Leading Economic Indicators
transform your Forex trading plan. Learn about GDP, Trade Balance, CPI, Unemployment & Interest Rates.
The daily news is filled with economic indicators. In the days of old only institutional brokers and high-powered investors had access to this data. Economic indicators take many forms, such as trading signals, surveys, important announcements and the like.
Fortunately, market indicators are available to casual traders, day traders and swing traders across the spectrum – novices, intermediate-level traders and professionals alike. The Internet provides a wealth of market indicators for Forex traders to tap into.
Among the many top economic indicators are the following: Gross Domestic Product (GDP), Trade Balance Report, Consumer Price Index (CPI), Unemployment Rate, Interest Rate and Inflation Rate. To be successful in Forex trading, you will need to have an intimate understanding of the impact of these economic indicators on overall trading activity. We will briefly explore the impact and significance of each of the aforesaid market indicators.
Gross Domestic Product (GDP)
Gross Domestic Product is the value of all the goods and services produced by a country during a calendar year. It is a measure of the overall health of a country’s economy. When the GDP increases year-on-year, the country’s GDP is growing.
When the country’s GDP decreases from year to year the country’s GDP is contracting. This market indicator does not factor in informal business which is not reported to the authorities. GDP measures the overall productivity of the country, not the individual well-being of its citizens.
In any event, GDP is by far one of the most critical market indicators used to assess the strength or weakness of a country’s currency. If the market forecast for GDP is lower than the actual GDP figure then Forex traders tend to go bullish on the currency of the country in question. The reverse also holds true. Investors react immediately to GDP news by buying or selling currency en masse.
The equation used to calculate Gross Domestic Product is as follows:
GDP = Consumption Expenditure + Government Expenditure + Investment Spending + Net Exports
Trade Balance Report
The Balance of Trade is the biggest part of a country’s balance of payments. This market indicator is the difference between imports and exports. Trade deficits exist when a country imports more than it exports, and trade surpluses exist when a country exports more than it imports.
The net effect of surpluses and deficits will be reflected in the actions taken by Forex traders. A country with a net deficit in its trade balance report may see a decline in the demand for its currency. A country with a net surplus may see an increase in the demand of its currency. This is how currency traders use the trade balance report in their trading activities.
Consumer Price Index (CPI) & Inflation Rates
The Consumer Price Index is a measure of a standard basket of goods and services to determine the cost of living, also known as inflation rates. Each of the goods in the basket is weighted according to its importance to the average consumer.
As the cost of living increases, inflation increases and the demand for that country’s currency may decrease. Forex traders routinely check the CPI for positive and negative changes, and react accordingly.
This market indicator is perfect for identifying inflationary or deflationary periods in an economy, as rapid spikes in CPI values over a short period of time can reflect inflationary pressures. The CPI figures for the eurozone were flat or falling during 2014, and this resulted in deflationary pressures and lower demand for the euro.
The inflation rate reflects how quickly the price of goods/services is rising. It also measures how the purchasing power of a currency is falling. Inflation is a state of being where prices are generally rising and deflation is a state of being where prices are falling. Both are equally dangerous.
Deflation is particularly worrying since consumers tend to hold back on making big item purchases – cars, homes etc. – since they believe prices will drop further. As a result, economic activity grounds to a halt in deflationary economies.
Monetary policy measures are typically implemented during either extreme. When there is inflation, there is too much money chasing too few goods and the money supply needs to be cut. During periods of deflation, the money supply needs to be increased. Forex traders react accordingly.
The unemployment rate is an important market indicator that is responsible for many decisions made by speculators in the Forex market. The strict definition of the unemployment rate is the percentage of the labor force currently seeking work, but unable to find work.
The unemployment rate is expressed as a percentage and it is posted monthly. The U.S. unemployment rate continues to decrease, meaning more people that are seeking work are finding work. However, the unemployment rate does not take into account those unemployed people who have become so disillusioned that they have dropped out of the workforce.
Overall, the lower a country’s unemployment rate the more productive the country is and the stronger its currency will be. Forex traders’ reactions are inversely related to the unemployment rate. As the rate goes down so Forex traders become bullish. When the unemployment rate increases, Forex traders become bearish.
Interest rates are annualized and expressed as an annual percentage rate. The interest rate is the charge levied by a lender on a borrower for the use of an asset. When you deposit money into your bank account, the interest rate is the payment you receive from the bank for depositing your capital with the bank.
When you borrow money from a bank, you will pay the principal back plus interest. The higher the interest rate the more beneficial it is for people with excess capital to save money at banks and financial institutions.
When the interest rate is low – as it currently is in the Eurozone, U.K. and U.S., there is little incentive to deposit your money into a fixed interest-bearing account. Typically, stock markets gain favor when interest rates are low.
Investment expenditure always thrives in a low interest-rate economy since the cost of borrowed capital is so low. As interest rates increase, the country’s currency typically gains favor. Currencies generally fare better when interest rates increase, since there is a higher demand for that country’s currency.