In our previous article, we touched on the impact of economic data on liquidity and spreads. In this article, we will delve a little deeper and explore how economic figures help to orient markets. Although many real-world factors contribute to the overall direction of a given market, today we will focus on the following: employment data, retail data, Gross Domestic Product, and inflation. For the purposes of this article, we will focus on the US as an example, given that it has the biggest impact on international markets.

EMPLOYMENT DATA

We first turn to the US Bureau of Labor Statistics, which is responsible for compiling and periodically releasing information about a variety of employment related statistics. The most prominent data point the Bureau is responsible for is arguably the Non-Farm Payrolls. NFPs are widely considered to be the most important figure in the more encompassing employment report, which is released on the first Friday of every month. This event is highly anticipated by traders and is a significant driver of market trends.

The NFP figure, simply put, tells us the change in the total number of paid workers in the United States. This figure, as its name suggests, excludes farm workers. It also excludes government and non-profit employees.

If the NFPs are higher than expected, this is an indication of strength in the US economy. Afterall, if more people are employed, it follows that US companies are growing. It also implies that people have more disposable income. As such the US stock markets and the USD have typically reacted favourably to such information.

The opposite case is self-explanatory. Weakness in employment indicates weakness in the economy overall, with all the pitfalls this entails.

Unfortunately, it gets more complicated than simply big number vs small number. Imagine if the NFPs are much larger than expected. This could indicate an economy that’s growing too quickly, which could prompt the Federal Reserve to step in with monetary policies designed to temper the economy until things cool down. This can lead to fear of future interest rate cuts, leading to pre-emptive Dollar outflows, putting downward pressure on the greenback.

Non-Farm Payrolls are generally considered to be one of the sounder data points. Less open to interpretation and manipulation, less biased; it is also one of the more timely releases of the economic calendar.

RETAIL SALES

We mentioned that better employment figures lead to people having more disposable income. Luckily the US Census Bureau is here to tell us just how much everyone is spending. It does so half-way through every month, in the form of the Advanced Monthly Sales for Retail and Food Services Report. Rolls off the tongue, doesn’t it? The report provides relative changes from the previous month (MoM) and from the same month of the previous year (YoY).

Retail sales include everything from car sales, food and drink services, gas, clothes, furniture and everything else people choose to spend their hard-earned cash on. Predictably, these numbers vary wildly over the course of the year, reaching a pinnacle in November/December as things go flying off the shelves in preparation for end of year festivities.

Markets have usually reacted in a similar way as they do to employment data, in that a bigger number is generally seen as more favourable. Roughly 70% of the US economy is driven by consumption, so people spending more money is seen as a good thing, leading to a positive outlook in stock markets, as well as a stronger Dollar.

GDP

Perhaps the term we are most familiar with, Gross Domestic Product is simply the sum of all consumption, government spending, investments and net exports. It is the most all-encompassing indicator of the general health of the economy of any given country. Despite this, its impact on the market isn’t as dramatic as one might expect.

The trouble with GDP figures, kindly provided by the Bureau of Economic Analysis, is that by the time the release comes around, it is usually priced in. This is because the data that goes towards GDP is already known. There are no surprises.

The usefulness of GDP figures is to ground traders within a greater trading environment. It is the GDP data which defines whether the economy is growing or contracting. This serves as a backdrop to the overall direction markets and currencies will adopt, even if the report is not a particularly tradeable event in itself.

CPI AND INFLATION

We return once again to the Bureau of Labor Statistics for our final data release. The Consumer Price Index tracks a basket of goods and services, the interesting aspect being the relative change over time. The CPI helps keep track of inflation and deflation through increases and decreases in the cost of living.

Much like Non-Farm Payrolls, the Consumer Price Index is a highly traded event, usually occurring in the middle of the month, with immediate impacts on stock markets and the Dollar. The way it is usually traded is by comparing the actual data against expected numbers. Hotter than expected inflation has historically sent the Dollar higher, because people operate under the assumption that the Federal Reserve will step in to increase interest rates, making the Dollar more attractive, thereby strengthening the currency. Conversely, lower than expected inflation may signal that the Fed will loosen the money supply, which has typically provoked the opposite response.

CONCLUSION

The basic trends discussed in this article serve to describe historical behaviour in the markets in response to a range of economic data releases. The reality of the situation however is that these data points cannot be analysed in isolation, forming a much broader picture that any well-informed trader would need to step back from to fully grasp.