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Importance of Economic Indicators

Economic indicators are the key statistics that show the direction of an economy. Important economic events drive the forex price movements, therefore it is important to get famil-iarized of the global economic events in order to perform proper fundamental analysis, which will enable Forex traders to make informed trading decisions.

Interpreting and analyzing the indicators is important for all investors as they indicate the overall health of the economy, anticipate its stability and enables investors to respond on time to sudden or unpredictable events, also known as economic shocks. They can also be referred to as a traders 'secret weapon' as they reveal what is to come next, what may be expected of the economy and which direction the markets can take.

GROSS DOMESTIC PRODUCT (GDP)

The GDP report is one of the most important of all economic indicators, as it is the biggest measure of the overall state of the economy. It is the total of monetary value of all the goods and service produced by the entire economy during the quarter being measured (does not include international activity).The economic production and growth- what GDP represents, has a large impact on nearly everyone within that economy. For example, when the economy is healthy, what we will typically see is low unemployment and wage increases as businesses demand labor to meet the growing economy. A significant change in GDP, up or down, usually has a significant effect on the market, due to the fact that a bad economy usually means lower earnings for companies, which translates into lower currency and stock prices. Investors really worry about negative GDP growth, which is one of the factors economists use to determine whether an economy is in recession.

CONSUMER PRICE INDEX (CPI)

This report is the most widely used measure of inflation. It measures the change in the cost of a bundle of consumer goods and services from month to month. The base – year market basket of which he CPI is composed of, is derived from detailed expenditure information collected from thousands of families across the U.S. the basket consists of more than 200 categories of goods and services separated into eight groups: food and beverage, housing, apparel, transportation, medical care, recreation, education and communication and other goods and services. The extensive measures taken to formulate a clear picture of changes in the cost of living helps keep financial players to get a sense of inflation, which can destroy an economy if it is not controlled. Movements in the prices of goods and services most directly affect fixed-income securities (an investment that provides a return in the form of fixed periodic payments and the eventual return of principal in maturity). Modest and steady inflation is expected in a growing economy, but if the prices of resources used in production of good and services rise quickly, manufacturers may experience profit declines. On the other hand, deflation can be a negative sign indicating a decline in consumer demand.

The CPI is probably the most important and widely watched economic indicator and it is the best known measure for determining the cost of living changes. It is used to adjust wages, retirement benefits, tax brackets and other important economic indicators. It can tell the investors of what may happen in the financial markets, which share both direct and indirect relationships with consumer prices.

PRODUCER PRICE INDEX (PPI)

Along with the CPI, this report is seen as one of the most important measures of inflation. It measures the price of goods at the wholesale level. As a contrast to CPI, PPI measures how much producers are receiving for the goods while CPI measures the cost paid by consumers for the goods. The biggest attribute in the eyes of the investors is the ability of PPI to predict the CPI. The theory is that most cost increases that are experienced by retailers will be passed on to consumers. Some of the strengths of the PPI are:

  • Most accurate indicator of future CPI
  • Long ‘operating history’ of data series
  • Good breakdowns from investors in the companies surveyed (miming, commodity info, some services sectors
  • Can move the markets positively
  • Data is presented with and without seasonal adjustment

On the other hand, the weaknesses are:

  • Volatile elements, such as energy and food can tilt the data
  • Not all industries in the economy are covered

The PPI gets a lot of exposure for its inflationary foresight and can be viewed as an influential market mover. It is useful for investors in the industries covered in terms of analyzing potential sales and earnings trends.

RETAIL SALES INDEX

This report measures goods sold within the retails industry and it takes a sampling of a set of retail stores across the country. It reflects data from the previous month. Companies of all sizes are used in the survey, from Wal-Mart to independent, small town businesses. As the survey will cover the previous month’s sales, it makes it a timely indicator of not only the performance of this important industry but of price level activity as a whole. Retail sales is considered a coincident indicator (metric that shows the current state of economic activity within a particular area) as it reflects the current state of the economy, and it is also considered a vital pre-inflationary indicator, which creates the biggest interest from Wall Street watchers and the Conference Review Board that tracks data for the Federal Reserve Board’s directors. The release of the Retail Sales report can cause above average volatility in the market.

Its clarity as a predictor of inflationary pressure can cause investors to rethink the likelihood of Fed rate cuts or hikes, depending on the direction of the underlying trend. For example, a sharp rise in the retail sales in the middle of the business cycle may be followed by a short-term hike in interest rates by the Fed in the hope of restricting possible inflation. If retail growth is stalled or slowing, this means consumers are not spending at previous levels and could signal recession due to the significant role personal consumption plays in the health of the economy.

EMPLOYMENT INDICATORS

The most important employment announcement occurs on the first Friday every month. It includes the unemployment rate (percentage of the work force that is unemployed, the number of jobs created, the average hours worked per week and average hourly earnings). This report usually results in significant market movement. The NFP (Non-Farm Employment) report is perhaps the report that has the biggest power to move the markets. As a result many analysists, traders and investors anticipate the NFP number and the directional movement it will cause. With so many parties watching this report and interpreting it, even when the number comes in line with the estimates, it can cause large rate swings.

As with other indicators, the difference between the actual NFP data and the expected figures will determine the overall effect of the data in the market. In the non-farm payroll is expanding, it is a good indication that the economy is growing and vice versa. However, if increases in NFP occur at a fast rate, this may lead to an increase in inflation.

CONSUMER CONFIDENCE INDEX (CCI)

As the name indicates, this indicator measure the consumer confidence. It is defined as the degree of optimism that the consumers have in terms of the state of the economy, which is expresses through consumers saving and spending activity. This economic indicator is released last Tuesday of the month, and it measures how confident people feel about their income stability that has a direct effect on their economic decisions, in other words, their spending activity. For this reason, CCI is seen as a key indicator for the overall shape of the economy.

