Market Moving Economic Data Reports from United States

Now we get down to the nitty-gritty data. I will run you through the major economic data reports that come out of the United States. My intention here is not necessarily to magnify the importance of U.S. economic data, even though the United States is the world’s largest national economy and the U.S. dollar is on one side of 80 percent of currency trades.

Nope, my aim here is to kill two birds with one stone:

• Introduce you to the major economic reports issued by every major currency country, using U.S. data as the example

• Let you in on the finer points of how the market views the important  data reports

Later in my coming post I will take you through a country-by-country look at major non-U.S. data reports that don’t fall into the main report categories or are too important to be ignored.

Labor Market Reports

I put the job market at the top of our economic model, and the various labor-market reports are what we use to keep tabs on the job market. The monthly U.S. employment report, the highlight of which is the non-farm payrolls (NFP) report, gets the most attention. Non-farm Fridays, as they’re semi-affectionately known, are among the most volatile trading days each month.

Non-farm payroll report (Relevance: High)

The NFP report, also referred to as the establishment survey (because it's based on responses from companies), is the government’s primary report assessing the overall labor market in the prior month. Here are the main components of the report:

• Change in non-farm payrolls: This is the big number everyone focuses on. If you see NFP estimates of +125,000, it means the consensus forecast is that the economy added 125,000 new jobs in the previous month. The NFP number accounts for 75 % to 80% of total U.S. employment, excluding government, self-employed, and farm workers, among other categories. The going wisdom among economist and academics is that the U.S. economy needs to add an average of 100,000 to 150,000 jobs each month to offset population growth and keep the unemployment rate steady. The market’s initial reaction will largely be based on the difference between the actual and the forecast change in non-farm payroll workers.

• Unemployment rate: The unemployment rate measures unemployed individuals seeking work as a percentage of the civilian labor force. Increases in the unemployment rate are typically interpreted as a sign of weakness in the labor market and the economy overall, while declines in the rate are considered a positive indicator of the job situation.

• Change in manufacturing payrolls: Measures the number of jobs added or lost in manufacturing industries and is looked at as a gauge of near-term production activity.

• Average hourly earnings: Measures the change in employee wages and is looked as an indicator of whether incomes are rising or falling and the implications for consumer spending.

• Average weekly hours: Measures the average number of hours worked each week and is looked at as a rough gauge of the demand for labor, with increasing weekly hours seen as a positive for the labor market.

ADP national employment report (Relevance: Medium)

The ADP national employment report is put together by the payroll processing company of the same name (www.adp.com) and comes out on Wednesdays at 8:15 a.m. ET, two days before the government’s NFP report. The ADP report is intended to serve as an alternative measurement of the labor market, but it’s a relative newcomer, having debuted in mid-2006. The report’s issuers say it has a roughly 90 percent correlation to the government NFP report over its lifetime, but several large discrepancies between the ADP report and the NFP report in the ADP report‘s first year have left market participants uncertain about how much weight to give the ADP report. At the moment, the ADP report seems to produce little market reaction on its own. Instead, the market may adjust its forecasts for the NFP depending on what the ADP indicates.

Weekly initial unemployment claims (Relevance: Law)

Initial jobless claims are reported every Thursday at 8:30 a.m ET for the week ending the prior Saturday and represent first-time filings for unemployment insurance. Initial claims are looked at as interim updates on the overall labor market between monthly NFP reports. The changes in initial claims can be volatile on a week-to-week basis - there are a fair number of hiccups caused by weather, strikes, and seasonal labor patterns - so analysts look at a four-week moving average of initial claims to factor out one-off events. Still, sharp increases or declines in initial claims data will get the market’s attention, producing a market reaction on their own, as well as causing estimates of upcoming monthly NFP reports to be downgraded or upgraded.

A second part of the weekly claims report is continuing claims, which is a measure of the total number of people receiving unemployment benefits, excluding first-time filers. The market looks at continuing claims as another gauge of labor-market conditions. Increases in continuing claims typically suggest deterioration in the job market, because unemployed individuals are finding it difficult to get work and staying on unemployment insurance longer. Declines in continuing claims are similarly viewed as an improvement in the job market, because workers are presumably finding jobs more easily.

Inflation Gauges

Inflation reports are used to monitor overall changes in price levels of goods and services and as key inputs into setting monetary-policy expectations. Increases in inflation are likely to be met with higher interest rates by central bank policy makers seeking to stamp out inflation, while moderating or declining inflation readings suggest generally lower interest-rate expectations.

There are a number of different inflation reports, with each focused on a different source of inflation or stage of the economy where the price changes are appearing. In the United States and other countries, inflation reports come out on a headline (total) basis and a core basis (which excludes food and energy to minimize distortions from these volatile inputs). Inflation reports report changes on a month-to-month basis (abbreviated MoM, for month-over-month) to monitor short-term changes; as well as changes over the prior year’s levels (YoY, for year-over-year) to gauge the longer-term rate of inflation. The main inflation reports to keep an eye on are

• Consumer price index (CPI) (Relevance: High): The CPI is what most people are familiar with when they think of inflation. The CPI measures the cost of a basket of goods and services at the consumer or retail level – the prices that we’re paying. The CPI is looked at as the final stage of inflation.

• Producer price index (PPI) (Relevance: Medium): The PPI measures the  change in prices at the producer or wholesale level, or what firms are  charging one another for goods and services. The PPI looks at upstream inflation by stage of processing and may serve as a leading indicator of overall inflation.

• Personal consumption expenditure (PCE) (Relevance: High): The PCE is roughly equivalent to the CPI in that it measures the changes in price of a basket of goods and services at the consumer level. But the PCE has the distinction of being preferred by the Federal Reserve as its main inflation gauge because the composition of items in the PCE basket changes more frequently than in CPI, reflecting evolving consumer tastes and behavior. If the Fed thinks the more-dynamic basket is the one to watch, who are we to disagree? When the Fed refers to an inflation target or tolerable level of inflation, it’s typically referring to core PCE readings.

• Gross domestic product (GDP) deflator (Relevance: Low): The GDP  deflator is a broad measure of inflation used to convert current GDP output to a constant-dollar value of GDP for historical comparison purposes. The GDP deflator is also called the implicit price deflator and is reported as part of the quarterly GDP release.

