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.
