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Which economic indicators can help forecast foreign exchange rates?

25 March 2022

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Economic indicators are closely monitored by forex market players. But their analysis raises a number of questions: How should these indicators be assessed? Which are the most compelling and relevant? How often should they be monitored?

 

What are economic indicators?

Economic indicators are economic data used to help assess the overall health of a country. They are published on a regular basis by public and private institutions. They offer an insight into the state of different economies and the fluctuations of the currencies they represent.

By analysing these indicators, it is possible to predict potential changes in the foreign exchange market, and more specifically, changes to currencies under a floating exchange regime. And yet, some economic metrics bear a greater influence than others. Their impact depends on a number of different variables, including the type of indicator, the relative clout of the index under consideration and the size of the country or currency area in question.

 

What are the different types of economic indicators?

There are three types of economic indicators: leading, coincident and lagging.

1. Leading indicators... 

  • Predict real economic activity.
  • Reflect the impressions consumers and professionals have of economic trends.
  • Leading indicators are then either confirmed or refuted by lagging indicators.
  • Example: consumer confidence index.

2. Coincident indicators... 

  • Measure real economic activity at the time of their publication.
  • Provide a concrete assessment of actual economic activity.
  • Example: manufacturing PMI for a country or an economy.

3. Lagging indicators...

  • Relate to past economic activities, assessed over a defined period.
  • Confirm or refute a trend reflected by a leading indicator.
  • Have an immediate impact on the currency market.
  • Example: the unemployment rate.
 

Which indicators are monitored most closely?

In terms of impact, reliability and regularity of publication, the list of economic indicators is long. There are however some factors that determine the indicators that greatly influence the foreign exchange market and that forex market players will decide to monitor most closely.

But how can you gauge the respective importance of different economic indicators?

1. Primary indicators

Although each indicator has its own level of importance, some announcements or publications bear an immediate impact on exchange rates. This is true of GDP, retail sales reports and the key interest rates set by central banks, for example.

2. Secondary indicators

Other indicators are more general. They offer an estimate of trends which may subsequently be refuted, such as consumer confidence indexes or those relating to housing construction. Their impact on the currency market is often less significant in the immediate term due to their predictive nature.

 

How to decide which international economic indicators to monitor?

The country, monetary area and currency pair of interest are key elements in determining which indicators are the most relevant to monitor. These will vary depending on your company’s business activities and international presence.

As some countries have very important economies and currencies in global terms, the associated economic indicators can equally generate a global impact. In addition to analysing the different types of indicators, it is recommended that they be read geographically, by country or currency area. While the economies of all countries part of the G7 should be monitored, four economies stand out:

With this in mind, four regions deserve special attention:
      1. The United States of America 
        The USA is the world’s largest economy in terms of GDP, and the US dollar is considered a safe haven.

      2. The eurozone 
        With more than 340 million inhabitants in 2019, the euro area is a particularly important economic zone with France and Germany spearheading the group with their strong economies. The EUR/USD is the most traded currency pair in the world.

      3. Japan 
        The Japanese economy ranks third in the world in terms of GDP. The Japanese yen (JPY) is one of the most widely traded currencies on the foreign exchange market.

      4. The United Kingdom 
        The sixth largest economy in the world in 2019, the United Kingdom and its pound sterling (GBP) have a major influence on the currency market.

Within these economic zones, a number of key economic figures are monitored closely by forex market participants. This leads us to ask, which indicators should we pay particular attention to?

 

Which indicators to follow for the United States?
      1. The Nonfarm Payrolls report 
        A monthly report that establishes the number of jobs created outside the agricultural sector.

      2. The ISM
        A monthly index that monitors changes in the manufacturing sector and provides a measure of the expansion or recession of the economy.
         
      3. The Chicago PMI
        An index similar to the ISM, covering the Midwest region only.
      4. Consumer Confidence
        A consumer survey that reflects their impressions of the state of the economy and the outlook for households.

    1.  
Which indicators to follow for the eurozone?

As Germany accounts for 30% of the euro area’s GDP, European indicators relate mainly to this country. They are not wholly representative of the entire euro area’s economic performance, but they do provide an insight into the performance of the single currency.

Which euro area indicators deserve special attention?

      1. The IFO 
        German survey on companies’ current situations and economic prospects.

      2. The ZEW
        A survey similar to the IFO, focusing solely on the banking sector.

      3. Euro area manufacturing PMI
        Survey of euro area purchasing managers as a reflection of confidence.

      4. Euro area CPI
        Monthly index offering a general overview of inflation in the euro area.

      5. CPI France
        A monthly index similar to the Euro area CPI, but solely relating to France.

Which indicators to follow for Japan?

In terms of GDP, Japan is the world’s third largest economy, despite a relatively low growth rate for an extended period.

Its currency, the yen (JPY), is part of the G7 currencies, the most traded in the world. Foreign exchange market players pay special attention to Japanese indicators.

Which Japanese indicators deserve special attention?

      1. The Tankan Survey
        A survey of private firms in the manufacturing sector conducted by the Bank of Japan, providing an indication of whether the economy is expanding or contracting.

      2. National CPI
        Monthly survey of service sector businesses that assesses the outlook for this sector.


Which indicators to follow for the United Kingdom?
      1. Manufacturing PMI
        A survey of private firms in the manufacturing sector reflecting this sector’s economic performance.

      2. Service sector PMI
        Monthly survey of service sector companies that assesses the outlook for this sector.

      3. CPI
        Monthly index that measures inflation in the United Kingdom.
      4. RPI
        Retail Price Index.

The types of indicators presented above are followed particularly closely by forex market players. Some have a significant impact at their time of publication. Others have no apparent effect at global level in the immediate term.

An indicator’s impact on the market depends on several factors, including the scope and accuracy of the data being analysed, as well as the currency area in question. One of the key factors remains the element of surprise. The more unexpected the data revealed, the greater the impact on exchange rates.

 

 

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