot of time to devote then just learn this one figure inside and out. It almost always provides excellent trading opportunities and creates lots of price volatility that traders need to get the prices moving.
This figure is released on the first Friday of each month. Depending on how much weight the Federal Reserve is currently placing on employment data this can be the biggest market-moving data release of the entire month. Most of the time it is super important because jobs are almost always on the mind of central bankers.
It measures the rate of employment in the U.S. economy for the largest sector of workers. Despite the name non-farm payroll, the report excludes workers from general government jobs, private household jobs, employees of non-profit organizations, and farm employees. But it does measure most of the jobs within the U.S. economy.
It’s important to note that NFP does not always move the market in an aggressive manner. Some months it can be an unimportant event. But when the market is focussing on NFP, which is a good majority of the time, there is not much else that can impact the pricing structure of the FX market more. This makes it one of the most exciting figures to trade.
Of course, this type of figure is very important for gauging the overall health of the U.S. economy and as a result, it can give traders clues as to the next interest rate move from the Fed.
For example, if NFP has recently missed expectations many times and is falling then we can assume that the Federal Reserve will take note of this. If this trend persists over a long enough time then the Fed will very likely step in at some point and try to stimulate the jobs market. They would most likely start by lowering the interest rates which we already know will have quite an impact on the USD.
The best way to trade NFP is to first research how much importance the market is placing on it for the given month and then position yourself accordingly.
Average Hourly Earnings
This is sometimes referred to as “Average Earnings Index” in certain countries such as the United Kingdom.
This is important because it tells you very directly which way employment earnings are heading. If earnings are going up then on average people have more disposable income which they may choose to spend within the economy. This makes it a leading indicator of consumer inflation. And we know just how important consumer spending is to most developed nations.
This is the change in the price that businesses have to pay for labour (employee’s average hourly wage). Employment is one of the largest costs of running a business. Of course, companies want to pay less for labour because it will help them make more profit from the products that the business produces and sells. This makes them more competitive, especially if they are exporting companies. But in the end, a central banks mandate is to the people and they want to see this indicator rise steadily over time.
Another reason that it is important is that it is the earliest inflation-related data released each month in the United States. This can give traders some clues as to where inflation might be heading over the short to medium-term.
In the United States, this data is released at the same time as NFP and the Unemployment Rate. So sometimes this can be just as big a deal as NFP itself depending on how positive or negative the number comes out.
For example, let’s pretend that NFP comes out at 200k and was expected to come out at 200k. No deviation here to trade from and you might expect the price of the USD to go nowhere. However, you see the USD starts getting hammered lower for example. You then notice that average hourly earnings came in at 0.0% when the expectation was 0.3%. Bang! That is exactly why the USD is dropping now in this example. The market shifted its focus to average hourly earnings because there was nothing to trade from the headline NFP number.
This is a common scenario on both the positive and negative sides. Sometimes trading economic data is not as simple as watching one indicator. Sometimes you need to know the relationship between other indicators as well.
It is advisable to do some research to see how much weight the Federal Reserve is giving to wage inflation data at the current time. Most of the time they consider it to be a big deal and so will the market in general.
Unemployment Rate
In its most basic form, the unemployment rate is the percentage of the total labour force that is unemployed but who are actively seeking employment and are also willing to work if the opportunity should come up.
The unemployment rate is very often used by central banks as a short-term target while they are managing monetary policy. This means any changes in the unemployment rate will be really important to traders.
Unemployment occurs when a person who is actively searching for employment is unable to find meaningful work. It is often used as a measure of the health of the economy. The most frequently cited measure of unemployment is the unemployment rate which is the number of unemployed persons divided by the number of people in the workforce. This equation gives you the percentage of people who are unemployed.
As we have already mentioned, employment figures not only display the overall headline but also a plethora of other data that is digested by the markets. There are many times where the other data inside each report can overtake the headline itself in importance and is worth keeping an eye out for.
A steady rise in unemployment is never good and can indicate a worsening of the economic situation for the country reporting it. This can cause consumer spending to drop which generally leads to weakness in the local currency.
Trade Balance
This measures the value of imported and exported goods and how they compare to each other for the given period of time being measured.
When imports and spending exceed exports and earnings the country is said to have a trade deficit. A trade deficit is generally considered a negative thing because it means that money is literally flowing out of the country.
