Economic indicators can have a marked effect on Forex and CFD (contract for difference) prices. Accordingly, many traders keep a sharp eye on the economic calendar, to ensure that they are abreast of any potential volatility bumps that lie in the road ahead.
Why does it have such a large effect on market prices?
Part of the answer lies in the timeliness of the report. The employment cycle and the business cycle are closely related and, historically, changes in nonfarm payrolls (NFPs) have moved along a very similar path to quarterly GDP changes. This close correlation means that payroll data can be used as a proxy for GDP.
The crucial difference between the two is that nonfarm payrolls come out monthly, reporting on the month that ended just a few days before. In contrast, GDP is reported quarterly, and with a big delay.
Another part of the answer is the impact the report has on monetary policy. Maximum employment and stable prices are two of the FED's (Federal Reserve) Three Monetary Objectives (these two key goals are often referred to as the FED's dual mandate). It follows then that employment data can have a serious effect on market perceptions of the future direction of monetary policy.
1. Gross Domestic Product (GDP)
GDP is the widest measure of the overall health of an economy. It takes such a long time to compile that its direct effect on Forex and CFD prices is frequently muted – and by the time the data is published, many of the components are already known, and, therefore, expectations are often fairly accurate. That being said, should the number come out markedly different to expectations, it still has the potential to move the market.
Despite its lack of timeliness, it is still a very important indicator to understand because it is the single best measure used to confirm where we stand in the business cycle.
The business cycle is a key concept in modern economics. It consists of an expansionary phase, whereby many areas of the economy grow at the same time, and a recessionary phase, when economic activity contracts. Because the broadest gauge of economic activity is GDP, economists tend to determine where we are in the business cycle by looking at alternations of growth and contraction in GDP.
The technical definition of a recession is two consecutive quarters of contraction in GDP. A recession ends as soon as we see a quarter of growth. Politicians, policymakers, and economic analysts all focus heavily on this indicator, precisely because it is such a comprehensive measure. Investment banks adopting a top-down approach to Forex analysis will start by making projections for the general economic climate. GDP is a key part of this kind of analysis of foreign exchange market macroeconomics.
As professional traders, we need to be aware of it is as well, but you should also be cognisant of the fact that because GDP is a lagging indicator, its main use is to confirm what we already expect. Its lack of timeliness means that its utility as a trading tool for short and medium-term trading is limited. US GDP only comes out once a quarter, and even the earliest estimate reports back many months into the past.
Very useful, therefore, would be something that can be used as a close proxy for GDP, but which reports more frequently – which brings us onto our next indicator.
2. Nonfarm Payrolls (NFP)
For most Forex and CFD traders, this is the single most important indicator in the monthly calendar. It's released on the first Friday of each month by the Bureau of Labor Statistics (BLS) alongside the unemployment rate (which is the next indicator on our list), as part of the Employment Situation Report. The reason it's so closely followed is because the report has a tendency to move Forex markets substantially.
The one-minute EUR/USD chart below illustrates such a move. The yellow vertical line marks the release of the Employment Situation report that was released on 7 July 2017. Notice how sharply the price moved in just one minute? Also, notice how much larger the average range of each bar becomes after the release of the report, compared to before.
Why does it have such a large effect on market prices?
Part of the answer lies in the timeliness of the report. The employment cycle and the business cycle are closely related and, historically, changes in nonfarm payrolls (NFPs) have moved along a very similar path to quarterly GDP changes. This close correlation means that payroll data can be used as a proxy for GDP.
The crucial difference between the two is that nonfarm payrolls come out monthly, reporting on the month that ended just a few days before. In contrast, GDP is reported quarterly, and with a big delay.
Another part of the answer is the impact the report has on monetary policy. Maximum employment and stable prices are two of the FED's (Federal Reserve) Three Monetary Objectives (these two key goals are often referred to as the FED's dual mandate). It follows then that employment data can have a serious effect on market perceptions of the future direction of monetary policy.
