In this article we will talk about advanced trading strategies for economic indicators. In prior articles we discussed the importance of economic indicators for the Forex markets. Economic indicators are powerful factors in the world economy and because of this economic indicators can change currency prices quickly. The Forex market trades 24 hours a day and the quick price changes that emerge in Forex markets, often after economic data is released, create numerous opportunities for profit.
Economic Calendar
The starting point for trading of economic indicators is the economic calendar. The calendar will give you a list of relevant economic data due for release on any given day, of the month or year.
Two-step advanced trading strategies for economic indicators
There are two main strategies that you can employ to trade economic indicators. First identify whether an economic report when released deviates from market consensus. Second, determine whether the deviation will be interpreted by the marketplace is bullish or bearish.
Release time and consensus
Most major Forex trading platforms provide an economic calendar .Most calendars will
have estimates of economic reports and market consensus for those reports. In addition, you can gather information about consensus market estimates from major financial news services.
Trading US unemployment
A good example of how to apply the two-step approach to economic indicators is a review of the US unemployment report released on January 9, 2009.
The unemployment report is released at a set time and a set day each month of the year. Consensus estimates for the report emerged days ahead of time. Consensus for the US unemployment report called for a nonfarm payroll decline of 520,000 and unemployment rise to 7%. In the run-up to the release of the report the consensus estimate for the nonfarm payroll began to widen dramatically because a much watched private group (ADP)forecast of the bigger US jobs decline. Prior to the release of the US January employment report the market was positioned for an extremely weak jobs decline. The report came out near the earlier market expectation. The USD rallied despite report of weak unemployment data because the data was not as bad had been feared. This is an example of the classic rule of advanced trading of economic indicators, “it's not the news but how the market reacts to the news”.
In addition, USD rallied after the nfp release because market focus was shifting to ECB policy outlook and potential rate cut by the ECB. To effectively profit from the US unemployment report and you need to know the consensus for the report, determine if the report was discounted by the market place and the current main market drivers for the USD.
Tier 1 and tier 2 economic reports
A third step when trading economic indicators is to differentiate between tier 1 and tier 2 reports. Unemployment reports usually are considered tier 1 economic reports. Tier 1 reports have potential for major market moving impact and generally include, GDP and employment, CPI, housing data manufacturing and service data. To monitor these reports you can go directly to the following government and private sector websites.
The internet helps to level the playing field
Thanks to the Internet everyone can have access to economic calendar, data and consensus forecasts .If you put in the time you can get a pretty good idea what the expectation is for an economic report and how the market may react on the release of a report.
There is really no reason that you need to be trained economist or for that matter have any substantial background in economics to trade foreign exchange. We discussed in earlier articles major drivers of foreign exchange trade. Simplify stated, when trading economic indicators you are looking to see how the data may influence interest-rate outlook, capital flows and general sentiment towards countries economy and currency.
If you know market consensus for economic report and what the current major fundamental drivers for the currency you are trading are, you can apply the advanced technique of determining how a report deviates from consensus and whether the deviation is bullish or bearish for the market.
What reports should I monitor?
You will also need to know which reports are likely to move markets and monitor trends in the reports to determine how any variation from market consensus in the report will impact price movement. A starting point for advanced trading of economic indicators is to familiarize you with the major US economic reports.
The major US economic reports can be broken down into these basic categories.
- Interest rate decisions
- Consumer sentiment / retail sales
- Unemployment
- General economy-which GDP, personal income and consumption, service and manufacturing reports consumer confidence
- Housing and construction
- Existing and new home sales
- Prices and inflation
- Trade balance and current account
Preparation
These reports come out at a set time and set day and you can prepare to trade the reports in advance of their release.
Major reports from other G-7 countries
G7 countries release reports similar to the US but the timing of these reports and impact of reports vary depending on which currency your trading. Every country has a set of major reports similar to the US list above. You can find these reports listed on the Internet along with a breakdown of market consensus for the report and prediction of whether the data is of high importance, moderate or low importance. Economic reports from other countries are similar to the US reports but each country has certain reports that carry greater weight for a currency. Here's a breakdown of the major reports from the countries of most actively traded currencies along with a brief analysis of the current market drivers for these currencies and the reports you need to focus on.
Japan
For the last two decades the JPY has been the primary funding currency for carry trades. Japanese interest rates have been near zero for many years and investors would borrow in the low yielding JPY and invest the funds in higher yielding assets. This is known as the carry trade. Because of low Japanese yields and the focus on the carry trade, the direction of USD-JPY was primarily a function of carry trade cross rate activity and not evaluation of the health of Japan's economy. Japanese economic data has less potential than most of the other countries economic releases to move JPY price direction. The current major driver for JPY is risk appetite. JPY is closely correlated to inverse relationship to equity markets. The major economic reports out of Japan have been largely ignored and the JPY has strengthened despite economic data pointing to significant risk of deep recession in Japan. Rising JPY makes Japans exports less price competitive contributing to Japans economic slowdown. Japanese officials have expressed concern about the strength of the JPY impact on Japan's exports and have hinted at the possibility of intervention to try and limit the JPY rise. One of the key numbers that can move the JPY is a Japans trade balance and current account. These reports reflect Japan's export sales. Other than Japan's export data, here is a list of the major reports to keep an eye on trading JPY.
