Chapter 7

Getting Down and Dirty with Fundamental Data

In This Chapter

Building a model to put the data in perspective

Getting to know data-reporting conventions

Understanding the key U.S. data reports

Looking at major international economic reports

Fundamental economic data reports are among the most 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 in this chapter, but you don’t need to understand it like an economist — you’re mainly interested in what it means for the market reaction. (If you’re interested in understanding data like an economist, we recommend reading The Secrets of Economic Indicators: Hidden Clues to Future Economic Trends and Investment Opportunities, 2nd Edition, by Bernard Baumohl.)

As we note in Chapter 6, the significance of individual reports varies depending on the economic environment, the market’s current focus, and a host of other factors. Always keep in mind that markets interpret incoming data based on what it means for the big picture outlook. If a country’s economic outlook is generally viewed as promising, data pointing to stronger growth will reinforce that view, while data that disappoints may suggest a more negative reaction. Most important, the market’s reaction to data is more important than the data itself.

In the first half of this chapter, we look at 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. In the second half of this chapter, we run 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 Chapter 6, 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 some calendars are not 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, CNBC, and Fox Business News typically carry U.S. data releases live on air. In our opinion, Bloomberg TV does the best job of covering non-U.S. data releases, and CNBC World is another option. But your best bet for seeing U.S. and global data releases immediately can be Twitter.

In addition, www.bloomberg.com, www.marketwatch.com, and www.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.

Also, many calendars may include some designations of market significance for each data series, like some are high impact or low impact. Remember it’s the big picture that counts and even a so-called low impact report could have a big impact if it’s big enough of a surprise.

In the next section, we sketch out a model for understanding where the types of data fit into the big picture. It should help you determine which categories of data are most significant, depending on the particular economic environment at any given time.

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 react to 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.

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

The labor market

We 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. Signs of broader economic growth will be seen as tentative or suspect unless job growth is also present. Both scenarios have major implications for interest rates moves and investment themes, which are key currency drivers.

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. Keep an eye on the job-specific reports outlined in the “Other labor-market indicators” sidebar, later in this chapter.

To illustrate the importance that markets place on jobs, Figure 7-1 shows changes in U.S. private payrolls overlaid with the S&P 500 stock index. As you can see, major turning points in the stock market (but not necessarily the economy) are closely associated with peaks and troughs in job markets.

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 60 to 70 percent or more of overall economic activity in developed economies.

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 further 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. (We’re leaving 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, meaning there are jobs again), 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 to 15 percent of overall activity versus shares of 30 to 40 percent and higher in other major-currency economies, such as Japan or Germany. 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 the interest rate outlook. Growth forecasts from economists are important benchmarks for evaluating subsequent economic data on growth.
• 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; the country loses from trade) 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; the country gains from trade) tends to appreciate because more of it is being bought to purchase that country’s exports. This is just a rule of thumb — it doesn’t always hold true. For example, between 2013 and 2014, the British pound appreciated by more than 11 percent, yet the U.K.’s trade balance continued to deteriorate.
• 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. Debts and deficits became a major theme for currency markets in the wake of the Great Financial Crisis of 2008–2009 (GFC) and the Eurozone debt crisis of 2009–2013, but they were always in the background.

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, but also about how markets interpret individual data reports.

In Chapter 6, we introduce the idea of consensus expectations as one of the keys to understanding how markets interpret economic news and data. In the following sections, we look at important data-reporting conventions and how they can also 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 retail sales are generally increasing, for instance, does a one-month drop in retail sales indicate that the trend is over, or was it a one-off decline due to bad weather keeping shoppers at home?

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 uneven 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 trend. 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 more disappointing. If a current report comes out better than expected, but the prior period’s revision is negative, the positive reaction to the current 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 spending 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. For example, food prices may change rapidly due to drought, floods, or unseasonably hot or cold weather. By excluding those items, the core reading is believed to paint a more accurate picture of structural, long-term price pressures, which is what concerns monetary policymakers the most.

Looking at consumer spending 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 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.