3. Unemployment Rate
The unemployment rate is defined as the percentage of the labour force actively looking for work. In periods of recovery, unemployment acts as a lagging indicator. We tend to see unemployment continuing to rise even after GDP has bottomed out. Unemployment is also closely tied to consumer sentiment (see number five on our list). Extended periods of unemployment are extremely damaging to consumer sentiment, and consequently also affect consumer spending and impact on economic growth.
Just as with nonfarm payrolls above, unemployment data offers CFD traders insights into one of the key metrics followed by the FED. This means that any strong divergence from expectations are likely to have a big impact on Forex and stock markets. All things being equal, US labour market weakness would conventionally be considered to be bearish for stock prices and for the US Dollar.
4. Federal Funds Rate
The Federal Open Markets Committee (FOMC) meets eight times a year as part of its regular schedule to determine US monetary policy. The outcome of an FOMC meeting can markedly affect the Forex market, should there be any disparity from the expected course. A key fundamental that drives Forex rates is the level of interest rates in the two countries involved, and the expectations regarding those interest rates.
If the FED makes a change to the federal funds rate, or simply alters perceptions about the future course of monetary policy, it makes a difference to the US Dollar, the most important currency in the world. As part of the statement released after each FOMC meeting, the FED provides forward guidance about the expected path of monetary policy.
This is a reasonably recent measure, aimed at providing greater transparency as part of an effort to reduce volatility in financial markets. As a consequence, changes in monetary policy are usually communicated to some degree in advance. This means that the forward guidance itself has the potential to move markets, just as much as an actual change in policy. A serious Forex or CFD trader will always ensure they are aware of the Calendar for FOMC Meetings.
5. Consumer Confidence Index/University of Michigan Index of Consumer Sentiment
At number five in our list we have two reports. The Consumer Confidence Index, compiled by the Conference Board, and the Consumer Sentiment Index, is compiled by the University of Michigan. There are many consumer surveys, but these two are the best known and the most widely followed by economists and Forex/CFD traders. These reports are important because nothing drives the US economy quite like consumer spending. Consumer confidence lets us know how consumers are feeling.
If they're feeling secure in their jobs and are optimistic about their future economic prospects, what can we infer? It is logical to presume that they may be more inclined to go out and spend. This will drive economic growth. Because consumer optimism or pessimism has such strong implications for the prospects of the economy, these two reports should be featured in any leading economic indicators list. The Consumer Confidence Index comes out toward the end of the month, while the University of Michigan publishes its survey twice a month.
This comprises a preliminary reading on the second to last Friday of the month. A final estimate follows two weeks later. These reports tend to have the most impact on the Forex and stock markets, when the business cycle is close to a turning point. Strong consumer sentiment points to a possible upturn for the economy going forward, which is bullish for stocks. Weak consumer sentiment presages a downtown, and is a bearish signal for the stock market.
The University of Michigan survey comes out more frequently, which is useful. The Conference Board's report samples a wider body of respondents, though, which implies greater statistical reliability. Both tend to correlate fairly well with turns in the business cycle, but they are heavily influenced by the labour market. If unemployment remains high when other parts of economy are recovering, market sentiment may remain depressed, thus behaving as a lagging indicator in such circumstances.
6. Consumer Price Index (CPI)
The CPI measures the cost of goods and services, index-linked to a base starting point. This provides us with an objective handle on how fast prices are rising or falling. As we mentioned earlier in the article, price stability is part of the FED's dual mandate. When inflation is within target levels, it is considered normal or even desirable. However, if inflation veers too far off target for too long, it can have very negative effects on the economy.
Economists at the FED prefer to focus on the PCE price index that comes as part of the GDP report. This is only reported quarterly, so Forex and CFD traders often follow the CPI as it is a more timely indicator of inflation. The CPI's usefulness as a leading indicator for the economy is limited. It has proven to be a poor predictor of turning points in the business cycle, despite a natural and logical association between economic growth, demand, and higher prices.