• Institute for Supply Management (ISM) prices paid index (Relevance: Medium): The national and regional purchasing managers indices have subcategories reporting on the level of prices paid and the level of prices received by firms. The prices-paid component usually gets the most attention as another corporate-level indication of price pressures, likely to be mirrored by the PPI.

Gross domestic product (Relevance: High)

Gross domestic product (GDP) measures the total amount of economic activity in an economy over a specified period, usually quarterly and adjusted for inflation. The percentage change in GDP from one period to the next is looked at as the primary growth rate of an economy. If GDP in the first calendar quarter of a year is reported as +0.5 percent, it means the economy expanded by 0.5 percent in the first quarter relative to the prior fourth quarter’s output. GDP is frequently calculated on a quarterly basis but reported in annualized terms. That means a 0.5 percent quarterly GDP increase would be reported as a 2 percent annualized rate of growth for the quarter (0.5 percent x 4 quarters = 2 percent). The use of annualized rates is helpful for comparing relative growth among economies.

In most countries, GDP is reported on a quarterly basis, so it’s taken as a big picture reality check on overall economic growth. The market’s economic outlook will be heavily influenced by what the GDP reports indicate. Better than-expected growth may spur talk of the need for higher interest rates, while steady or slower GDP growth may suggest easier monetary policy ahead. At the same time, though, GDP reports cover a relatively distant economic past - a quarter’s GDP report typically comes out almost midway through the next quarter and is looking back at economic activity three to four months ago. As a result, market expectations continue to evolve based on incoming data reports, so don’t get too caught up in GDP for too long after its initial release.

Trade and current account balances

Two of the most important reports for the forex markets, because there are direct and potentially long-term currency implications, are trade balance and current account balance:

• Trade balance (Relevance: High) measures the difference between a  nation’s exports and its imports. If a nation imports more than it exports, it’s said to have a trade deficit, if a nation exports more than it imports, it's said to have a trade surplus. Trade balances are reported on a monthly basis; prior periods are subject to revision.

• Current account balance (Relevance: High) is a broader measure of international trade, and includes financial transfers as well as trade in goods and services. Current accounts are also either in deficit or surplus, reflecting whether a country is a net borrower or lender to the rest of the world. Nations with current account deficits are net borrowers from the rest of the world, and those with current account surpluses are net lenders to the world. Current account reports are issued quarterly, and because the monthly trade balance comprises the bulk of the current account balance, markets tend to have a good handle on what to expect in current account data.

Countries with persistently large trade or current account deficits tend to see their currencies weaken relative to other currencies, while currencies of countries running trade surpluses tend to appreciate. The basic idea is that the currency of a deficit nation is in less demand (it’s being sold to buy more foreign goods) than the currency of a surplus nation (it’s being bought to pay for domestically produced goods).

For example, the U.S. dollar has been under pressure for the past several years owing to its widening (increasing) trade and current account deficits. In late 2006, however, the size of the deficit stopped increasing, which removed some of the pressure on the dollar. But because the deficit remains high in absolute and historical terms, the U.S. trade deficit is still a major U.S. dollar negative.

Another economic report that tends to serve as a counterweight to the U.S. trade and current account deficits is the net foreign purchases of securities report, issued monthly by the U.S. Treasury and commonly known as the TIC report. (TIC is short for Treasury International Capital.) The TIC report tallies net financial inflows into and out of the United States for stocks, bonds, and other securities. If investment inflows into the United States are sufficient to cover the monthly trade deficit, the thinking is that the United States is still able to attract sufficient funds from abroad, and the U.S. dollar need not weaken. (For more on the TIC reporting system, check out www.treas.gov/tic)

Leading economic indicators: (Relevance: Low)

The index of leading economic indicators (LE1) is compiled by the Conference Board and issued on a monthly basis. The index is based on ten components that typically lead overall economic developments, such as initial unemployment claims, average hourly wages, and consumer sentiment, to single out just a few.

The LEI index is looked at as a gauge of the economy's direction over the next six to nine months. Increases in the index point to stronger growth in the months ahead, while declines in the index point to likely future weakness. Because eight of the ten components in the index are known in advance of its release, the LEI index tends to have a subdued market impact, but it's still useful to guide future expectations.

Institute for Supply Management and purchasing managers reports

The Institute for Supply Management (ISM) calculates several regional and national indices of current business conditions and future outlooks based on surveys of purchasing managers. ISM readings are based on a boom/bust scale with 50 as the tipping point - a reading above 50 indicates expansion, while a reading below 50 signals contraction.

The main ISM reports to keep an eye on are

• Chicago Purchasing Managers Index (PMI) (Relevance: Low):The  Chicago PMI remains the key regional manufacturing activity index because the Chicago area and the Midwest as a whole are still significant hubs of manufacturing activity in the United States. The Chicago PMI is also the first of the national PMIs to be reported, and the market frequently views it as a leading indicator of the larger national ISM manufacturing report, which is released a few days after the Chicago PMI.

• ISM manufacturing report (Relevance: Medium): The ISM manufacturing report is the monthly national survey of manufacturing activity and is one of the key indicators of the overall manufacturing sector. The ISM manufacturing report also includes a prices-paid index, which is viewed as an interim inflation reading, along with other key subsector measurements, like the employment situation. The market tends to react pretty aggressively to sharp changes in the report or if the ISM is moving above or below 50, but keep in mind that the manufacturing sector accounts for a relatively small portion of overall U.S. economic activity, so the importance of the ISM manufacturing gauge tends to be exaggerated.

• ISM non-manufacturing report (Relevance: Medium): The ISM non-manufacturing report is the monthly ISM report that covers the other 80 percent of the U.S. economy. The ISM manufacturing report may get more attention, but the ISM non-manufacturing report is the one to focus on.

Consumer sentiment reports

Consumer psychology is at the heart of the market’s attempts to interpret future consumer activity and, with it, the overall direction of the economy. The theory is that if you feel good, you‘ll spend more, and if you feel lousy, you‘ll stop spending. The market likes to pay attention to consumer confidence indicators even though there is little correlation between how consumers tell you they feel and how they’ll actually go on to spend.