Market-Moving Economic Data Reports from the United States

Now let’s get down to the nitty-gritty data. In this section, we run through the major economic data reports that come out of the United States. (We list the data reports according to the model we outline earlier in this chapter.) Our 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, our 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

At the end of this chapter, we 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

We put the job market at the top of our economic model because job creation/destruction is the single-most important driver of overall economic growth. Every major economy issues updates on its labor market by reporting the number of jobs added/lost, the unemployment rate, or some variation of those. United States employment data holds special significance because it reflects on the world’s largest economy and the primary global reserve currency. The following are the key U.S. employment reports.

U.S. monthly employment report

Typically released on the first Friday of each month and covering the prior month, the U.S. jobs report is considered among the timeliest of economic indicators. But it’s also subject to large revisions to prior periods and significant statistical volatility. The main components of the report include:

• Change in non-farm payrolls (NFP): This is the big number everyone focuses on. The NFP change is derived from the establishment survey (because it’s based on responses from companies), and shows the number of jobs gained or lost in the prior month. The going wisdom among economists is that the United States needs to add around 200,000 jobs each month just to offset population growth and keep the unemployment rate steady. The market’s initial reaction is based on the difference between the actual and the forecast change in NFP. The prior two months’ NFP changes are also revised, and those revisions will color the market’s interpretation of the current report.
• Unemployment rate: Measures unemployed individuals seeking work as a percentage of the civilian labor force. The unemployment rate is derived from a separate survey (the household survey because it surveys real households), which also includes a jobs change number that may be at odds with the change in NFP. 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 sign for the job market and the overall economy.
• 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

The ADP national employment report is put together by the payroll processing company of the same name (www.adp.com) and works in close collaboration with Moody’s Analytics. It comes out on Wednesdays at 8:15 a.m. ET, two days before the government’s NFP report (see the preceding section). ADP measures only private jobs and excludes government hiring. The ADP report is intended to serve as an alternative measurement of the labor market, but it’s got a spotty track record of predicting the NFP with any accuracy. Because of that uncertainty, market reaction to the ADP is typically minor and short-lived, but economists may adjust their forecasts for the NFP depending on what the ADP indicates.

Weekly initial unemployment claims

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.

Consumer-level data reports

Personal consumption accounts for two-thirds or more of most developed nations’ economies, so how consumers are doing has a big impact on the economic outlook and the direction of interest rates, which are both key drivers of forex rates. Here are the main U.S. data reports focusing on personal consumption.

Consumer sentiment

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 uncertain, you’ll cut back 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 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: 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: 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: 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

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 (such as 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 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

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 and a movie. 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 number to get a handle on how the consumer is behaving, but substantial strength or weakness in the auto industry doesn’t go unnoticed. 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

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 multiple percentage swings (as opposed to 0.1 percent or 0.3 percent 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 real estate or housing market is a major factor behind consumer spending since homes typically represent the largest asset on a household’s balance sheet. Rising home prices are seen to support consumption through the wealth effect (the richer you feel, the more likely you are to spend), whereas falling house prices can be a major drag on personal spending. The U.S. real estate bubble burst in 2006–2007 and triggered the GFC and recession of 2008–2009, turning U.S. housing data into a major drag on U.S consumption. One of the hangovers from the financial crisis is that the markets continue to look closely at the U.S. housing market as a gauge of economic strength. If you see a weak housing market, it can send a chill through the U.S. dollar market and the U.S. stock markets.

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

• Existing-home sales data is reported by the National Association of Realtors (NAR). Sales of preexisting homes (condos included) account for the lion’s share of residential real-estate activity — about 85 percent 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.
• New-home sales are just that, brand-new homes and condos built for sale, reported on an annualized basis. New-home sales account for about 15 percent 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.
• Housing starts 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.
• Building permits 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.

Business-level data reports

Getting a handle on how businesses are faring is an important clue to the strength of the economy, which in turn drives the outlook for interest rates and the overall investment environment. The following series of data reports offer insights into how companies are responding at the enterprise level.

Institute for Supply Management and Purchasing Managers Index

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, whereas a reading below 50 signals contraction.

