Global events (both expected and unexpected), as well as various economic reports that are released on a daily, monthly, or annual basis, can have significant impacts on international markets. Because of the frequency of these events, however, it can become somewhat easy to overlook their influence on various industries. As an investor, it is of great importance to keep an eye on the pulse of the economy, and these global events and indicators provide decision-makers with a reliable way to do so. In this post, we discuss how some of the most important economic indicators and global events affect markets on a worldwide scale.
Gross Domestic Product (GDP)
The Gross Domestic Product of a state refers to the total value of all finished goods and services produced within the country’s borders over a given period of time. It includes both goods and services provided by both citizens of the country as well as foreigners. As long as production or service provision occurs within the geographic boundaries of the state, it is included in the GDP. GDP is usually used as an indicator to measure a country’s overall economic health. It consists of both public and private consumption, paid-in construction, the foreign balance of trade, government outlays, and private inventories.
Natural disasters, terrorism, and war are all considered favorable to GDP. This is because all of the labor, capital, land, and entrepreneurship outlays that go into rebuilding broken infrastructure from war, terrorism, or natural disasters is added to the year’s GDP. GDP fails to differentiate between destructive and productive expenditure; it simply counts them all as expenses and the higher the total, the better it is for the economy. Any amount of expenditure spent on rebuilding infrastructure to an earlier state can be deemed wasteful, but GDP recognizes it as expenditure. Therefore, such expenses, wasteful or not, are added to GDP growth figures which, in turn, reflect positively on the economy.
Retail Sales Report
The retail sales report is monitored closely by investors and economists. It tracks the monetary value of merchandise sold within the retail industry by sampling a number of companies that are engaged in the direct sales of products to customers. Companies in the sample include both fixed POS (Point-of-Sale) businesses and non-store retailers. They are also of various sizes, ranging from well-established retailers such as Walmart to small independent companies. All of these companies provide data such as end-month inventories and retail sales which are compiled in the report.
The market importance of retail sales report is high because many investors, businesses, government agencies, academic analysts, economists, and researchers use data from it to make decisions and guide policy. Moreover, it is a crucial component in the calculation of GDP (Gross Domestic Product). The Federal Reserve uses it to analyze trends in consumer purchases as part of their analysis of the greater economy. Investors use it to measure trends in consumer spending and how consumer spending affects various companies and industries on a more micro level. Furthermore, the release of the report can cause volatility in the stock market, so investors follow the report closely to be aware of trends and figures as soon as they are available.
If retail sales growth is slowing down or stalling, it means that consumers are not spending as much as before. This slow-down could point to a potential recession because of the large role that personal consumption plays in the health of an economy. Of utmost importance, though, is how far off the reported number is from the consensus number. The stock market is extra sensitive to such news, both good and bad, so any figure that’s higher or lower than expected could trigger a rise or fall in the demand of bonds and stocks, triggering a ripple effect in other parts of the economy. Note- the Currency Market may also be affected and experience high volatility after the retail sales report is released.
Consumer Price Index (CPI)
The consumer price index is a comprehensive measure that estimates the changes in prices of a basket of consumer goods and services to measure the effect of inflation on purchasing power. It is an important economic indicator that tells investors and interested parties what might happen to financial markets that are closely related to consumer prices. The index itself is recognized as one of the best lagging indicators that are frequently used to identify periods of inflation or deflation. The CPI index is a figure that is arrived at after rigorous calculations that involve classifying consumption into various categories and sub-categories across rural and urban regions and analyzing changes and trends.
There are many reasons why tracking the CPI is important. For example, movement in the prices of services and goods tends to affect fixed-income securities. If prices rise too quickly (inflation), bond payments become worthless, as bond yields are lowered significantly. Therefore, the CPI can help investors protect themselves and make appropriate investment decisions. The government uses the CPI to adjust retirement benefits, tax brackets, wages, and other official outlays. As such, it provides businesses, citizens, and the government with clues about price changes in the economy that can then be used as a guide for making better-informed business and policy decisions.
