Forex Fundamental Analysis : Economic Indicators
Economic indicators occur in a steady stream, at certain times, and a little more often than changes in interest rates, governments, or natural activity such as earthquakes etc. Economic data is generally (except of the Gross Domestic Product and the Employment Cost Index, which are released quarterly) released on a monthly basis.
All economic indicators are released in pairs. The first number reflects the latest period. The second number is the revised figure for the month prior to the latest period. For instance, in July, economic data is released for the month of June, the latest period. In addition, the release includes the revision of the same economic indicator figure for the month of May. The reason for the revision is that the department in charge of the economic statistics compilation is in a better position to gather more information in a month’s time. This feature is important for traders. If the figure for an economic indicator is better than expected by 0.4 percent for the past month, but the previous month’s number is revised lower by 0.4 percent, then traders are likely to ignore the overall release of that specific economic data. Economic indicators are released at different times. In the United States, economic data is generally released at 8:30 and 10 am ET. It is important to remember that the most significant data for foreign exchange is released at 8:30 am ET. In order to allow time for last-minute adjustments, the United States currency futures markets open at 8:20 am ET.
Information on upcoming economic indicators is published in all leading newspapers, such as the Wall Street Journal, the Financial Times, and the New York Times; and business magazines, such as Business Week. More often than not, traders use the monitor sources—Bridge Information Systems, Reuters, or Bloomberg—to gather information both from news publications and from the sources’ own up-to-date information.
The Gross National Product (GNP)
The Gross National Product measures the economic performance of the whole economy.
This indicator consists, at macro scale, of the sum of consumption spending, investment spending, government spending, and net trade. The gross national product refers to the sum of all goods and services produced by United States residents, either in the United States or abroad.
The Gross Domestic Product (GDP)
The Gross Domestic Product (GDP) refers to the sum of all goods and services produced in the United States, either by domestic or foreign companies. The differences between the two are nominal in the case of the economy of the United States. GDP figures are more popular outside the United States. In order to make it easier to compare the performances of different economies, the United States also releases GDP figures.
Consumption is made possible by personal income and discretionary income. The decision by consumers to spend or to save is psychological in nature. Consumer confidence is also measured as an important indicator of the propensity of consumers who have discretionary income to switch from saving to buying.
Investment—or gross private domestic spending – consists of fixed investment and inventories.
Government spending is very influential in terms of both sheer size and its impact on other economic indicators, due to special expenditures. For instance, United States military expenditures had a significant role in total U.S. employment until 1990. The defense cuts that occurred at the time increased unemployment figures in the short run.
Net trade is another major component of the GNP. Worldwide internationalization and the economic and political developments since 1980 have had a sharp impact on the United States’ ability to compete overseas. The U.S. trade deficit of the past decades has slowed down the overall GNP. GNP can be approached in two ways: flow of product and flow of cost.
Industrial production consists of the total output of a nation’s plants, utilities, and mines. From a fundamental point of view, it is an important economic indicator that reflects the strength of the economy, and by extrapolation, the strength of a specific currency. Therefore, foreign exchange traders use this economic indicator as a potential trading signal.
Capacity utilization consists of total industrial output divided by total production capability. The term refers to the maximum level of output a plant can generate under normal business conditions. In general, capacity utilization is not a major economic indicator for the foreign exchange market.
However, there are instances when its economic implications are useful for fundamental analysis. A “normal” figure for a steady economy is 81.5 percent. If the figure reads 85 percent or more, the data suggests that the industrial production is overheating, that the economy is close to full capacity.
High capacity utilization rates precede inflation, and expectation in the foreign exchange market is that the central bank will raise interest rates in order to avoid or fight inflation.
Factory orders refer to the total of durable and nondurable goods orders. Nondurable goods consist of food, clothing, light industrial products, and products designed for the maintenance of durable goods. Durable goods orders are discussed separately. The factory orders indicator has limited significance for foreign exchange traders.
Durable Goods Orders
Durable goods orders consist of products with a life span of more than three years. Examples of durable goods are autos, appliances, furniture, jewelry, and toys. They are divided into four major categories: primary metals, machinery, electrical machinery, and transportation.
In order to eliminate the volatility pertinent to large military orders, the indicator includes a breakdown of the orders between defense and nondefense.