The main ISM reports to keep an eye on are

• Chicago Purchasing Managers Index (PMI): The Chicago PMI remains the key regional manufacturing activity index because the Chicago area and the Midwest region 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 typically released a day after the Chicago PMI.
• ISM manufacturing report: 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 strongly 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 nonmanufacturing report: The ISM nonmanufacturing report is the monthly ISM report that covers the other 80 percent of the U.S. economy, namely the service sector. The ISM manufacturing report may get more attention, but the ISM non-manufacturing report is the one to focus on.

  The equivalent of the ISM reports in Europe and China are the PMI reports that are put together by a data collection company called Markit. Since 2011, Markit has produced an index for the U.S., which is released at the end of each month. Although not as popular as the ISM survey, the fact that it’s released before the ISM survey has seen its popularity start to rise, although it has some way to go before it overtakes the ISM as the business survey of choice for the markets.

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. The main regional Fed indices to watch are

• Philadelphia Fed index: Usually the first of the major Fed indices to be reported each month, covering the manufacturing sector in Pennsylvania, New Jersey, and Delaware. The Philly Fed index includes subindices focusing on new orders, employment, inventories, and prices, among others.
• New York Empire State index: Assesses New York state manufacturers’ current and six-month outlooks.
• Richmond Fed manufacturing index: A composite index based on new orders, production, and employment, covering the Middle Atlantic states.

Industrial production and capacity utilization

Industrial production measures the amount of output generated by the nation’s factories, mines, and utilities on a monthly basis and is viewed as an indication of changes in the broader economy. The manufacturing sector is still viewed as a leading indicator for overall business cycles, so changes here could signal a larger swing in the economic outlook. The capacity utilization report measures actual output versus a theoretical maximum capacity and is looked at for what it suggests about inflationary pressures. High levels of capacity utilization above 80 percent may indicate price pressures are building and send a warning sign to policy makers. Lower levels of capacity utilization may signal the absence of inflationary pressures and allow monetary policy makers to keep interest rates lower.

The Fed’s Beige Book

The Beige Book, named for the color of its cover, 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 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 that was steady or moderately expanding; 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:

• Is the economy expanding or contracting? How fast, and how widespread?
• Which sectors are strongest, and which sectors are weakest?
• Are there any signs of inflation?
• 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.

Structural data reports

Structural data reports are the big picture, macroeconomic data that depict the longer-term economic outlook. What is the structure of the economy? Is it growing or contracting? If so, how fast? Is inflation under control or are prices rising too fast? Is the economy gaining or losing from trade? These reports can be some of the most significant drivers of central bank monetary policy.

Inflation gauges

Inflation reports are used to monitor overall changes in price levels of goods and services and as key inputs into setting interest rate 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 indexes 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): 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): 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): 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 the 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.
• Institute for Supply Management (ISM) prices paid index: 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 producer-level indication of price pressures, likely to be mirrored by the PPI.

Gross domestic product

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 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 × 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 and current account balances:

• Trade balance 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 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, whereas 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 was under pressure for several years before the GFC, 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, although the U.S.’s increased oil production in recent years could cause the trade deficit to shrink sharply in the future and could be a dollar positive in the future.

Government debt and budget deficits

The aftermath of the GFC has exposed high debt and deficit levels in many major economies, especially in the United States, Europe, the U.K., and Japan. Fears of a debt restructuring (where terms of a bond are altered) or default can seriously undermine confidence in a national currency, leading to an extended bout of weakness, as was seen with the euro in the 2010 European debt crisis.

There’s no single data release that adequately covers the debt situations in major economies, though most national governments typically release a monthly budget statement. Instead, monitoring the debt/deficit picture of key countries depends on a series of news and data flows:

• Budget and deficit forecasts: Issued by individual governments and the IMF, these are the best way to stay on top of evolving fiscal changes.
• Government bond yields, spreads, and CDS (credit default swaps): As investors’ fears increase over the creditworthiness of governments, they sell those countries’ bonds, driving yields higher. Yield spreads are another measure of risk, noting the difference between the yields of an embattled nation and a safer alternative. Credit default swaps are a form of insurance that pays investors in the event of a default — the higher they are, the greater the perceived risk.
• Government debt auctions: When governments seek to borrow in capital markets, lack of demand or too high a price can shut them out and possibly trigger a default. Watch for indicators of demand, like the bid/cover ratio, which measures the amount of bids submitted relative to the issuance amount (the higher the better) and pricing (the higher the yield demanded, the greater the risk).
• Sovereign credit ratings: Major credit rating agencies, like Moody’s, S&P and Fitch, may announce periodic credit reviews of sovereign debt, possibly suggesting a downgrade. Actual credit rating downgrades can send investors fleeing, driving up a country’s borrowing costs and increasing the risks of default.

Major International Data Reports

In the preceding sections, we cover the main economic reports using U.S. data as the basis for explaining what each report measures and how the market views them. The main data reports of other major national economies essentially mirror the U.S. data reports, but with some minor differences in calculation methods or reporting. In other words, the CPI report out of the United Kingdom is looked at the same way as the CPI report is viewed in the United States — as a measure of consumer-level inflation.

But plenty of national data reports don’t have an equivalent in the United States, and others are followed more closely in local markets and require extra attention. In the next few sections, we highlight the main data reports of other national economies beyond what we cover earlier.

Eurozone

The main data reports out of the Eurozone are remarkably similar to those of the United States. The key difference is that individual European countries report national economic data, which comes out alongside Eurozone-wide reports from Eurostat or the European Central Bank (ECB).

Because the Eurozone has a common currency and central bank, the forex market focuses primarily on indicators that cover the entire region, such as Eurozone industrial production and CPI, for example. Among individual national reports, the market concentrates on data from the largest Eurozone economies, mainly Germany and France. Keep an eye on all the major reports coming out of those countries. They can generate sizeable reactions based on the idea that they’re leading indicators of Eurozone-wide data. If German industrial production slumps, for instance, it may suggest that overall Eurozone industrial production is set to decline, too. Since the Eurozone sovereign debt crisis, the market has also tended to concentrate on how countries that received bailouts (Greece, Ireland, and Portugal) are faring. Believe it or not, a Greek unemployment report has been known to move the market!

The only European reports that may escape your attention due to unusual names are the principal European confidence indicators. These reports can generate sizeable reactions depending on how they compare to forecasts:

• ZEW survey: This survey measures growth expectations over the next six months by institutional investors and analysts. The survey is done for Germany and the whole Eurozone.
• IFO and GfK surveys: IFO is a corporate sentiment survey that queries businesses across Germany on current sentiment and how business is expected to develop over the next six months. The GfK survey is a monthly measure of consumer confidence
• Purchasing Manager Indexes (PMIs): A data firm called Markit produces monthly PMIs for the manufacturing and service sectors for Germany, France, and the whole Eurozone, similar to the Chicago PMI in the United States. The reports come out on a preliminary and final basis.
• Eurozone Confidence: The European Commission (EC) produces monthly confidence surveys for a variety of sectors: consumer, services, industrial, and overall economic sentiment.

Japan

When looking at Japanese data, keep in mind that the Japanese economy is still heavily export oriented. In addition to following all the usual reports, pay special attention to industrial production and manufacturing data because of their large role in the economy. Since 2012, the Bank of Japan has tried to fight off the threat of deflation, which means that CPI reports have also taken on a special significance in recent years. Outside the standard reports to watch, keep an eye on the following:

• Tankan index: The Tankan survey is a quarterly survey of business outlooks produced by the Bank of Japan (BOJ). The survey produces four readings — current conditions and future outlook from both large manufacturers and large non-manufacturers. The large all-industry capital expenditures survey is an important gauge of capital spending and is often the focus of the entire Tankan survey.
• Trade balance: Japan’s monthly trade balance is nearly always in surplus. The size of that surplus carries indications for the health of the export sector as well as potential political repercussions against excessive JPY weakness when the trade surplus is seen to be too large.
• All-industry and tertiary industry (services) indices: Monthly sentiment gauges of industrial and service-sector firms.

