The role of economic indicators in shaping the Forex market

Economic indicators are data that inform us about the activity and development of the economic sector or the entire economy related to a country or the world. For Forex trading, it is important to know how economic indicators behave because they reflect the evolution of macroeconomic aspects that will eventually affect the movement of the economies of certain countries, and will have consequences for the movement of their currencies. In our article, we will look at the main types of economic indicators, their impact on exchange rates and methods to analyse them for successful trading.

Types of economic indicators

Economic indicators provide important information about the state of the economy and they are published at different intervals. Some indicators are released daily, while others are released monthly or quarterly. Financial institutions often take positions in the market prior to the release of these data. There are usually two types of market movements following the release of indicators: the first is an immediate reaction that occurs immediately after the announcement, and the second is a slower and more prolonged reaction as market participants analyse and digest the information.

Different economic indicators can have different effects on the supply and demand for the currency of the country or region to which they relate. Some indicators have a direct impact on the currency, while others are dependent on it. Economic data can also be categorised into leading indicators (reflecting the confidence of economic agents) and lagging indicators (e.g. consumer price index, unemployment rate, inflation).

Central banks use economic indicators to develop their monetary policy, which in turn affects exchange rates and economic events. Although economic indicators exist for all of the world's economies and different currencies, the most important ones are those related to the U.S. dollar, as it is the base currency. All traders closely follow the release of data on the US economy and its dynamics, as these indicators have a significant impact on the global financial markets.

Consumer price index

The Consumer Price Index (CPI) measures changes in the prices of a basket of goods and services and is an important indicator of the state of inflation in an economy. Central banks, such as the European Central Bank (ECB), are often faced with the task of managing inflation, and the CPI provides valuable data on its dynamics. To stimulate economic growth, central banks typically lower interest rates. This boosts inflation, which in turn increases wages and improves employment. However, if inflation becomes excessive, it has a negative impact on savings as our money loses purchasing power. In response, central banks raise interest rates to bring inflation under control. These changes in interest rates and inflation rates have a direct impact on currency movements, which is important to consider when analysing the economic situation.

Producer price index

The Producer Price Index (PPI) measures the change in the cost of raw materials and semi-finished goods used by companies in various industries such as agriculture, mining and utilities. Knowing the trend of PPI can predict how the Consumer Price Index (CPI) will change. A rising CPI indicates a growing economy, which helps create jobs in the manufacturing sector.

When PPI rises, it often indicates a future rise in inflation, predicting that CPI will also rise. In turn, this can lead to higher interest rates. In the Forex market, higher interest rates mean increased demand for a currency, making it stronger against other currencies. For example, the US economy is showing good growth, which leads to a stronger dollars. At the same time, the Eurozone is having trouble generating inflation, which weakens the Euro against the dollars.

Gross domestic product

Gross Domestic Product (GDP) is a graphical representation of all the goods and services produced by a country or region (such as the Eurozone) over a given period of time. One of the difficulties in analysing this indicator is the correct interpretation of its data. GDP can be presented in real and nominal terms, where real GDP excludes the effect of inflation. At a glance at GDP, one can determine whether the economy is growing or not. If inflation and employment data are additionally taken into account, one can get a pretty clear picture of what the monetary policy of the Central Banks will be. This helps in understanding what measures will be taken to regulate economic growth and ensure stability.

Retail sales

This indicator reflects the total sales of goods made by all retail establishments in a country. In the US, it takes into account the sales of all retail shops, excluding sales of health care and education services. The release of this data usually triggers a significant movement in the market. A high level of retail sales indicates a growing economy and improved consumer confidence, while a low figure signals a decline in personal consumption and raises concerns about the state of the economy, possible job losses and other negative factors.

Personal income

The personal income indicator measures changes in income received by consumers in monetary terms. It includes wages, subsidies, dividends, interest on bills, and other types of income. This indicator serves as a predictor of future retail sales. It is logical to assume that the higher the income, the more people spend, and the more money they can allocate to savings. Increased consumer spending fuels economic growth. Savings, in turn, can be invested in financial markets, which fuels asset growth. When savings flow to banks, they have more capacity to lend. This stimulates lending and hence economic growth.

Trade Balance

The balance of trade reflects a country's dependence on the outside world and its strength or weakness against other currencies. It measures the difference between the value of imports and exports. If a country imports more than it exports, it can negatively affect its economy, including the value of its currency. When a country is a net exporter, its currency is in demand abroad, causing it to appreciate. Conversely, if a country imports more than it exports, its currency is likely to depreciate against other currencies. Analysing past trade balance data helps to assess domestic demand and determine economic trends. A country is considered to have a trade deficit if it imports more than it exports. If exports exceed imports, a country has a trade surplus.

Philadelphia Fed Index

This is one of the most fascinating economic indicators because it is a survey of business prospects. The survey is conducted among manufacturers located in the states of Pennsylvania, Delaware and New Jersey. Participation in the survey is voluntary and respondents are asked about the current status and growth of their business. The Philadelphia Fed Index, when above 0, indicates expansion of the manufacturing sector and when below 0, indicates contraction. This indicator measures the health of the manufacturing sector and if manufacturing is growing, then employment will also increase, which in turn contributes to overall economic growth.

Conclusion

The publication of economic indicators can be useful for short-term speculation. To use this information effectively, you need to have a good understanding of the financial markets and understand how the results can affect currency movements. This is not always easy, although some traders achieve significant gains. However, it is most useful to apply the analysis of economic indicators over the medium to long term. This requires understanding how each data point affects the real economy and what actions governments can take based on that information. Even if we understand how the currency market may develop based on the available data, our recommendation is to use technical analysis to improve the timing of any position and only trade in the direction of the trend we believe is correct.