In fact, consumer sentiment is more frequently the result of changes in gasoline prices, how the stock market is faring, or what recent employment indicators suggested. More reliable indicators of consumer spending are money-in-the-pocket gauges like average weekly earnings, personal income and spending, and retail sales reports. Still, the market likes to react to the main sentiment gauges, if only in the short run, with improving sentiment generally supporting the domestic currency and softer sentiment hurting it. The key confidence gauges are:

• Consumer confidence index (Relevance: Medium): A monthly report  issued by the Conference Board comprised of the expectations index (looking six months ahead) and the present-situation index. The surveys ask households about their outlooks for overall economic conditions, employment, and incomes.

• University of Michigan consumer sentiment index (Relevance: Medium): Comes out twice a month: a preliminary reading in the middle of the month and a final reading at the start of the next month.

• ABC Consumer Confidence (Relevance: Low): A weekly consumer-sentiment report issued each Tuesday evening. The weekly ABC confidence report can be used to update your expectations of upcoming monthly consumer confidence and University of Michigan reports.

If market forecasts envision an increase in the Michigan or Conference Board’s consumer confidence index, for example, but the prior two or three weeks of the ABC survey suggest confidence is waning, you’ve got a pretty good indication that the monthly surveys may disappoint.

Personal income and personal spending (Relevance: Medium)

These two monthly reports always come out together and provide as close an indication as we can get of how much money is going into and out of consumers’ pockets. The market looks at these reports to get an update on the health of the U.S. consumer and the outlook for personal consumption going forward. Personal income includes all wages and salaries, along with transfer payments (like Social Security or unemployment insurance) and dividends. Personal spending is based on personal consumption expenditures for all types of individual outlays.

Personal income is watched as a leading indicator of personal spending on the basis that future spending is highly correlated with personal income. The greater the increases in personal income, the more optimistic the consumption outlook will be, and vice versa. But it’s important to note that inflation adjusted incomes are the key. If incomes are just keeping pace with inflation, the outlook for spending is less positive.

Retail sales (Relevance: High)

The monthly advance retail sales report is the primary indicator of personal spending in the United States, covering most every purchase Americans make, from gas-station fill-ups to dinner out and a night at the movies. Retail sales are reported on a headline basis as well as on a core basis (which excludes automobile purchases). The market focuses mainly on the core headline to get a handle on how the consumer is behaving, but substantial strength or weakness in the auto industry doesn’t go unnoticed, because it still plays a major role in the manufacturing sector. The advance retail sales report is a preliminary estimate based on survey samples and can be revised substantially based on later data.

Retail sales reports are subject to a variety of distorting effects, most commonly from weather. Stretches of bad weather, such as major storms or bouts of unseasonable cold or heat, can impair consumer mobility or alter shopping patterns, reducing retail sales in the affected period. Sharp swings in gasoline prices can also create illusory effects, such as price spikes leading to an apparent increase in retail sales due to the higher per-gallon price, while overall non-gas retail sales are reduced or displaced by the higher outlays at the pump.

Durable goods orders (Relevance: Medium)

Durable goods orders are another major monthly indicator of consumption, both by individuals and businesses. Durable goods measure the amount of orders received by manufacturers that produce items made to last at least three years. As a data series, durable goods is one of the most volatile of them all, with multi-percentage swings (as opposed to 0.1 % or 0.3 % changes) between months a norm rather than an exception. Durable goods are reported on a headline basis and on a core basis, excluding transportation, or ex-transportation (mostly aircraft).

Durables are generally bigger-ticket purchases, such as washing machines and furniture, so they’re also looked at as a leading indicator of overall consumer spending. If consumers are feeling flush with cash and confidence, big ticket spending is more common. If consumers are uncertain, or times are tight, high-cost purchases are the first to be postponed. Also, businesses tend to concentrate their spending in the final month of each quarter, which can distort prior months and exaggerate the last.

Housing-market indicators

The housing market in the United States and other major economies has taken on increased importance in recent years as real-estate valuations increased dramatically, ultimately producing the dreaded real-estate bubble. As a result, the housing sector has become an important factor in gauging the overall economic outlook.

There’s a raft of monthly housing market reports to monitor the sector, based on whether the homes are new or existing:

ü  Existing-home sales (Relevance: High) is reported by the National Association of Realtors (NAR). Sales of pre-existing homes (condos included) account for the lion’s share of residential real-estate activity - about 85% of total home sales. Existing-home sales are reported on an annualized rate, and the market looks at the monthly change in that rate. Median home prices and the inventory of unsold homes are important clues to how the housing market is evolving. Existing-home sales are counted after a closing. Pending home sales are a separate report viewed as a leading indicator of existing home sales. Pending home sales are counted when a contract is signed to buy an existing home.

ü  New-home sales (Relevance: Medium) are just that, brand-new homes and condos built for sale, reported on an annualized basis. New-home sales account for about 15% of residential home sales, but the sector was the fastest growing during the recent real-estate boom and has since seen activity decline steeply. New home sales are counted when a contract is signed to purchase the new home, which means that contract cancellations (not reported) may result in lower actual sales than originally reported.

ü  Housing starts (Relevance: Medium) measure the number of new-home  construction starts that took place in each month, reported on an annualized rate. Housing starts are considered a leading indicator of new-home sales but more recently have been looked at as an indication of home builder sentiment, as builders try to reduce inventories of unsold new homes.

ü  Building permits (Relevance: Medium) are the starting point of the whole new-housing cycle and are reported alongside housing starts each month. Building permits are required before construction can begin on  new homes, so they’re viewed as another leading indicator of housing starts and new-home sales. 

Regional Federal Reserve Indices

A number of the Federal Reserve district banks issue monthly surveys of business sentiment in their regions, usually concentrated on the manufacturing sector; The regional Fed indices are looked at on their own as well as for what they suggest about subsequent national sentiment surveys, like the ISM index. The main index reading is a subjective response on general business conditions, with responses above zero indicating that conditions are improving and readings below zero indicating deterioration. Here are the main regional Fed indices to watch:

ü  Philadelphia Fed index (Relevance: Medium): Usually the first of the major Fed indices to be reported each month, covering the manufacturing sector in Pennsylvania, New Jersey, and Delaware.

ü  New York Empire State index (Relevance: Medium): Assesses New York state manufacturers’ current and six-month outlooks.

ü  Richmond Fed manufacturing index (Relevance: Low): A composite index based on new orders, production, and employment, covering the Middle Atlantic states.