Purchasing Managers Index
The purchasing manager’s index (PMI) is a survey-based indicator that indicates the economic health of the service and manufacturing sector of an economy. Data consolidated within the index is derived from surveys conducted specifically on the service and manufacturing sectors. It is based on factors such as employment levels, new orders, inventory levels, production, and supplier deliveries. The purpose of the PMI is to provide some insight into current business conditions to decision makers, purchasing managers, and analysts. The PMI number reads between 0 and 100, where 50 represents no change in the economy. Any reading above 50 represents economy expansion, while any reading below 50 represents a contraction in the economy.
The PMI is a critical decision-making tool for investors, manufacturers, suppliers, and financial institutions. Investors use it as a leading indicator of GDP, while central banks use it to formulate monetary policies. Manufacturers use it to make product decisions, while suppliers use it to estimate the future demand for products. Various components of the PMI are used in multiple markets. For instance, those in the bond markets keep an eye on the PMI to gain insight into the potential for inflation. Traders in the forex market monitor it as it can lead to changes in monetary policy that can either weaken or strengthen a nation’s currency against rivals in the market.
Non-Farm Payroll (NFP- U.S.)
The non-farm payroll is a critical economic indicator used in the United States to represent the total number of paid workers in the economy, excluding government employees, private household employees, employees in military and intelligence agencies, and employees of non-profit organizations. The NFP report also indicates the number of additional jobs added from the previous month. It reports which sectors are generating the most employment additions. Reports contained within the NFP report provide insights into the labor force, and these insights have a direct impact on the U.S. dollar, gold prices, and the stock market. Together, these figures can be used to determine the overall health of the economy.
The NFP is usually released on the first Friday of every month. The report causes significant yet expected rate movements within the forex and stock markets. Therefore, many analysts, traders, speculators, and investors try to predict NFP figures, along with the directional change it will cause. For companies, its release creates a favorable environment for them as it guarantees tradable movement after the announcement. As for forex traders, a higher than expected reading is taken as positive and bullish for the U.S. dollar, while a lower than expected reading is bearish or negative for the U.S. dollar.
The unemployment rate is another key economic indicator that is defined as the percentage of all unemployed workers in the labor force. These are workers who are willing and able to work and have actively sought employment but failed to secure it. The rate provides an insight into an economy’s spare labor capacity and available human resources. It is closely monitored as a rising rate can signify a weakening economy while a falling rate can signify a growing economy. When a significant portion of the labor force is unemployed, consumer spending is low, and this reduces business revenue, which may ultimately lead to a recession or depression.
The unemployment rate is of great importance to governments, organizations, and even investors. The more the number of employed people, the higher the retail sales, savings, economic output, and corporate profits. If the unemployment rate is too high, the government tries to create jobs by having the Federal Reserve (the FED) step in with expansionary monetary policies (policies aimed at growing or expanding the economy). Moreover, the unemployment rate can affect the prices of securities and stocks. In short, stock markets, as well as forex, tend to rise or fall depending on whether the employment rate report is good or bad.
No matter how excellent a trader or investor’s skills are, whenever a rate announcement is made, it can deliver a surprise shock across several markets. Whenever such an incident occurs, it’s essential for investors and traders to know which direction the markets will move in. For instance, when the central bank delivers a surprise rate hike, the currency of a nation will appreciate (not always), which means that traders will want to purchase it. However, if there is a surprise cut, it will trigger a sell-off where traders will sell and buy currencies with higher interest rates. Rate announcements are important to traders as the forex market’s response to change or news of potential change is immediate.
The federal funds rate, also referred to as the discount rate, is usually used by the Federal Reserve (the Fed) to control inflation. It is the rate that depository institutions (such as banks) are charged for borrowing cash from the Fed. If the Fed wants to shrink the supply of money available for spending, it increases the federal funds rate. This makes the cost of borrowing is expensive, which means that demand for bonds drops. This causes their price to fall. If it decreases the federal funds rate, it increases the money supply making it easier to borrow and spend. This increases the demand for high-yielding bonds, forcing the price to rise.
Not only have natural disasters increased in frequency over the past decade, but they have grown in severity as well. Unfortunately, many people tend to assume that natural disasters only affect the geographical regions they hit. However, in today’s highly interconnected global economy, nothing could be further from the truth. Some natural disasters have been so intense that their long-term effects have been felt worldwide. For instance, the 2011 Japan earthquake was so severe that it caused the earth’s axis to shift slightly, ultimately altering the length of a day. Other common natural disasters include hailstorms, hurricanes, floods, and harsh winters, among others.