When exports and earnings exceed imports and spending the country is said to have a trade surplus. A surplus is generally considered to be a positive thing for the country and particularly for its currency. The reason for all of this is due to demand. If the demand for a country’s exports is high then the exporting companies will likely make more money. These extra earnings can add to growth in GDP which, as we know, is pretty important.
For example, if the UK is exporting lots of goods to foreign countries, those foreign countries will need to purchase British Pounds in order to buy those products. This can obviously have a potentially positive impact on the British Pound if it is done in large enough quantities. Vice versa if UK citizens are buying most of their products from abroad then they will first need to sell their British Pounds in order to buy the local currency where they are purchasing from. Again, this can cause selling pressure on the British Pound over time. This has an impact on the overall trend in currency values relative to each other.
Large traders know this so when figures like trade balance show that some kind of trend is possibly forming they will immediately try and get in first causing an initial wave of movement right after the figure is released. This comes with the caveat that the trade balance needs to be important to the market at the time it is being released.
Current Account
This measures all of the money coming into the country versus all of the money flowing out of the country. Basically, the current account is the difference between the nation’s overall savings and its purchases/investments.
The current account is an important indicator that tells us about the health of a particular economy. It’s the sum of the balance of trade, net income from abroad, and net current transfers out of the country.
A positive current account balance indicates that the nation is a net lender to the rest of the world, while a negative current account indicates that it is a net borrower from the rest of the world. Said another way, a positive current account reading indicates that a lot of capital is flowing into the country which could strengthen demand for the local currency and see it rise in value. A negative current account means that capital is flowing out of the country which means there is less money available in the home nation.
Producer Price Index (PPI)
PPI is a family of indexes that measures the average change in selling prices received by domestic producers of goods and services.
PPI measures the percentage price change from the perspective of the seller of the goods. This differs from other indicators such as CPI which measures price change from the perspective of the purchaser or consumer.
The PPI looks at three areas of production:
- Industry–based
- Commodity-based
- Commodity-based demand
However, the headline number takes all these into the calculation as equally important, so traders only need to focus on the headline reading rather than the individual components because they are all equally weighted.
Traders follow the trend in the PPI numbers which are released monthly. If we see that PPI is increasing steadily over several months it is reasonable to believe that the economy is performing well and that future interest rate hikes might be in the cards. This situation could potentially create demand for the currency.
On the other hand, if PPI is showing that it is trending lower over several months then the central bank may become concerned about inflation. If other inflation-related indicators start showing weakness as well then the market might start to think that interest rate cuts are in the future. This could potentially devalue the currency.
This indicator tends to have a lot of revisions. This is because it takes into account seasonal food price fluctuations and the highly unstable nature of energy prices such as oil.
Industrial Production
This measures the monthly raw volume produced by industrial firms such as factories, mines, and utility companies.
This indicator is a bit different in that it has a “reference year”. The reference year for this economic indicator is 2002. This means that every new reading we get will have its levels compared to 2002. Full industrial production within an economy is pegged at a reading of 100. So the closer the reading is to 100 the better the economy is performing.
Industrial production can reflect the tone of the overall economic activity in most modern nations. A positive reading is generally considered to be a good thing for the local currency while a negative reading tends to be not so good.
Industrial production is related to capacity utilization and is considered to be a coincident indicator. This means that changes in the levels of these indicators usually reflect similar changes in overall economic activity very close to the time it is released. It’s a more efficient indicator than other coincident or lagging indicators.
ISM Manufacturing Index
ISM stands for Institute of Supply Management. This is a U.S. data point only. The ISM Manufacturing Index is one of the first pieces of news released each month, so it has the potential to influence the tone of investor and business confidence.
The purpose of this index is to monitor employment, production inventories, new orders, and supply deliveries. This information is then interpreted into a “composite diffusion index” that monitors overall conditions within the industrial industry. The diffusion index simply means that it shows how all of the indicator components are moving together with the overall indicator index. It is a way of visually smoothing out an index that has many moving parts to it which ISM manufacturing does.
This is important to the Forex market because it’s composed of a survey of more than 300 large and important manufacturing companies. This gives a very good overview of how manufacturing companies are feeling about the current economic climate.