- Tankan business sentiment
- CPI
- Machinery orders
- GDP
EU
When evaluating EU economic data you must be aware that ECB policy mandate is price stability. ECB mandate is not to promote growth in the EU. All European economic data needs to be looked at through a prism of the ECB policy mandate. Because the mandate is focused on price stability EU economic reports that focus on inflation are of major importance. EUR direction is often influenced by statements from EU officials and ECB president concerning ECB monetary policy outlook. Monitoring the newswires and the dates of major speeches by EU officials and ECB president will be necessary when trading EUR.
- ECB policy meetings
- CPI/money supply
- Employment
- German IFO
- Manufacturing and service PMI
UK
UK economy has deteriorated to its worst levels in two decades and in response to the economic decline Bank of England has lowered rates to record low. The key market drivers for the GBP trade are BOE policy outlook, UK economic outlook and EUR/GBP cross flows. EUR/GBP rallied to a record high at the end of 2009 with GBP pressured by speculation the Bank of England would cut rates faster than the ECB. The trade is trying to determine whether the Bank of England will make more rate cuts to combat recessionary pressures in the UK. You need to look at UK data to gauge if the UK economy will continue to weaken (bearish for GBP)or whether UK economy show signs of rebound ( bullish for GBP).To look for signs of rebound you want to focus on UK housing data ,UK inflation data and manufacturing data. Two weeks after the Bank of England meet, the BOE releases minutes from the meeting called MPC (Monetary Policy Counsel) minutes. The minutes include a breakdown of BOE members vote for or against policy change and an assessment of UK economic outlook. You can monitor the MPC minutes to evaluate the direction of BOE monetary policy.
- BOE policy meetings
- Manufacturing PMI
- Service PMI
- Nationwide housing data
- CPI
- Unemployment
- Trade balance
- MPC minutes
AUS
Australia is a commodity-based economy and AUD price direction is closely correlated to the direction of commodity prices. Australian economic data is often overshadowed by the direction of the CRB. RBA overnight rate is of 4.25%. The Reserve Bank of Australia has been aggressively easing interest rates and the AUD was down over 20% in 2008 pressured by RBA rate cuts, declining commodity prices and slowing global growth. RBA policy outlook is key to AUD price direction. RBA policy outlook will take into consideration three key factors in determining whether they will change interest rates, Australian housing, employment and inflation. AUD often trades inversely to risk appetite and apart from monitoring Australian economic data to forecast RBA policy outlook you also need to monitor risk sentiment. The goal is to determine if AUD will be supported by yield gap as Australian yields remain higher than US, Japan and Europe or AUD will be pressured by concern about risk appetite. Monitor Australian economic data to evaluate RBA policy outlook and equities for gauge the risk appetite.
- RBA policy meetings
- Retail trade
- CPI
- Building approvals
- Unemployment
- Trade balance
Canada
The CAD is a commodity currency and the direction of commodities and outlook for the global economy are the key drivers for the currency. The main drivers for the CAD are similar to the AUD. The Bank of Canada aggressively lowered interest rates in 2008 to combat the impact of slowing global growth on Canada’s economy. CAD has weakened pressured by concerns about slowing US growth, slowing global economy and concern about Canadian exports. When trading the CAD you need to monitor BOC policy outlook CRB and risk sentiment. Bank of Canada rate policy is partly focused on inflation and partly on growth. Canadian inflation is moderating and the economy has slipped into recession .The Bank of Canada will look economic growth figures from Canada for determining its next policy moves. Canadian unemployment and GDP are major market movers. Canada has been the only surplus nation in the G7 and because of this, Canada’s trade and current account figures tend to have greater importance for the direction the CAD. The major reports for CAD are CPI, IVEY PMI, and trade balance and employment data.
- BOC policy meetings
- CPI
- Employment
- GDP
- IVEY PMI
- Trade balance
Summary
The key to advanced trading of economic indicators is to know when the indicators will be released, whether the economic indicators are top-tier with potential for market movement or lower tier with less potential for market movement, the consensus for the economic indicator, whether the economic report deviates from consensus, and whether that deviation from consensus is considered bullish or bearish.
Test your knowledge
- True or false.
The most effective way to trade economic indicators is to know the market consensus, how the actual report deviates from consensus and whether that deviation is likely to be interpreted as bullish or bearish.
- True or false.
Top tier economic data will have greater impact on currency markets than tier two economic data.
- ECB policy mandate is price stability and this makes ________ a major indicator to monitor when trading the EUR.
- CPI
- unemployment
- GDP
- Manufacturing PMI
- True or false.
Economic indicators from Japan have limited impact on JPY because the main market driver for JPY is risk sentiment.
- When trading CAD and AUD you must monitor ________ along with major economic indicators.
- commodity prices
- Baltic freight Index
- wage settlements
- weather
Answer key
- True
- True
- a, CPI
- True
- a, commodity prices
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