One of the most significant and immediate impacts of natural disasters is infrastructure destruction. With infrastructure damage, it’s not uncommon for businesses and productivity to be disrupted. Tangible assets such as buildings and equipment, along with human capital, are destroyed, decreasing the production capacities of firms. Decreased productivity leads to scarcity of products and services, which in turn leads to inflated prices. Not to mention, substantial amounts of capital are needed to restore damaged infrastructure to its former state. The only beneficial outcome of all of this, however, is that through rebuilding and more spending on construction, development, and paying human capital to take care of it all, the affected economy’s GDP rises because of the reasons already outlined above. Furthermore, the economy in question can become more productive than it initially was thanks to new investments in infrastructure and production capacity, further boosting GDP over the long run.
Politics play an important role in the economic development of nations across the world. This is because the political regime, regulatory norms, and government-enforced policies have an important impact on development. For instance, nations which are prone to internal conflicts and terrorism are considered to be less stable. Therefore, the risks of operating in the country are high and not worth the cost for many companies. Such risks can negatively impact global businesses, especially when government decisions become volatile or self-serving. With a single regulation or subsidy, governing bodies can send global shockwaves, destroying global companies and industries.
The kind of regime that exists in a country determines the national and international policies that are enacted by the state. For instance, a company operating in a democratic nation may be able to grow and expand more easily and pay employees better rates according to their work-loads than a company operating in a stricter environment. For example, communist countries tend to have stricter regulations such as paying all employees equally, and this affects economic development. Political management, how governments monitor and enforce policies, and laws also matter. Unethical and illegal practices such as corruption, nepotism, among others, can seriously disrupt economic development and international relations of a country.
As many economists like to say, war is good for the economy. While there is certainly some truth to this statement in the short-run, the adverse effects of war usually last for years. These effects may either occur concurrently with the war or arise later in the form of long-term residual effects that impede the economy’s growth after the fact. War can cause severe economic damage such as loss of infrastructure, a decline in the labor force, disruption of normal economic activities, inflation, and a rise in debt. The most significant damage occurs in welfare, specifically the loss of human life and the deterioration of living standards in the country or region in question.
Wars tend to drain wealth, disrupt global economies, and lead to stunted economic growth. They are destructive, disruptive, and most importantly, expensive. In many situations, governments channel all their resources such as money, capital, and human labor towards funding war efforts. This leads to increased government spending, which leads to increased domestic taxes and reduced consumption and investment. In other circumstances, war can lead to inflation, causing people to lose their savings and their confidence in global markets. A battle between nations can also lead to a collapse in tourism, along with a decline in foreign investments.
Currency devaluation is the deliberate decision of a government to reduce the value of its currency relative to a group of currencies, currency, or a standard. Currency devaluation helps in lowering the price of a country’s domestic output, which has the potential to benefit the economy, because a lower rate, or a weaker currency, makes it easier (i.e. cheaper) to buy, meaning the exports of the country are now cheaper relative to other currencies, which should increase the demand of the exports of the country in question.
Countries that have a fixed or semi-fixed exchange rate tend to use it as a monetary policy tool. As stated above, devaluation reduces the cost of a nation’s exports, which makes them more affordable in the global market. This increases the prices of imports, which makes them unaffordable to the domestic consumer, strengthening local businesses. This way, exports increase while imports decrease, thereby, creating an improved balance of payment which shrinks trade deficits.
While the active decision of currency devaluation seems attractive, it has a number of potential negative consequences. Although the increase in the price of imports boosts the market of domestic industries, the lack of competition may render these industries less efficient. Higher exports relative to imports can also cause aggregate demand, which in turn can lead to inflation. Total demand causes demand-pull inflation, whereby manufacturers are reluctant to reduce costs as exports are cheaper. Over time, this increases the cost of products and services.
While the above list isn’t an exhaustive one, we discussed the events and indicators whose impact on the markets are felt much stronger than others. However, it is important to note that knowing how these factors impact global markets is only half the battle. The real work lies in interpreting the indicators and events and predicting their eventual market impact. Therefore, it’s important to learn how to understand these events and indicators for better decision-making in trading and investing. Also, keep in mind, fundamentals are only one piece of the puzzle. Learn how to interpret and understand the markets from a Technical Analysis point of view- join our online Trading MasterClass.