It’s also a survey of the purchasing managers who have control and influence over their companies' supply chains. Manufacturers need to respond quickly to changes in demand because they need to ramp up or scale back purchases of the stuff they need to make their products to match the current demand from the market. They do this to ensure the company’s continued profitability. As a result of their position in the company, they are perhaps better positioned than anyone to speak to the ebb and flow of current business conditions.
The reason that traders watch this indicator carefully is that the Federal Reserve tends to place great value on it at certain times in the economic cycle. This indicator becomes more widely watched when the economy is trying to get moving after a slowdown. The Fed uses this information to form part of its opinions which leads to central bank decisions and actions on monetary policy.
Durable Goods Orders
Durable goods are generally considered to be something that has a fairly long and useful life after being purchased. For example, cars, trucks, and washing machines could be classed as durable goods because they are something that people use for many years before they need to be replaced.
Think about durable goods like this; a car is a durable good because it is meant to last many years. The gasoline you put in the car's tank is a non-durable good because it has a very short usable life. If you turn on the car and drive a couple of miles then you have burned off some gasoline but the car will be no worse for wear as a result.
This is an economic indicator that is released monthly by the Bureau of Census. It reflects new orders placed with domestic manufacturers for delivery of these durable goods in the near term future.
Durable goods come in two releases per month:
- The advanced report on durable goods
- Manufacturers’ shipments, inventories, and orders of durable goods
The problem with durable goods is that it can be quite volatile and tends to see plenty of revisions. In the short term, it can impact the markets and move prices but typically only if the Fed is paying close attention to manufacturing. For this reason, traders should keep an eye on these data points and understand where the country is within the economic cycle.
Housing Starts and Building Permits
Housing starts are the number of new residential construction projects that have begun during any particular month. The New Residential Construction Report, commonly referred to as "housing starts," is considered to be a very important indicator of economic strength.
Housing start statistics are released on or around the 17th of each month by the U.S. Commerce Department. The report includes building permits, housing starts and housing completion data. Surveys of homebuilders nationwide are used to compile the data and are cross-referenced from the permits that have been issued by municipalities.
Building permits are a type of legal authorization that must be granted by a government or another regulatory body before the construction of a new or existing building can take place. The U.S. Census Bureau reports the finalized number of the total monthly building permits on the 18th work day of every month.
These particular figures are heavily influenced by the level of mortgage interest rates. Mortgage rates are largely influenced by central bank interest rates because the financial companies that lend out mortgages need to borrow from the central bank first and then lend out mortgages at a higher rate to make a profit. This will be watched carefully by FX traders to see if there are any trends in place or developing over time.
New Home Sales
As the name implies, new home sales are an economic indicator that measures sales of newly built homes. This includes houses, condos, townhomes, and any structure that requires a permit to allow people to live in them.
It’s released monthly by the U.S. Department of Commerce’s Census Bureau and includes both quantity and price statistics.
It’s considered to be a lagging indicator of demand in the housing market because permits are issued a long time before the structure is finally completed and sold. For larger projects such as condo buildings, this can take several years.
High readings are considered indicative of a strong and growing economy. Low readings can indicate that the economy is stalling out or even moving into a recessionary period within the economic cycle.
You will also see this positive or negative tone reflected in the prices to join in on the positivity.
Consumer Confidence Index
This is a United States figure and is similar to the ISM report in that it’s a survey of several thousand people. However, this is a survey of normal everyday people rather than businesses. Other countries do have their own version of consumer confidence but they tend to be calculated differently or are included inside of other indicators.
This is considered important because consumer spending is a very large factor that affects the GDP reading for most modern developed economies. If this index is really positive then it could possibly indicate that significant growth may follow. If you think about it, if everyday people are very positive then they are more likely to spend their money rather than save it. If they do go ahead and spend their cash it will in turn help grow the economy if enough people are doing it. This means more spending in the economy and more demand for the U.S. Dollar which could in turn strengthen the USD over the long run. The opposite is true if the number is overly negative because if people are worried about the economy and their job security then they are more likely to save their money rather than spend it. If people are saving their money then this is not going to help local businesses prosper and lower profits will filter into a negative reading for GDP.
This index is released on the last Tuesday of each month and is a barometer of the health of the U.S. economy. It is also based on consumer perceptions of the current business and employment conditions, and expectations of those two plus personal income for the next six months.
IFO Business Climate Survey
This is a German indicator and is similar to ISM in that it gauges the sentiment of the business climate in Germany.