In the 1970s and early 1980s, high inflation was a real issue for the US economy. In contrast, in the aftermath of the global financial crisis, there was a real danger of deflation (sustained price decreases). Deflation hurts the economy by incentivising consumers to hold off making purchases because they will be cheaper in the future, so long as prices continue to fall. As consumer spending constitutes such a large part of GDP, this will slow economic growth, and can create a vicious circle.
Because inflation feeds into monetary policy so directly, the CPI report can have a high impact on prices in the bond, FX, and stock markets. As usual, it is diversions from expected results that tend to have the highest impact. For example, if CPI comes in much higher than expected, it will alter the perceptions that the FED will be more likely to tighten monetary policy going forward. All things being equal, this should be bullish for the US Dollar.
Similarly, a CFD trader might interpret such inflationary data as being bearish for the stock market, as tighter monetary policy tends to curtail risk appetite. Since the financial crisis, we have been in a very low inflationary environment, which has forced the Federal Reserve to stick with very loose monetary policy. This has to some degree been responsible for the extended bull-market we have seen in the US.
7. Industrial Production Index
The Industrial Production Index measures the level of US output (in terms of quantity of material produced rather than Dollar amount) relative to a base year over three broad areas: manufacturing, mining, and gas and electric utilities. The report is compiled by the Federal Reserve, and is published around the middle of each month. Some of the index data comes from hard data, reported directly for certain industries from trade organisations or official surveys, but this may not always be available on a monthly basis.
To fill the gaps, the FED makes estimates using proxies, such as hours worked from the Employment Situation report, or THE amount of power used in the month by the industry in question. The full process for calculating the index is set out in the best place to look for a full rundown of the methodology involved – the FED's own 'Explanatory Pages'. There are hundreds of components that make up the index, which is then reported as an index level.
For example, the preliminary release of the industrial production index for May 2017 came in at 105.0. This is an expression of the current output relative to the base year. At the time of writing, the FED used 2007 as its base period. The May 2017 level of 105.0 signifies, therefore, that production levels were 5% higher than the average level in the base period of 2007. Manufacturing only makes up roughly 20% of the US economy, but is closely monitored by FX and CFD traders.
The industrial sector is important because, along with the construction sector, it is responsible for the majority of the change in US output seen in the business cycle, and can offer insights into the evolution of structural economic changes. The Industrial Production Index is procyclical. This means there is agreement between its movements and the changes in the business cycle. The correlation between this index and economic activity is close enough for some analysts to use this report as an early signal for how GDP might be performing.
8. Capacity Utilisation
This indicator gauges how the US manufacturing sector is running as a proportion of full capacity. The definition of full capacity is the greatest level of sustainable output a factory can achieve within a realistic framework. In other words, it takes into account things such as normal downtime. It is calculated as a ratio of the industrial production index divided by an index of full capacity.
This provides us with a timely indication of manufacturing/economic health, as well as an insight into trends that may be forming within the manufacturing sector. It may also provide clues about inflation. If factories are running hot, it's a reasonable assumption that producers may raise prices. If factories are running close to their maximum capacity, machines are likely to fail as a result of being overworked.
Taking machines offline poses the risk of laying off workers at a time of high demand, which is undesirable. Accordingly, manufacturers are likely to cope with high demand by raising prices, rather than laying off workers. This, in turn, is likely to feed through to consumer prices, leading to higher inflation. Conversely, if capacity utilisation is running at low levels, it is a signifier of economic weakness.
As a general rule, rates below 78% have historically tended to point to a forthcoming recession — or may even mean that the economy is already in recession. As such, this indicator is used by the FED to gauge trends in manufacturing, the wider economy, and also inflation. This makes it an important indicator for CFD traders to follow, particularly for bond traders, but it's also a key marker for those involved in the shares and FX markets.