The Fed s Beige Book (Relevance: High)

The Beige Book is a compilation of regional economic assessments from the Fed's 12 district banks, issued about two weeks before every Federal Open Market Committee (FOMC) policy-setting meeting. (The Beige Book gets its name from the color of its cover.) The regional Fed banks develop their summaries based on surveys and anecdotal reporting of local business leaders and economists, and the report is then summarized by one of the Fed district banks, all of which take turns issuing the report. The Beige Book is designed to serve as the basis of economic discussions at the upcoming FOMC meeting.

Markets look at the Beige Book’s main findings to get a handle on how the economy is developing as well as what issues the FOMC might focus on. A typical Beige Book report may include generalized observations along the following lines: Most districts reported retail sales activity was steady or expanding moderately; a few districts reported declines in manufacturing activity; some districts noted increased labor market tightness and rising wage demands; all districts noted a sharp slowing in real-estate activity.

 The key for the market is to assess the main themes of the report, such as:

ü  Is the economy expanding or contracting? How fast, and how widespread?

ü  Which sectors are strongest, and which sectors are weakest?

ü  Are there any signs of inflation? '

ü  How does the labor market look?

The Beige Book is released in the afternoon (New York time), when liquidity is thinner, so it can generate a larger-than-normal response if its tone or conclusions are significantly different from what markets had been expecting.

Assessing Economic Data Reports from a Trading Perspective

The data that you find in economic textbooks is very neat and clean but the data as it actually arrives in the market can be anything but neat and clean. We’re talking here not only about the imperfections of economic data gathering, which relies heavily on statistical sampling methods, but also about how the market interprets individual data reports.

In “Reality Check: Expectationsversus Actual”,  I introduce the idea of consensus expectations as one of the keys to understanding how markets interpret economic news and data. In my following post, we will look at important data-reporting conventions and how they can affect market reactions. When currencies don’t react to the headlines of a data report as you would expect, odds are that one of the following elements is responsible, and you need to look more closely at the report to get the true picture. 

Understanding and revising data history 

Economic data reports don’t originate in a vacuum - they have a history. Another popular market adage expressing this thought is “One report does not make a trend.” However, that saying is mostly directed at data reports that come in far out of line with market estimates or vastly different from recent readings in the data series. To be sure, the market will react strongly when data comes in surprisingly better or worse than expected, but the sustainability of the reaction will vary greatly depending on the circumstances. If home sales are generally slowing, for instance, does a one-month surge in home sales indicate that the trend is over, or was it a one-off improvement due to good weather or a short-term drop in interest rates?

When you’re looking at upcoming economic data events, not only do you need to be aware of what’s expected, but it also helps to know what, if any, trends are evident in the data series. The more pronounced or lengthy the trend is, the more likely the reactions to out-of-line economic reports will prove short lived. The more ambiguous or fluid the recent data has been, the more likely the reaction to the new data will be sustained.

The other important element to keep in mind when interpreting incoming economic data is to see whether the data from the prior period has been revised. Unfortunately, there is no rule preventing earlier economic data from being changed. It’s just one of those odd facts of life in financial markets that what the market thought it knew one day (and actually traded for several weeks based on that understanding) can be substantially changed later.

When prior-period data is revised, the market will tend to net out the older, revised report with the newly released data, essentially looking at the two reports together for what they suggest about the data series. For example, if a current report comes out worse than expected, and the prior report is revised lower as well, the two together are likely to be interpreted as very disappointing. If a current report comes out better than expected, but the prior period‘s revision is negative, the positive reaction to the most recent report will tend to be restrained by the downgrade to the earlier data.

As you can imagine, there are many different ways and degrees in which current/revised data scenarios can play out. A general rule is that the larger the revision to the prior report, the more significance it will carry into the interpretation of the current release. The key is to first be aware of prior-period revisions and to then view them relative to the incoming data. In general, current data reports tend to receive a higher weighting by the market if only because the data is the freshest available, and markets are always looking ahead.

Getting to the core

A number of important economic indicators are issued on a headline basis and a core basis. The headline reading is the complete result of the indicator, while the core reading is the headline reading minus certain categories or excluding certain items. Most inflation reports and measures of consumer activity use this convention.

In the case of inflation reports, many reporting agencies strip out or exclude highly volatile components, such as food and energy. In the United States, for instance, the consumer price index (CPI) is reported on a core basis excluding food and energy, commonly cited as CPI ex-F&E. (Whenever you see a data report “ex-something,” it‘s short for “excluding” that something.) The rationale for ignoring those items is that they‘re prone to market, seasonal, or weather-related disruptions. Energy prices, for example, may spike higher on geopolitical concerns or disasters that disrupt refinery output, like Hurricane Katrina in 2005. Food prices may change rapidly due to drought, frost, infectious diseases, or blights. By excluding those items, the core reading is believed to paint a more accurate picture of structural, long-term price pressures, which is what monetary-policy makers are most concerned with.

Looking at consumer activity reports, the retail sales report in the United States is reported on a core basis excluding autos (retail sales ex-autos), which are heavily influenced by seasonal discounting and sales promotions, as well as being relatively large-ticket items in relation to other retail expenditures. The durable goods report is also issued on a core basis excluding transportation (durable goods ex-transportation), which mostly reflects aircraft sales, which are also highly variable on a month-to-month basis as well as being extremely big-ticket items that can distort the overall data picture.

Markets tend to focus on the core reading over the headline reading in most cases, especially where a known preference for the core reading exists on the part of monetary-policy makers. The result can be large discrepancies between headline data and the core readings, such as headline retail sales falling 1 percent on a month-to-month basis but rising 0.5 percent on a core ex-autos basis. Needless to say, market reactions will be similarly disjointed, with an initial reaction based on the headline reading frequently followed by a different reaction to the core.

Economics 101 for Currency Traders: Making sense of Economic Data

If you're like most people, you probably have a decent idea of what certain economic reports mean, like the unemployment rate or the consumer price index (CPI). But like lots of people, you probably don’t have a strong idea of how to put the data together to make sense of it all. Having a fundamental model to put the data in perspective is critical to understanding what the data means and how the market is likely to interpret the data. The sooner you’re able to make sense of what a specific report means and factor it into the bigger picture, the sooner you’ll be able to react in the market.