It is widely followed as an early indicator of the state of the German economy. It’s based on a survey of approximately 7,000 monthly survey responses from firms in manufacturing, construction, wholesale and retail.
As the largest economy in the European Union, Germany’s business climate has implications for the rest of the European Union. This gives a good reading about the overall economic health in the Eurozone as a whole because other large European nations such as France have similar business climates.
A growing IFO reading signals growing optimism which in turn can lead to a strengthening of the Euro over time if there are other fundamental economic reasons to be buying the Euro as well.
GDT Price Index
GDT stands for Global Dairy Trade. This is an indicator that is unique to New Zealand that is released twice per month.
It represents the change in the average price of dairy products that are sold at auction. It’s derived from taking a weighted average price of the 9 dairy products that were sold at the current auction then the new number is compared to the previous releases. The new reading is then expressed as a percentage gain or loss from the previous reading.
This is important because it’s a leading indicator of New Zealand’s trade balance with other countries. Dairy sales happen to make up a large percentage of New Zealand’s GDP which is another good reason its reading can have an impact on the price of the New Zealand currency.
Rising commodity prices will help boost export income while falling prices will give a decline in export prices. If the Percentage change is showing a trend of positivity then this could have a positive effect on the New Zealand Dollar. If the trend is looking not so good then this could weaken the New Zealand Dollar over time. Any significant deviation could produce a sharp move in New Zealand currency pairs.
This piece of data can be a bit tricky because they do not give you a time for when the actual figure will be released. They only give you a date. So you will need to have a decent audio squawk on if you want to hear this release as fast as possible. But if you do see a sudden price spike in New Zealand currency pairs on the date that this is scheduled to be released then it is time for you to hunt for that information to see what the numbers were.
A note of caution about this indicator: There are times when the market will be very focused on this piece of data. But at other times it will not produce the slightest of price movements regardless of how big a deviation it produces. This is one that you will need to know if the market has been giving any weight to it if you are going to trade it.
Crude Oil Inventory Numbers
This is an American indicator but it tends to have more of an impact on the Canadian Dollar. This is because, at the time of this writing, Canada is the number one exporter of oil to the United States. Oil profits also make up a large percentage of Canada’s GDP so these numbers can be very important to the Canadian Dollar.
This indicator measures the change in the number of barrels of crude oil held in reserve by commercial firms during the previous week.
The way that traders look to trade this is when there is a big drawdown this could cause the Canadian Dollar to strengthen. This is because if there is a lot less oil in reserve then it is natural to assume companies will need to buy more to keep up with their demand which could push the price of oil higher. Basically, if the price of oil goes up then Canada’s oil companies will make more money which will contribute to a higher GDP over time.
If there is a large build of oil then traders will look to potentially short that Canadian Dollar because the chances are that there will be less production from Canada and therefore fewer profits.
You need to take some caution here and not blindly trade a correlation you believe should exist. The reality is that this indicator may or may not have an impact on the Canadian Dollar. It really all depends what is happening with the price of oil at the specific time. If volatility is high with oil prices then it might have more of an impact as a general idea.
The Canadian Dollar tends to be impacted by the price of oil when people are panicking about oil and the price is going down hard. The key is that oil prices need to be volatile to move the Canadian Dollar around significantly.
The market tends to be able to only focus on one or two things at a time when it comes to a specific currency or commodity. For example, during much of 2017, there was a decent correlation to oil prices and the Canadian Dollar. It wasn’t perfect but it was there. This was because there was not enough going on in Canada at that time to have traders only focus on events going on within Canada. So they would trade the CAD in line with oil.
This is an indicator that you will have to be in tune with if you are thinking about trading along with it.
Economic Indicator Wrap Up
All of these figures are watched closely by the markets but the overall thing to bear in mind with all risk events is that the market will only pay attention to the ones the central banks are currently paying attention to. Central banks are typically only ever focussed on one or two types of indicators at any given time which can make a traders job fairly simple.
For example, if the Fed is focused on inflation with no regard for other data points then NFP will likely create no significant moves across the FX market. If on the other hand, the Fed is data dependent with a major focus on labour conditions then NFP will be one of the biggest data releases of the month. This same principle applies to all Central banks and data points around the world. This is perhaps the most important thing to bear in mind if you are trying to position yourself in the markets around key risk events.
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