9. Retail Sales
This is more well-known as Advance Monthly Sales for Retail Trade, to give the report its full name. It is, however, better known by Forex traders simply as retail sales. The Census Bureau, which is a division of the U.S. Department of Commerce, releases the report roughly two weeks after the month in question, at 08.30 ET. The report gives an early estimate of the nominal Dollar value of sales within the retail sector (that is, the number is not adjusted for inflation) and it also reports the number as a percentage change from the previous month.
Usually, it is this latter figure that CFD and Forex traders respond to. It is a closely-followed report and has the potential to send perturbations through market prices, especially if there is a big divergence between the reported figure, and Wall Street expectations. Why is it such a closely-followed report? It's all about personal consumption expenditures (PCE). PCE is a major contributor to the growth of US economy. It's also worth comparing with the Personal Income And Outlays report from the Bureau of Economic Analysis (BEA).
This specifically includes a PCE component, which then feeds directly into GDP calculations. The data covered in that report is more comprehensive than the retail sales report. Crucially, though, retail sales data comes out a good couple of weeks earlier, thus providing a more timely insight into effectively the same area of the economy. If retail sales are increasing, it is an indication of economic health, and it tends to have a bullish effect on the stock market.
Strong sales data may lead to rising prices, however, meaning that there are inflationary considerations to be taken into account. This tends to have a positive effect on the US Dollar, but is bearish for bond prices. Conversely, weakness in the retail sales report tends to depress the stock market, is bearish on the US Dollar, but bullish for bond prices.
Certain components of the report may contribute to unwanted volatility from an analysis perspective. Motor vehicles, because of the expense of such items, tend not to be evenly distributed month to month. Accordingly, analysts often focus on retail sales, excluding auto sales in order to remove unpredictable variations, and to perceive underlying trends in the data more easily.
10. Durable Goods Orders
The report on Durable Goods Orders is released by the Census Bureau, a part of the U.S. Department of Commerce. The Advance Report on Durable Goods, to give it its full name, is released around 18 business days into the month, after the month for which it is reporting (the precise day varies according to the schedule of other key releases at the time). Durable goods are defined as items that are expected to last for at least three years. In other words, we are generally talking about expensive items that tend to be bought infrequently.
This infrequency means that the report is subject to volatility and you need to be very careful about what you read into a single report in isolation. Analysts often exclude the transport component of the report, to try and mitigate this volatility. Another method employed is to consider a series of reports together in order to try and gauge some kind of feeling for an underlying trend. Also, beware of revisions to a previous month's data, which can be substantial.
If demand is strong and companies have an upbeat outlook, we would expect to see increases in new orders for durable goods. On the other hand, in a weak economic climate, we would expect to see lower orders. Therefore, strength in this report is bullish for risk appetite, and weakness is bearish.
As far as CFD traders go, strength in durable goods is a positive sign for stocks, all other things being equal. In terms of the effect on the Forex market, it is a similar story for the US Dollar as it is for stocks: a strong report is bullish for USD, as a burgeoning economy would tend to lean towards a tighter bias in monetary policy from the FED.
11. Initial Jobless Claims
This 'Weekly Report' measures the number of people making first-time claims for unemployment benefit insurance. This provides a useful update on the strength of the labour market, particularly when it coincides with the sample week used for the 'Employment Situation' report.
Jobless Claims' are a useful resource for trying to get a feel for upcoming movements in the all-important monthly nonfarm payrolls report, though there is not a precise correlation between the two. Short-term changes in the labour market are much more likely to be reflected in the weekly initial jobless claims data, than in the monthly employment report. Still, this is one of the more impactful weekly reports on FX and CFD prices.
We hope that these detailed definitions of economic indicators have helped you. Of course, the list is far from comprehensive, but you should find that those included here are among the more impactful economic indicators for Forex trading. Bear in mind, that when we have described the possible impact of economic results, it is with the caveat of 'ceteris paribus'.
Which is to say, the actual results may be more nuanced than simply one variable being at play. A strong payrolls result would normally be considered a bullish result for the US Dollar, but Forex traders also need to look at how inflation expectations may be influencing monetary policy, the path other central banks are following, and what has already been priced into the Forex market.
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