This data is fairly important to foreign exchange markets because it gives a good indication of consumer confidence. Because durable goods cost more than nondurables, a high number in this indicator shows consumers’ propensity to spend. Therefore, a good figure is generally bullish for the domestic currency.
Business inventories consist of items produced and held for future sale. The compilation of this information is facile and holds little surprise for the market. Moreover, financial management and computerization help control business inventories in unprecedented ways. Therefore, the importance of this indicator for foreign exchange traders is limited.
Construction indicators constitute significant economic indicators that are included in the calculation of the GDP of the United States. Moreover, housing has traditionally been the engine that pulled the U.S. economy out of recessions after World War II. These indicators are classified into three major categories:
- housing starts and permits;
- new and existing one-family home sales and
- construction spending.
Private housing is monitored closely at all the major stages. (See Figure 4.1.) Private housing is classified based on the number of units (one, two, three, four, five, or more); region (Northeast, West, Midwest, and South); and inside or outside metropolitan statistical areas.
Construction indicators are cyclical and very sensitive to the level of interest rates (and consequently mortgage rates) and the level of disposable income. Low interest rates alone may not be able to generate a high demand for housing, though. As the situation in the early 1990s demonstrated, despite historically low mortgage rates in the United States, housing increased only marginally, as a result of the lack of job security in a weak economy.
Housing starts between one and a half and two million units reflect a strong economy, whereas a figure of approximately one million units suggests that the economy is in recession.
The rate of inflation is the widespread rise in prices. Therefore, gauging inflation is a vital macroeconomic task. Traders watch the development of inflation closely, because the method of choice for fighting inflation is raising the interest rates, and higher interest rates tend to support the local currency.
Moreover, the inflation rate is used to “deflate” nominal interest rates and the GNP or GDP to their real values in order to achieve a more accurate measure of the data. The values of the real interest rates or real GNP and GDP are of the utmost importance to the money managers and traders of international financial instruments, allowing them to accurately compare opportunities worldwide.
To measure inflation traders use following economic tools:
- Producer Price Index (PPI);
- Consumer Price Index (CPI);
- GNP Deflator;
- GDP Deflator;
- Employment Cost Index (ECI);
- Commodity Research Bureau’s Index (CRB Index);
The first four are strictly economic indicators; they are released at specific intervals. The commodity indexes provide information on inflation quickly and continuously.
Other economic data that measure inflation are unemployment, consumer prices, and capacity utilization.
Producer Price Index (PPI)
Producer price index is compiled from most sectors of the economy, such as manufacturing, mining, and agriculture. The sample used to calculate the index contains about 3400 commodities. The weights used for the calculation of the index for some of the most important groups are: food – 24 percent; fuel – 7 percent; autos – 7 percent; and clothing – 6 percent. Unlike the CPI, the PPI does not include imported goods, services, or taxes.
Consumer Price Index (CPI)
Consumer price index reflects the average change in retail prices for a fixed market basket of goods and services. The CPI data is compiled from a sample of prices for food, shelter, clothing, fuel, transportation, and medical services that people purchase on daily basis. The weights attached for the calculation of the index to the most important groups are: housing – 38 percent; food – 19 percent; fuel – 8 percent; and autos – 7 percent.
The two indexes, PPI and CPI, are instrumental in helping traders measure inflationary activity, although the Federal Reserve takes the position that the indexes overstate the strength of inflation.
Gross National Product Implicit Deflator
Gross national product implicit deflator is calculated by dividing the current dollar GNP figure by the constant dollar GNP figure.
Gross Domestic Product Implicit
Gross domestic product implicit deflator is calculated by dividing the current dollar GDP figure by the constant dollar GDP figure. Both the GNP and GDP implicit deflators are released quarterly, along with the respective GNP and GDP figures. The implicit deflators are generally regarded as the most significant measure of inflation.
Commodity Research Bureau’s Futures Index (CRB index)
The Commodity Research Bureau’s Futures Index makes watching for inflationary trends easier. The CRB Index consists of the equally weighted futures prices of 21 commodities. The components of the CRB Index are:
- precious metals: gold, silver, platinum; industrials: crude oil, heating oil, unleaded gas, lumber, copper, and cotton;
- grains: corn, wheat, soybeans, soy meal, soy oil;
- livestock and meat: cattle, hogs, and pork bellies;
- imports: coffee, cocoa, sugar;
- miscellaneous: orange juice.