I will suggest a basic model to interpret the deluge of economic indicators you’ll encounter in the forex market. By no means is this models the be-all and end-all of economic theory, but I do think it's a solid framework on which to hang the economic indicators and see how they fit together.

The labor market

I place the employment picture first for the simple reason that jobs and job creation are the keys to the medium- and long-term economic outlook for any country or economic bloc. No matter what else is going on, always have a picture of the labor market in the back of your mind.

If jobs are being created, more wages are being paid, consumers are consuming more, and economic activity expands. If job growth is stagnant or weak, long-run economic growth will typically be constrained and interim periods will show varying degrees of strength and weakness. Signs of broader economic growth will be seen as tentative or suspect unless job growth is also present.

From the currency-market point of view, labor-market strength is typically seen as a currency positive, because it indicates positive growth prospects going forward, along with the potential for higher interest rates based on stronger growth or wage-driven inflation. Needless to say, labor-market weakness is typically viewed as a currency negative.

The employment indicator that gets the most attention is the monthly U.S.non-farm payrolls (NFP) report. The NFP report triggers loads of attention and speculation for a few days before and after it’s released, but then the market seems to stop talking about jobs.

The consumer

If it weren’t for the overarching importance of jobs to long-run economic growth, the consumer would certainly rank first in any model seeking to understand economic data. The economies of the major currencies are driven overwhelmingly by personal consumption, accounting for 65 percent to 70 percent or more of overall economic activity.

Personal consumption (also known as private consumption, personal spending, and similar impersonal terms) refers to how people spend their money. In a nutshell, are they spending more, or are they spending less? Also, what’s the outlook for their spending - to increase, decrease, or stay the same? If you want to gauge the short-run outlook of an economy, look no farther than how the individual consumer is faring.

The business sector

Businesses and firms make up the other third of overall economic activity after personal spending. (I leave government out of our model to simplify matters.) Firms contribute directly to economic activity through capital expenditures (for example, building factories, stores, and offices; buying software and telecommunications equipment) and indirectly through growth (by hiring, expanding production, and producing investment opportunities).

Look at the data reports coming from the corporate sector for what they suggest about overall sentiment, capital spending, hiring, inventory management, and production going forward.

Keep in mind that the manufacturing and export sectors are more significant in many non-U.S. economies than they are in the United States. For instance, manufacturing activity in the United States accounts for only about 10 percent to 15 percent of overall activity versus shares of 30 percent to 40 percent and higher in other major-currency economies, such as Japan and the Eurozone. So, Japanese industrial production data tends to have a bigger impact on the yen than U.S. industrial production has on the dollar.

The structural

Structural indicators are data reports that cover the overall economic environment. Structural indicators frequently form the basis for currency trends and tend to be most important to medium and long-term traders. The main structural reports focus on:

• Inflation: Whether prices are rising or falling, and how fast. Inflation readings can be an important indicator for the direction of interest rates, which is a key determinant of currency values.

• Growth: Indicators of growth and overall economic activity, typically in the form of gross domestic product (GDP) reports. Structural growth reports tell you whether the economy is expanding or contracting, and how fast, which is another key input to monetary policy and interest rates. Growth forecasts are important benchmarks for evaluating subsequent overall performance.

• Trade balance: Whether a country is importing more or less than it exports. The currency of a country with a trade deficit (the country imports more than it exports) tends to weaken, because more of its currency is being sold to buy foreign goods (imports). A currency with a trade surplus (the country exports more than it imports) tends to appreciate, because more of it is being bought to purchase that country’s exports.

• Fiscal balance: The overall level of government borrowing and the market’s perception of financial stability. Countries with high debt levels run the risks of a weakening currency if economic conditions take a turn for the worse and markets fear financial instability.

Getting Down and Dirty with Fundamental Data

Fundamental economic data reports are among the more significant information inputs because policy makers and market participants alike use them to gauge the state of the economy, set monetary policy, and make investment decisions. From a trader’s perspective, data reports are the routine catalysts that stir up markets and get things moving.

We run through a lot of economic information while learning about forex trading, but you don't need to understand it like an economist - you’re mainly interested in what it means for the market reaction. To help, I classify each data report in terms of its usual impact on the market according to the following relevance levels. Keep in mind that these classifications are how I look at the data reports (others may attach different significance) and also that the relevance levels can change depending on the environment.

• Low: These data reports normally don‘t move the market significantly, but instead color in the background of the bigger economic picture. When these reports do exert an impact, it’s usually to reinforce an existing trend, such as when a currency is under pressure, and a low relevance report for that country comes in weak or worse than expected, the existing selling pressure may be amplified. Rarely will low-relevance reports reverse a directional movement.

• Medium: These data reports can have a larger impact on the market, especially in the immediate minutes and hours following the release, if the circumstances are right, such as when the data is sharply out of line with market expectations or significantly contradicts the market’s future outlook. Medium-relevance reports typically amplify an existing directional trend when they support that trend and may provoke reversal if they’re sufficiently at odds with the directional move.

• High: These data reports are the biggest market movers and can lead to the greatest price volatility both immediately after their release and over successive trading days. These reports form the foundation of the market's primary future outlook and will reinforce existing trends and provoke potentially larger reversals. Get to know these ones.

As I note in “Putting Market Information into Perspective: Focusing on Themes”,  the significance of individual reports rises and falls depending on the environment, the market’s current focus, and a host of other factors. A data series (an economic report viewed over time, also called data points) that’s regularly driving the market over a period of months may lose relevance quickly if it changes course or other themes become the center of attention.

If you go through my blog from the first post, you would notice that I’ve discuss on how to absorb the various data reports and factor them into a broader view of the economic outlook for each particular country, with its attendant implications for interest rates and currency values. And then, I go through the major data reports to give you an idea of what they cover and how the market interprets them.

Finding the Data

Before you can start processing all the economic data, you need to know where to find it. In my post “Understanding and Applying Market News, Data and Information: Sourcing Market Information”, we look in greater detail at where to find data info, but here’s a quick overview.

The starting point is the economic calendars typically provided by online forex brokerages. Be aware that not all calendars are as comprehensive as others, so be sure to look for calendars that show events and speakers and not just data. Also, look for a broker that provides data and event previews, and real-time data and market analysis; this type of commentary will help you get a sense of what the market is expecting, how it may be positioned for the news, and how it’s likely to react.

