So far we’ve seen what economic indicators are and the relationships they have with financial markets. In this lesson, we’ll see how indicators influence each other and factors of growth and decline of a country, which are essential elements for predicting the movements of the reference currency and its strength in a particular currency pair.
The first economic indicator we’ll analyse are the effects of interest rates since this affects all the other indicators. The interest rate is certainly the variable that has the greatest impact on the Forex market, and the stock and bond markets. Everything moves according to rates, their trends and even their predictions. Sometimes the markets are based so much on the forecasts or announcements of a rate change, that when this actually arrives, it no longer takes effect because the markets have already adapted in anticipation.
On the currency market or on the Forex market, an increase in real interest rates (i.e., net of inflation) sees an increase in the attraction of capital due to higher yields. This factor should in theory strengthen the currency within the currency pair relationship.
GDP (Gross Domestic Product)
Let’s start with GDP or the Gross Domestic Product. A high GDP usually follows increases in the interest rate or at least expectations for a rise in interest rates. Being a positive factor, this causes a country to increase rates to strengthen its currency unless the country itself does not fear that inflation will not damage confidence in the same currency. For example, if Japan has an increase in its GDP and decides to raise interest rates, the YEN will be worth more, but it will also cost more even for those who buy from abroad where the exchange strengthens in favour of the YEN. Therefore, the increase in inflation affects the welfare of the country.
Countries that are interested in attracting capital are in charge of low inflation. Even if they have high GDP, they are not interested in raising interest rates and therefore don’t show large variations in currency ratios, i.e., in currency pairs.
Some indicators are able to anticipate the future evolution of GDP, as this depends on the evolution of aggregate demand. According to the macroeconomic model, considering the GDP as an offer, the demand consists of consumption, investments, changes in stocks, and net exports. Therefore, by analysing components of demand, one can deduce the possible evolution of GDP. Basically, this is what forecasts are based on to predict change in GDP percentage. We often hear, for example, “in 2015 the GDP will grow by 0.1%” (usually when it comes to Italy it is always a matter of very little). Well now you know what factors are based on those forecasts.
Industrial production is usually published together with the rate of utilization of production capacity. If this rate exceeds 85%, it can lead to a large inflationary imbalance in the production process.
If growth in retail sales is strengthening, we can expect an increase in rates as in the case of GDP, so you can bet on strengthening a currency in a currency pair and then be able to aim for the rise or fall of accordingly.
Durable Goods Orders
If durable goods orders grow, it is a sign of a strengthening economy, so even in this case a rate hike can be expected.
If factory orders increase, it means that the potential productivity of companies grows as do their profits. This is a factor that serves to assess whether there will be a downturn in the economy in the near future. Obviously if orders increase, a decline is unlikely, but rather there will be a strengthening of companies and stock indices.
Stocks of companies, stocks of wholesalers
If the inventories of companies (business inventories) or stocks of wholesalers (wholesale trade) decrease, these are a positive factor for the economy, especially at the end of periods of recession or other delicate periods.
Obviously, higher household incomes, usually means the possibility of increased consumption (above all) and savings. Savings are divided between bank deposits and investments. It is certainly a fundamental thermometer to gauge the well-being of a country with.
Personal spending is certainly a positive factor because it denotes well-being, but it can also become a factor that triggers inflation.
Trade balance is particularly important for Forex, as it is about exports and imports. Exports and export trends determine the strength of foreign economic activity and competitiveness. Imports, on the other hand, are the result of domestic economy. A strong trade deficit is accompanied by a weak currency and therefore loses ground in currency cross ratios.
As we Italians know well, the unemployment rate, if very high causes the lowering of interest rates by the Central Bank.
Inflation creates uncertainty and makes data analysis more difficult in an economic context. It also translates into a negative trend in share prices, as the authorities increase interest rates and restrict liquidity to face inflation. Moreover, inflation causes the weakening of a national currency, especially when there is a loss of competitiveness of exported goods.
Go to the next lesson – Daily Variations and Operations