The preponderance of food commodities makes the CRB Index less reliable in terms of general inflation. Nevertheless, the index is a popular tool that has proved quite reliable since the late 1980s.
The “Journal of commerce” Industrial Price Index (JoC)
The “Journal of commerce” industrial price index consists of the prices of 18 industrial materials and supplies processed in the initial stages of manufacturing, building, and energy production. It is more sensitive than other indexes, as it was designed to signal changes in inflation prior to the other price indexes.
Merchandise Trade Balance
is one of the most important economic indicators. Its value may trigger long-lasting changes in monetary and foreign policies. The trade balance consists of the net difference between the exports and imports of a certain economy. The data includes six categories:
- raw materials and industrial supplies;
- consumer goods;
- capital goods;
- other merchandise.
The employment rate is an economic indicator with significance in multiple areas. The rate of employment, naturally, measures the soundness of an economy. (See Figure 4.2.) The unemployment rate is a lagging economic indicator. It is an important feature to remember, especially in times of economic recession. Whereas people focus on the health and recovery of the job sector, employment is the last economic indicator to rebound. When economic contraction causes jobs to be cut, it takes time to generate
psychological confidence in economic recovery at the managerial level before new positions are added. At individual levels, the improvement of the job outlook may be clouded when new positions are added in small companies and thus not fully reflected in the data. The employment reports are significant to the financial markets in general and to foreign exchange in particular. In foreign exchange, the data is truly affective in periods of economic transition—recovery and contraction. The reason for the indicators’ importance in extreme economic situations lies in the picture they paint of the health of the economy and in the degree of maturity of a business cycle. A decreasing unemployment figure signals a maturing cycle, whereas the opposite is true for an increasing unemployment indicator.
Employment Cost Index (ECI)
Employment cost index measures wages and inflation and provides the most comprehensive analysis of worker compensation, including wages, salaries, and fringe benefits. The ECI is one of the Fed’s favorite quarterly economic statistics.
Consumer Spending Indicators
Retail sales is a significant consumer spending indicator for foreign exchange traders, as it shows the strength of consumer demand as well as consumer confidence. component in the calculation of other economic indicators, such as GNP and GDP.
Generally, the most commonly used employment figure is not the monthly unemployment rate, which is released as a percentage, but the nonfarm payroll rate. The rate figure is calculated as the ratio of the difference between the total labor force and the employed labor force, divided by the total labor force. The data is more complex, though, and it generates more information. In foreign exchange, the standard indicators monitored by traders are the unemployment rate, manufacturing payrolls, nonfarm payrolls, average earnings, and average workweek. Generally, the most significant employment data are manufacturing and nonfarm payrolls, followed by the unemployment rate.
Despite the importance of the auto industry in terms of both production and sales, the level of auto sales is not an economic indicator widely followed by foreign exchange traders. The American automakers experienced a long, teady market share loss, only to start rebounding in the early 1990s. But car manufacturing has become increasingly internationalized, with American cars being assembled outside the United States and Japanese and German cars assembled within the United States. Because of their confusing nature, auto sales figures cannot easily be used in foreign exchange analysis.
The leading indicators consist of the following economic indicators:
- average workweek of production workers in manufacturing;
- average weekly claims for state unemployment;
- new orders for consumer goods and materials (adjusted for inflation);
- vendor performance (companies receiving slower deliveries from suppliers);
- contracts and orders for plant and equipment (adjusted for inflation);
- new building permits issued;
- change in manufacturers’ unfilled orders, durable goods;
- change in sensitive materials prices.
is the income received by individuals, nonprofit institutions, and private trust funds. Components of this indicator include wages and salaries, rental income, dividends, interest earnings, and transfer payments (Social Security, state unemployment insurance, and veterans’ benefits). The wages and salaries reflect the underlying economic conditions.
This indicator is vital for the sales sector. Without an adequate personal income and a propensity to purchase, consumer purchases of durable and nondurable goods are limited.
For the Forex traders, personal income is not significant.