Introduction
When I was younger, I was curious about how the economic indicators affect the markets. My passion for the financial markets came from a long time ago. Maybe I’m more focused on the interest rates markets (bonds, futures, swaps) than in the stock market and another kind of products. I follow all the products in general because I consider that investing is one of the smartest things we can do with our savings. Depending on your knowledge and risk aversion, you should look for the product or the style that suits you, even if it´s a simple cash savings deposit.
I remember that I was amazed at how the markets moved after an important macroeconomic indicator was released, and I admit that I enjoy watching how the products move in these kinds of events. This is the reason why I did my dissertation based on this interesting subject.
I’m going to explain in a simple way the most important macroeconomic indicators without using the advanced statistical methods I used in the past.
GDP
The Gross Domestic Product is a monetary measure of the market value of all final goods and services produced in a specific country and period of time. I prefer the GDP change because it´s easier to make international comparisons and to measure the economic performance of the country or economic area.
US GDP, own elaboration
Let’s consider for a moment that the Smart money goes to the countries that offer better risk-reward. Assuming a world with 2 similar economic areas and the GDP growth is higher in one economic area than the other one, the investors will assume that the interest rates will be higher in the first one in the future (to fight with the growing inflation), so the investors will move their deposits to the first economic area. This is only an example because the investors should consider the future expectations, the way that the region is growing, the risks involved…
Source: TradingView, 10 Year T-Note Dec17 future, 15 min
The USD GDP released on the 28th September was 3.1% while the market expected only 3%. This is a really good growth for a developed economy. This future fall with the good news and the candle after the release confirm the movement. This is not the best example but it’s the most recent one.
US CPI
The consumer price index measures the change in the price level of a market basket of consumer goods and services purchased by the households. To sum up, it’s a measure of the inflation.
US CPI, own elaboration
This is the last 15 consumer price index. I rose from July 16 to February 17, where was the máximum reading at 2.7%. After that, it declined until July. The last three readings have been positive and in line with the expectations.
How can we take advantage of the releases? This is a very difficult question but I will help you at least to understand the theory. The first thing, we need to know how the product moves. In terms of currencies, if the economic release is positive, the value of the currency affected by the good news will go up. If we have a look at bond futures or interest rate futures with good data they will go down. Let me recap this in the following table which can be used for all macroeconomic indicators:
|
Expected movement
|
Macroeconomic release
|
Bond Futures
|
Interest Rate Futures
|
Currencies
|
Better than expected
|
Down
|
Down
|
Up
|
Worse than expected
|
Up
|
Up
|
Down
|
How the futures move when there are macroeconomic releases, own elaboration
The reason why the bonds and the interest rate go down with a better than expected data is the way that they are priced at the market. The easiest way to understand it is with Eurodollar Futures. The price of these instruments is 100 – Expected interest rate, so if the traders expect higher interest rate the price goes down.
Source: TradingView, 5 Year T-Note Dec17 Future, 15 min
I’ve chosen the 5 Year T-Note because it’s yield sometimes is considered as a medium-term inflation. If you trade interest rate derivatives such as bonds, interest rate futures, you should write down the date on your agenda because these markets will move. As you can see this future rose aggressively because the US CPI YoY was 1.7% when the market expected 1.8%
US Non-Farm Payrolls
This is an indicator that measures the number of jobs that have been added to the economy. It doesn’t include farm workers, private household employees or non-profit organizations employees. You can think that the people that got a job in the period will spend more money in the future and the consumption of the economy will increase. If this happens, the price of the goods and services will increase creating inflation. The assets will react like in the table shown above.
Non Farm Payrolls, own elaboration
The Non-Farm Payrolls doesn’t follow a determined pattern. There is seasonality involved in the job creation. Obviously, a high number helps the economy but it’s important to read the job reports. Knowing the sectors that are hiring, the percentage of permanent jobs created out of all the jobs created during the period is quite useful to understand how good it’s the figure.
Source: TradingView, EURUSD Dec17 future, 15 min
This is a great example of a movement after the reading of the Non-Farm Payrolls and the unemployment rate. There is a lot of volatility in these events. The NFP was -33k and the market expected a lower value than in the previous release. At this point, I would have sold the future but everything moves really quickly and it´s better not to trade it if you don’t like high volatility. At the same time, the unemployment rate was better than expected, this is why the movement bounced back looking for higher prices. In case you trade these events, you should respect the risk management.
US Unemployment rate
The unemployment rate measures the percentage of unemployed individuals in the labor force. In order to be considered as unemployed, you should have been actively looking for a job in the last 4 weeks. Theoretically, in a growing economy, the unemployment rate will be small. It´s supposed that an employed individual is more willing to spend or invest part of his/her money. This fact will help the economy. The US unemployment data is released the same day and at the same time as US Non-Farm Payrolls, so, in the case of mixed data, will be volatile until it takes direction.
US Unemployment rate, own elaboration
When the unemployment rate is lower than 5% I consider that the economy is in full employment. The US economy has been performing well in the last years and this is reflected in the unemployment rate.
ISM PMI
The ISM PMI is made up of different surveys collected from purchasing executives at more than 300 industrial companies. These surveys include new orders, Factory orders, employment levels, supplier delivery times and inventories. If this indicator is above 50 but lower than 53 means that the economy is expanding slowly. A Reading above 53 means that the economy is expanding and it has momentum. In my opinion is a leading indicator of its nature.
ISM PMI, own elaboration
We can see an improvement in the ISM PMI during the last 15 month, what is reflected in the economy and in the chart of the SP500 for the same period.
Source: TradingView, SP500 futures, daily, From Jun16 to Oct17
This represents the same trade that the evolution of the ISM PMI for the same period. We can use the PMI as a leading indicator and make medium to long-term investments.
Let´s check what happens when it´s released:
Source: TradingView, GBPUSD Dec17 future, 15 min
The US ISM PMI reading was 60.8 and the market expected 58. This made the USD rose vs the GBP. It´s not as volatile as other releases, I prefer using the ISM PMI for medium and long-term investing in the stock market.
Conclusion
I hope this post helps you understand these situations. This is applicable to every economic area. If you know about macroeconomics, you could have come up with the same indicators. The only thing is that I demonstrated with a statistical model, at least, in my dissertation. Surprisingly Retail Sales wasn’t as relevant as the economic indicators explained above but I think we should follow due to the economic nature of the United States. You shouldn’t trade considering that the release is good or bad, it´s better to compare with the number the market expected.
Have a good trading!
Disclaimer
I wrote this article myself, and it expresses my own opinions that shouldn't be used as a trading advice. Trading carries considerable risk due to the high leverage involved