United Kingdom

In addition to the usual major government-issued data reports, be alert for the following reports that can frequently trigger sharp reactions in GBP:

• Bank of England (BOE) Minutes: Released two weeks after each Monetary Policy Committee (MPC) meeting, they show the voting results for the most recent decision. Market expectations and GBP are frequently upended when the policy discussion or vote shows a split leaning in the direction of an interest rate change.
• BOE Quarterly Inflation Report: Although it only comes out quarterly, the BOE’s forecasts for growth and inflation over the next two years can have a significant impact on the interest rate outlook and GBP. It also includes a press conference, which is watched closely by the markets.
• Purchasing Manager Indexes (PMIs): A data firm called Markit produces monthly PMIs for the manufacturing, construction, and service sectors.
• GfK consumer confidence and Nationwide consumer confidence: Two separate, monthly, consumer-sentiment gauges put out by GfK, a U.K./European marketing agency, and the Nationwide Building Society, a U.K. mortgage lender.
• CBI distributive trades survey and industrial trends survey: Two monthly reports put out by the Confederation of British Industry, a private trade group. The distributive trades survey is a measure of retail and wholesale sales, and the industrial trends survey is a survey of manufacturers’ current and future outlook.
• British Retail Consortium (BRC) retail sales monitor and shop price index: Two monthly reports put out by the British Retail Consortium, a private trade organization. The retail sales monitor is another measure of retail sales, and the shop price index measures inflation at the retail level.

Canada

Canadian data mirrors U.S. data in many respects, but here are a few other important Canadian indicators to watch:

• International securities transactions: Roughly the equivalent of the U.S. Treasury’s TIC report (see “Trade and current account balances,” earlier in this chapter), showing net investment flows into and out of Canada on a monthly basis. High inflows typically support the CAD, and outflows tend to hurt it.
• Ivey Purchasing Manager index: A key monthly gauge of Canadian business outlooks issued by the Richard Ivey School of Business. The report covers purchases, employment, inventories, deliveries, and prices.

Australia

Australian data reports exert a strong influence on Aussie, similar in many respects to how U.K. data affects the pound. In particular, keep an eye on

• RBA rate decisions and RBA Minutes: The RBA’s statement following a rate decision, and the subsequent release of the minutes two weeks later, can drive interest rate expectations and AUD big time.
• Westpac consumer confidence and National Australia Bank (NAB) business confidence: Two separate monthly sentiment gauges put out by two of Australia’s leading banks.

New Zealand

New Zealand data is similarly provocative for the Kiwi. In addition to the main data reports and Reserve Bank of New Zealand (RBNZ) statements, keep an eye on the following Kiwi-specific data:

• NZ Card Spending: This monthly report covers purchases using credit, debit, and store cards, and gives another view of retail sales.
• ANZ Consumer Confidence: This monthly survey of consumer sentiment is conducted by ANZ Bank.

China

In early 2011, China surpassed Japan as the world’s second largest national economy after the United States. Chinese growth over the last decade has been nothing short of astronomical and played a major role in supporting the global recovery after the GFC. Data out of China has taken on increased prominence as a result, with global markets frequently reeling on weaker China data or surging on stronger reports.

The Chinese growth outlook affects global markets through a number of different channels. Stronger Chinese growth is good for global trade and tends to positively influence stock markets around the world. Chinese demand for commodities is also influenced by its growth trajectory, with consequent implications for individual commodity markets (China also recently surpassed the U.S. as the largest oil consumer) and commodity producing countries such as Australia and South Africa. As a result, financial markets around the world are increasingly driven by Chinese growth prospects.

In terms of economic reports, Chinese data that reflects growth are the most significant, and we would highlight the trade surplus, industrial production, manufacturing PMIs, and quarterly GDP as the key data releases to watch. Chinese consumers are also increasingly seen to be key to developed nations’ economic outlooks and signs of rising imports and gains in retail sales are viewed as supportive of global growth.

The Chinese still manage their currency and it’s not accessible to individual traders. But Chinese data can have an impact far beyond its borders due to its newfound prominence in the global economy. This is especially relevant for the Aussie dollar, because China is Australia’s main trading partner.