Cable TV business channels such as Bloomberg TV, MSNBC, and CNBC typically carry U.S. data releases live on air, and they’re probably your best bet for seeing U.S data immediately. In my opinion, Bloomberg TV does the best job of covering non-U.S. data releases.

In addition, Bloomberg.com, MarketWatch.com and Reuters.com provide excellent data coverage, both before and after it‘s' released, along with event calendars. Read the economic data news stories on these sites to get the inside story of the data reports, such as any subcomponent readings or significant revisions.

Reality Check: Expectations versus Actual

When it comes to reacting to data reports and market events, the forex market typically displays two responses. The first reaction is a short-term, knee-jerk price response to the data report or news itself, which is where most of the intraday fireworks in the forex market go off. The second reaction, usually more important in the bigger picture, comes in later trading, when the underlying themes (outlined earlier in Putting Market Information In to Perspective: Focusing on Themes)  are updated to reflect the latest piece of news or data.

In one case, the data or news may be in line with the dominant themes of the moment, and the initial directional price reaction may be extended even further in subsequent trading action. The market may be anticipating lower U.S. interest rates, for example, and a weak U.S. consumer confidence report is released, sending the USD initially lower against other currencies. Because the weaker confidence reading support the theme that the U.S. economy may be weakening, additional selling interest may materialize and lead to further price declines in the USD.

In other cases, the data report may fly in the face of the prevailing market themes, leading to an initial reaction in the opposite direction of the recent theme. The market may be trading on the theme that Eurozone interest rates are going higher and that the Eurozone economic outlook is improving. A subsequent Eurozone retail sales report may come in on the weak side, potentially leading to an initial market reaction that sees the euro weaken. Whether the euro’s move lower will be sustained depends largely on what the market decides the latest retail sales report means in terms of the larger theme of higher Eurozone interest rates.

The data report may have been influenced by bad weather keeping shoppers at home, for example, and may be interpreted as just a bump in the road on the way to higher Eurozone interest rates. In such a case, initial euro weakness may be short lived and eventually reverse course higher. On the other hand, the weak retail sales report may cause the market to reconsider that higher European Central Bank (ECB) rates are a sure thing and keep on selling euro.

Of course, there’s never a set recipe for how data and news are ultimately going to be acted on by the market. The potential data and event outcomes and subsequent market reactions are myriad, to say the least. That’s one reason the market reaction to the data is always more important than the data itself.

But as currency traders, we still have to understand what the data means to make sense of what the subsequent market response suggests for the bigger picture. The starting point for interpreting the market’s likely overall reaction is to understand the initial market response to the data/news in terms of what the market was expecting and what it actually got. We need a baseline from which to interpret subsequent price movements.

The role of consensus expectations

Data reports and news events don’t happen in a vacuum. Forex markets evaluate incoming data reports relative to market forecasts, commonly referred to as consensus expectations or simply the consensus. Consensus expectations are the average of economic forecasts made by economists from the leading financial institutions, banks, and securities houses. News agencies like Bloomberg and Reuters survey economists for their estimates of upcoming data and collate the results. The resulting average forecast is what appears on market calendars indicating what is expected for any given data report.

The consensus becomes the baseline against which incoming data will be evaluated by the market. In the case of economic data, the market will compare the actual result - the economic figure that’s actually reported with what was expected (the consensus). The actual data is typically interpreted by the market in the following terms:

• As expected or in line with expectations: The actual data report was at or very close to the consensus forecast.

• Better than expected: The report was generally stronger than the consensus forecast. For inflation reports, a better-than-expected reading it means inflation was lower than expected, or more benign.

• Worse than expected: The data is weaker than the consensus forecast. For inflation reports, a worse-than-expected reading means inflation was higher than forecast, or more inflationary.

Additionally, the degree to which a data report is better or worse than expected is important. The farther off the mark the data report is, the greater the likelihood and degree of a subsequent price shift following the data release.

When evaluating central bank statements and comments from monetary policy makers, the market evaluates the language used in terms of hawkish (leaning toward raising interest rates) and dovish (leaning toward steady to lower interest rates). I posted about interpreting central bank rhetoric in greater detail in “Interpreting Monetary Policy Communication”) 

Pricing in and pricing out forecasts

Financial markets don’t typically wait for news to actually be released before they start trading on it, and the currency market is no different. Currency traders begin to price consensus expectations into the market anywhere from several days to several hours before a report is scheduled. Pricing in is the practice of trading as though the data were already released and, usually, as though it has come out as expected. The more significant the report, the sooner markets are likely to start pricing in expectations.

Unfortunately, there’s no clear way to always tell whether or how much the market has priced in consensus expectations, so you need to follow market commentaries and price action in the hours and days before a scheduled report to get a sense of how much the market has priced in any forecast. And it‘s not always a case of the market pricing in an as-expected result. Market sentiment may have soured (or improved) in the run-up to the release, leading the market to price in a worse-than-expected (or better-than expected) report. Stay on top of the market reports to get a handle on the mood.

Consensus estimates can also sometimes change in the days leading up to the report, based on other interim reports. For example, Institute for Supply Management (ISM) manufacturing forecasts may be downgraded (or upgraded) if the regional Chicago purchasing managers’ index, which comes out a few days before the ISM index, is weaker (or stronger) than expected. This can lead to pricing out of consensus expectations, depending on to what degree the consensus was priced in.

When good expectations go bad

Data miss is the market euphemism for when a data report comes in outside expectations. If the consensus was for an improvement in a particular indicator, and the actual report is worse than expected or disappointing, the result may be a sharp reversal in price direction. If core U.S. durable goods orders are expected to rise, for example, but they end up falling, we may be looking at a sharp drop in the USD. If the USD has gained prior to the release on the basis of pricing in the positive consensus, those who went long are going to at be dumping their positions alongside traders selling the USD on the weak result. The same thing can happen in reverse if negative expectations are met by a surprisingly positive data report.

With as-expected data reports, it’s frequently a case of “buy the rumor, sell the fact” (meaning, traders have already priced in a strong report, and if it meets expectations and sometimes even exceeds them, traders who bought in advance will be looking to take profit and sell on any subsequent gains). This market phenomenon can also happen in the other direction - as in “sell the rumor, buy the fact” depending on the currency pair involved and the nature of the consensus forecast.

