The Impact of Economic Indicators on Forex Markets

The release of economic statements such as the Consumer Price Index (CPI) are news that is relevant to forex traders, as they tend to cause significant movements in the market. CPI data could lead a central bank to raise interest rates to quell inflationary pressures; this normally strengthens a currency, whereas lower interest rates typically weaken one.

Inflation

Measured by inflation, it’s among the main things that helps to set exchange rates between different currencies. To put it simply, inflation is a measure of any increase in prices that outstrips parallel economic growth; central banks try to control it by pushing up or down official interest rates, and high inflation makes imported goods look good value for money to local consumers and businesses.

But inflation plays a key role in what traders call the ‘economic surprise index’. If a country’s economy is growing more than analysts expected, that’s positive for the economy as a whole. For example, if China reports GDP growth of 7.3 per cent when markets were expecting only 7 per cent, investors will start pouring money into the local economy, lifting the stock market and fuelling interest in its currency. Conversely, weak GDP growth is taken as evidence of an economy heading for recession, which can increase volatility.

It’s also important to keep up with global economic news and central bank announcements. This being said, Pepperstone’s macroeconomic calendar can provide you with important data like interest rates and inflation levels having a major impact on the market; you can even sign up to receive notifications about recent changes in the forex market via email or SMS.

GDP

GDP (gross domestic product), meanwhile, the granddaddy of economic yardsticks, is often the most important economic release in terms of its influence. It measures the monetary value of a country’s total output over a period of time. A reading on GDP that exceeds the forecasted level could cause your currency to strengthen as it raises the anticipated yield for money market accounts or for investments in properties or stocks; and, the highest yield almost always draws the most investment dollars.

An inflation rate can have a significant impact on a country’s currency, because high inflation rates decrease the value of the currency and restrict investor purchasing power. Retail sales and auto sales are economic indicators that help measure spending trends.

Buying in a hurry without any back-testing of the system or paying for updates puts you in the situation of buying a pig in the poke. A big risk with forex trading is letting personal feeling and intuition sway your decisions. Forex traders need to keep an eye on market-moving economic reports and assess their impact. A few days or hours ahead of a scheduled report, it’s a good idea to study the data against the market’s expectations for it. When the report comes out of a trader’s chosen currency pair, the professional trader has a chance to enter the market with the knowledge gained from this backward-looking data. This might mean entering the market long instead of short, or vice versa. Non-professional forex traders, on the other hand, tend to simply buy when they’re feeling good or sell when they’re feeling bad, buying the pig in the poke. Forex always carries a significantly greater level of risk for amateurs. Retail traders need to take into account long-term effects and broader market considerations when looking at indicators.

Unemployment rate

The unemployment rate is the key economic parameter, influencing the value of any currency. High unemployment rates in a country usually means a poor state of a country’s economy, lower consumer spending powers which in turn will decrease the value of its currency; the opposite is also true thus traders should know how the movements are interconnected before dealing any currency pairs.

But just like when analysing employment figures, there’s another issue: seasonal trends. Raw data consists of observational facts that, certainly in the case of employment data, undergo a well-understood cyclical trend. If that cyclical trend is not taken into consideration, the factual accuracy of the raw data could well be distorted, sometimes significantly. Figure 2: The correlation between (seasonally adjusted) US non-farm employment change and the weekly claims for unemployment insurance Source: AuthorAs with employment figures, the weekly measure of initial claims for unemployment insurance is seasonally adjusted. It is therefore important never to trade the forex markets using the raw data.

The unemployment data also tends to correlate with other economic indicators, such as consumer spending and retail sales, providing traders with a better idea of the health of a country’s economy and making the trading decision that is likely to be the most successful. Finally, the unemployment rate can influence central bank policy. This can affect the attitude of investors, and consequently the exchange rates of individual nations.

Trade balance

Another very important economic indicator on Forex market is trade balance. This is the difference between the amount of money, which the country earns from export goods and losses in imports. Increasing of trade balance leads to weaken the currency, on the contrary, lowering of trade deficit can strengthen the currency. This is an important indicator for traders, because the growing of deficit is a clear early harbinger of future economic problems.

Purchaser manager indices and business confidence indices are a further alternative – and this is an indicator based on an opinion survey that can be used by traders to understand the existing and expected shape of business conditions and underlying trends which might re-emerge later on. Indicators of this type can, therefore, provide a lead on what might lie ahead for the economy.

Central bank interest rate decisions are a very important factor in the Forex market. As a higher interest rate will attract more foreign investments and strengthen a currency, while a lower rate on one will weaken it, such events must be known by traders in advance in order that they could take a position that should end up being profitable.