The measurements are used as an indicative of consumption component level of the gross domestic product and the Federal Reserve looks at CCI when determining interest rate changes.

DURABLE GOODS ORDERS

This report gives a measurement of how much people are spending on longer-term purchases (products that are expected to last more than 3 years) and it may provide some insight into the future of the manufacturing industry. It is useful for investors not only in nominal terms of order levels, but as a sign of business demand as a whole. Capital goods represent the higher – cost capital upgrades a company can make and signals confidence in business conditions, which could lead to increased sales further up the supply chain and gains in hours worked and non-farm payroll. Some of the strengths of the durable goods orders are:

  • Good industry breakdowns
  • Data provided raw and with seasonal adjustments
  • Provides forward-looking data such as inventory levels and new business, which count towards future earnings

On the other hand, the weaknesses that can be identified are:

  • The survey sample does not carry a statistical standard deviation to measure error
  • Highly volatile; moving averages should be used to identify long – term trends

The report in general gives more insight into the supply chain that most indicators, and can be especially useful in helping investors to get a feel for earnings potential in the most represented industries.

BEIGE BOOK

The release date of this indicator is two Wednesdays before every Federal Open Market Committee (FOMC) meeting on interest rates, eight (8) times per year. The term ‘Beige Book’ is used for the Fed report called the Summary of Commentary on Current Economic Conditions by Federal Reserve District.

The Beige Book in general consist of reports from banks and interviews with economists, market experts, etc. and is used to inform the members on changes in the economy that may have occurred since the last meeting. The discussions usually held are around the labor markets, wage and price pressures, retail and ecommerce activity and manufacturing output. The importance the beige Books brings to the investors is that they can see comments which are forward-looking and may assist in predicting the trends and anticipate changes over the next few months.

INTEREST RATES

Interest rates are the major drivers of the forex market and all the above mentioned economic indicators are closely watched by the Federal Open Market Committee in order to determine the overall health of the economy. The Fed can decide accordingly if they will lower, rise or leave the interest rates unchanged, all depending on the evidence gathered on the health of the economy. The existence of interest rates allows borrowers to spend money immediately instead of waiting to save the money to make a purchase. The lower the interest rate, the more willing people are to borrow money to make big purchases, such as houses or cars. When consumers pay less in interest, this gives them more money to spend which can create a ripple effect of increased spending throughout the economy. On the other hand, higher interest rates mean that consumers do not have as much disposable income and must cut back on spending. When higher interest rate are combined with increased lending standards, banks make fewer loans. This affects the consumers, businesses and farmers who will cut back on spending for new equipment, thus slowing the productivity or reducing the number of employees. Whenever interest rates are rising or falling, we hear about the federal funds rate (the rate banks use to lend each other money). The changes in the interest rates can affect both inflation and recession. Inflation refers to the rise in the price of goods and services over time, as a result of a strong and healthy economy. However, if inflation is left unchecked, it can lead to a significant loss of purchasing power. As can be seen, interest rates affect the economy by influencing consumer and business spending, inflation and recessions. By adjusting the federal funds rate, the Fed helps keep the economy in balance over the long term.

Understanding the relationships between interest rates and the U.S. economy, helps investors to understand the big picture and make better investment decisions.

HOUSING DATA

The report comprises the number of new homes that have begun building within the month as well as existing home sales. Residential activity is a major cause of economic stimulus for a country and is a good measure of economic strength. Low existing home sales and low new home starts can be viewed as a sign of a weak economy. Both building permits and housing stats will be shown as a percentage change from the prior month and year-over-year period. The housing starts and building stats are both considered as leading indicators, and building permit figures are used to compute the Conference Board’s U.S. Leading Index (an index used monthly to predict the direction of global economic movements in the months to come). This is typically not a report that shocks the market, however some analysts will use the housing starts report to help create estimated for other consumer-based indicators.

Corporate Profits

This statistic report is created by the Bureau of Economic Analysis (BEA) on quarterly basis and summarizes the net income of corporations in the National Income and Product Accounts (NIPA).

Their importance lies in the correlation with the GDP, as strong corporate profits reflect a rise in sales and encourage job growth. Corporations use their profit to raise financing, pay dividends to the shareholders or to re-invest in their business. In addition, investors look for good investment opportunities, therefore they increase the stock market performance.

Trade Balance

The Trade Balance is the difference between imports and exports of a given country for a given time period. It is used by economists as a statistical tool, as it enables them to understand the relative strength of a country’s economy compared to other countries’ economies and the flow of trade between nations.

Trade surpluses are desirable, where a positive value means that the exports are greater that imports; while on the other hand, trade deficits can lead towards a significant domestic debt.

The index is published monthly.

Consumer Sentiment

This statistical measurement is an economic indicator of the overall health of the economy, determined by the consumer opinion. It comprises of feelings of the current financial health of an individual, the health of the county’s economy in the short term and predictions of long-term economic growth.

Consumer sentiment can be used so as to see how optimistic or pessimistic people are towards the current market conditions.

Manufacturing PMI

The Manufacturing PMI is an indicator the economic health of the manufacturing sector of a given country. The index is based on the surveys of sales managers from leading companies across the manufacturing sector, measuring their opinion of the current economic state and the future prospects.

The index is published by Markit and ISM, where ISM survey is considered to be of more importance.

An index increase leads to currency strengthening and 50 point mark is considered as the key level, above which the manufacturing business activity is on the rise and below is declining.

The Manufacturing PMI index is published monthly.

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