Anticipating alternative outcome scenarios

We’ve found that it frequently helps to think through the likely reactions to major data releases to prepare for how the market may react in the very likely case that the data surprises one way or the other. It’s a thoroughly academic exercise, and it won’t cost you anything, but it may just give you a significant leg up on the rest of the market if you’re inclined to trade around data reports. Considering various “what if” scenarios helps us focus our attention and our trading strategies on the major themes currently operative.

For example, if the market is expecting a drop in the upcoming U.S. consumer price index (CPI) report, we like to ask ourselves what’s the likely reaction if the CPI falls more than forecast, and also what happens if it surprises to the upside. This makes us focus on the most recent price action, and perhaps we note that the USD has declined slightly in advance of the report based on the consensus.

If CPI registers lower than expected, we’re now thinking about how many pips lower the USD is likely to fall. We pinpoint key support levels and use those as our benchmarks to gauge the subsequent market reaction. If the report should surprise to the upside, we’ve also identified key resistance levels above that may come into play and where the next resistance levels are after them.

When the data does come out, we have a fairly rational baseline to judge the subsequent market reaction. If CPI declines as expected, we already know which support levels may be tested. If they’re not being tested, we're starting to think that maybe the market is already overly short and that profit-taking short-covering may ensue. If the report comes in higher than expected, we’ve  already identified the likely upside price points that will trigger a larger reaction.

Think ahead about what the market is expecting based on consensus expectations and how much has been priced in. Be prepared to factor various data outcomes in the larger themes you’ve already identified. Think through how the market is likely to react based on those scenarios, and you’re likely to be several steps ahead of the crowd. 

Analyzing technical themes

Technical themes are perhaps a little harder to grasp than fundamental themes, especially if you’re not familiar with technical analysis. But to make a long story short, sometimes currency prices move simply because currency prices are moving.

The economic or political fundamental themes may not have changed dramatically, but price levels have, and that is frequently enough to bring major market interest out of the woodwork.

In most cases, breaks of major technical or price levels will be in the direction suggested by the prevailing fundamental themes, but the timing is often suspect and can leave traders scratching their heads, asking what just happened. But sizable price movements have a way of taking on a life of their own, forcing market participants to take action based on price adjustments alone.

In addition, the prevalence of technical analysis as the basis for many trading decisions can add weight to existing fundamental-driven moves, generating yet another theme to propel the move - the technical theme. It may be a trending market movement that attracts trend-following traders who don't give a hoot about the underlying fundamentals. As long as the technical trend is in place, they keep pushing the market in the direction its going, prolonging the price adjustment perhaps far beyond what the fundamentals would dictate.

When a currency pair has broken through important technical levels, it’s also going to attract breakout traders - speculators who focus on jumping in on breaks of key price levels, looking to get in on the move for an easy trade. (But nothing is ever quite that easy, and breakout traders can suffer when the breaks are false and the ranges survive.) The additional interest entering the market in the direction of the move again propels the price farther and faster than it may ordinarily go.

Having a sense of where a currency pair stands from a technical perspective is always important, even if you’re not basing your trades on technical analysis. The technical-theme phenomenon also stems from several real-life considerations that all relate back to the relative level of currency prices:

• Option interest: The currency options market is massive and is one of  the reasons that the spot currency market is as large as it is. Option-related hedging is one of the biggest sources of spot market activity outside short-term spot speculation. When spot prices have been trading in well worn territory (a relatively narrow price range, for example), option interest tends to accumulate around the recent range. If the ranges are broken, sizeable option-related interest is frequently forced to come into the market and trade in the direction of the price breakout, either to unwind hedges or to cover new exposures created by the price break, and usually some combination of both. The amounts can be staggering, propelling the directional move in an extreme way.

• Systematic models: We look at so-called black box or algorithmic trading in “Hedge Funds”. Algorithmic trading has dramatically increased in size and number in recent years, which has added further weight to technical themes in day-to-day trading. In many cases, systematic-models trading decisions are generated based solely on price movements. They may be short a currency pair until a certain price level on the upside is traded, for example, which triggers a signal to exit the short and go long, no questions asked.

• Hedgers: Large-scale hedgers may be forced to come into the market if a rapid and unexpected price movement develops. Many firms identify an internal hedging rate for corporate and financial management purposes. As long as they’re able to sell above or buy below that rate, they’re looking good. If the market moves sharply on them, they may be forced to jump in on the direction of the move for fear of not ever seeing the internal hedging rate again. 

Putting Market Information In to Perspective: Focusing on Themes

At any given moment in the forex market, several themes dominate the market’s attention. Market themes are the essence of the real-world driving forces currently holding sway in the market. Themes are what market commentators and analysts are talking about when they explain what's happening in the market. But most important, themes are the filters through which new information and data are absorbed by the market. Or to put it another way, they’re the lenses through which the market sees events and data.

Market themes come in all shapes and sizes, and have differing impacts on the market over time. Some are long-term themes that can color the market’s direction for months and years; others may hold sway for only a few hours, days, or weeks.

Market themes come in two main forms that coexist in parallel universes but that also frequently overlap. The two types of themes that I like to focus on are fundamental themes and technical themes.

Driving fundamental themes

Each currency has its own set of fundamental circumstances in which it's being evaluated by the market. The basic fundamental environment is ever-present, but it’s also subject to change over time, just as economic conditions will change in the course of business cycles. Fundamental themes will also shift in relative importance to one another, with certain themes being pushed to the side for a period when news or events focuses the market’s attention on other, more pressing themes. Keep in mind that each theme applies to each and every currency but in varying degrees at any given moment.

Rising or falling interest rates

Interest rates are usually the single most important determinant of a currency’s value. (We go into greater detail on the significance of monetary policy and interest rates in “Currencies and Interest Rates”).  But it’s not just about where interest rate levels are now, though that’s still important (higher interest rate currencies tend to do better against lower-yielding Currencies). What matters most is their overall direction (whether they're going up or down), their future level (how high or low they’re likely to go), and the timing of any changes (how fast rates are likely to change).

Markets are constantly speculating about the direction of interest rates, even though interest rate changes are relatively infrequent. Speculation over the direction and timing of interest rate changes is one of the primary drivers of a currency’s value on a daily basis as well as over longer time frames.

The information inputs that drive the interest rate outlook are centered on economic growth data and inflation reports. The stronger the growth picture is, or the higher inflation pressures are, the more likely interest rates are to move higher, normally improving a currency’s outlook. The weaker the growth outlook or the lower the inflation readings, the more likely interest rates are to remain steady or move lower, typically hurting a currency in the process.

Bond markets also have a lot to say about the direction of interest rates and are probably the best real-time barometer of the markets interest rate expectations. Central banks can really influence only short-term interest rates, which are essentially based on the central bank’s official rate. But longer-term bond yields, with the ten-year maturity as the benchmark, reflect the market’s long-term view of an economy’s outlook and the direction of future interest rate moves. Falling bond yields (lower interest rates) point to a weaker economic outlook and the probability of lower interest rates ahead, typically denting that currency, while higher bond yields point to economic optimism and likely higher rates, usually supporting that currency.

The effect of interest rate themes is most powerful when the interest rates of two currencies are seen to be diverging when one currency’s interest rate is expected to move higher and the other lower.

When you’re looking at economic data or monetary policy rhetoric, always assess the incoming information first in terms of what it means for the interest rates of the nation’s currency - the interest rate theme. A currency that is expected to see lower rates in the near future, for example, is likely to stop declining and may even rebound if an economic growth report or an inflation reading comes in higher than expected. The market will pause to consider whether its outlook for lower rates is correct. By the same token, a currency facing the prospect of lower interest rates ahead, when hit with weaker economic data or lower inflation readings, is likely to weaken further. I say “weaken further” because it was probably already under pressure and moving lower before the latest batch of data hit the market.

Looking for growth

Economic growth prospects are the linchpin to _a host of currency value determinants, from the interest rate outlook to the attractiveness of a nation‘s investment climate (stocks and bonds). Not surprisingly, the stronger the outlook for growth, the better a particular currency is likely to perform relative to currencies of countries with lower growth outlooks. Strong economic growth increases the likelihood of higher interest rates down the road, as central bank officials typically seek to restrain too rapid growth to head off inflationary pressures. Weaker growth data increases the prospect of potentially lower interest rates, as well as dampening the outlook for the investment environment.

Many growth data reports reflect only a particular sector of a nation's larger economy, such as the manufacturing sector or the housing market. Depending on how significant that sector is to the larger national economy, those reports will tend to be interpreted as correspondingly more or less significant. Industrial production data in Japan, for example, is more significant to the Japanese outlook than it is to the U.S. outlook because of the more prominent role manufacturing plays in Japan.

There’s no set recipe for how growth data will impact a currency’s value, but when the interest rate outlook is generally neutral, as in no solid conviction on the direction of two countries’ rates, the growth theme becomes more important.

Fighting inflation

Inflation is the bogeyman that all central bankers have nightmares about. Even when inflation is low, they still worry about it - it’s just part of the job. When inflation is running too high for their comfort, fuhgeddaboutit. As a currency trader attuned to monetary policy developments, you need to monitor inflation readings as well.

The inflation theme is far more nuanced than the growth theme in what it implies for a currency’s value. Depending on the bigger picture, it can produce starkly different outcomes for a currency. In general, if growth is good, and inflation is too high, it's a currency plus. If growth is low or weakening, and inflation is too high, it’s a currency negative. Come again? Both scenarios point to steady-to-higher interest rates, which should typically be a currency plus, right? The rub is that the low-/slow-growth scenario coupled with high/higher interest rates increases the risks of an economy dropping into recession, which would ultimately result in interest rate cuts farther down the road. In this sense, currencies are a bit fickle in that they like higher interest rate some of the time, but not all the time.

The same phenomenon can happen when a central bank holds rates too high for too long, usually based on fighting inflation, and the market begins to sense that an economic downturn is ahead. The response is actually not that bizarre if you consider that the forex market is, first and foremost, always anticipating future interest rates.

When factoring inflation data into the interest rate theme, be aware of how the overall growth theme is holding up. If growth is good, and inflation is high because of economic strength, higher inflation readings will be currency supportive. If growth is slowing, and inflation is still too high, the currency impact will be decidedly less positive and very likely downright negative.

Gauging the strength of structural themes

Beyond interest rates, growth, and inflation, several other prominent themes regularly assert themselves, mostly in the structural sphere (the big-picture elements of how an economy is performing or national events are playing out).

Structural themes are the most fleeting - they can be in full force one day or for several weeks or months and then drop from the radar screen altogether. These themes are also usually secondary to the three we above (interest rates, growth, and inflation), but structural themes can still exert significant influence on a currency on their own. Most important, they can amplify the impact of the primary themes, like throwing salt in a wound. Following are frequently recurring structural themes: 

• Employment: Employment is the key to an economy’s long-run expansion and a primary driver of interest rates. As long as employment is rising, the longer-term economic outlook is supported. But if job growth begins to falter, as reflected in incoming labor market reports, economic prospects will tend to be marked down. Sharp increases in unemployment are among the fastest triggers to interest rate cuts by central bankers, going back to the primary interest rate theme.

• Deficits: Both fiscal and trade deficits are typically currency negatives. The USD has been especially prone to weakness based on recent increases in both the federal deficit and the ballooning trade and current account deficit. During times of low/slow growth, the impact of deficits can be magnified, as the very credibility of a currency can be questioned. During times of steady/high growth, their impacts tend to be more muted but are still a negative hanging over the outlook.

• Geopolitical issues: It seems like a fact of life now, but geopolitical tensions weren’t always ever-present, as they seem to be today, from North Korean nuclear tests to conflicts in the Middle East or trade disputes with China. Geopolitical issues typically used to develop in relatively short order and tended to influence currency values on the margins, limiting gains in a currency's appreciation or increasing losses during a weakening phase. The USD is the most vulnerable to geopolitical issues, given the size of it economy, reliance on world trade, and potential military involvement. After geopolitical tensions subside, the market is quick to revert to pre-existing themes.

• Political elections or uncertainty: Changes of government and political uncertainty in the major-currency countries can certainly dent the market’s sentiment toward the affected currency. The impact on the currency will usually be felt on the margins, hurting a softening currency and restraining an appreciating one. But shortly after the political situation is resolved, political issues tend to fade quickly into the background.