Fundamental/economic indicators are utilized by analysts to identify investment opportunities and assess economies. Reports such as GDP and the CPI can help investors analyze the changes in the trajectory of a country’s economy. Let’s pick up where we left off in part 1 of our deep dive into the top 10 fundamental indicators every forex trader should know.
6. Consumer confidence index (CCI)
The CCI is an indicator that measures the outlook of consumers towards the economy. It attempts to establish whether they are optimistic or pessimistic about the economy’s future. The logic that drives the CCI is that when consumers are optimistic, they tend to purchase more goods and services, which revamps the economy.
On the other hand, if consumers are feeling pessimistic, they will avoid spending unnecessarily on goods and services. This, in turn, slows the economy.
Therefore, when CCI is trending upwards, consumers are spending more money, which gives the impression of a robust economy. Conversely, when their confidence dwindles, they avoid spending, saving more instead, which points to a struggling economy.
In the forex market, a strong CCI can cause sudden uptrends for that country’s currency, especially if it happens when its economy is struggling. Typically, a rising CCI will often be accompanied by rising retail sales and rising personal consumption and expenditure.
7. Industrial production index (IPI)
The industrial production index is a measure of the real volume of output produced by a country’s manufacturing sector. This includes industries, mines, and utility providers. This index is released monthly. In the US, manufacturing industries account for around 20% of the economy. The sectors that are not covered by this index, the service and construction industries, account for the remaining 80%.
The IPI also measures capacity utilization. This is the rate at which the country’s capital is being utilized to produce goods. Industrial production and the capacity utilization levels are expressed as a percentage of production from a base year. The current base year is 2017. The fluctuations of this index are a vital indicator of the country’s economic growth.
Capacity utilization acts as a measure of the strength of demand. When capacity utilization is low, it leads to overcapacity, which means demand for manufactured goods is low. This could point to an impending downturn for investors or an incoming stimulus from the government. This is usually bearish for a currency.
When capacity utilization is higher than expected, it could point to an overheating economy. This could lead to price pressure increase, ultimately causing inflation. Such situations lead to lower bond prices, increased bond yields, and tend to compel policymakers to increase interest rates. This tends to be bullish for such a country’s currency.
8. Retail sales
The retail sales report gives a measure of how much a country’s citizens are spending on goods and services. Usually, when the citizens have confidence in their country’s economy, they are not afraid to spend on goods and services. However, if they are unsure of the future of their country’s economy, they tend to cut back on spending and prioritize saving instead.
Therefore, an increase in retail sales is usually bullish for a country’s currency but leads to lower bond prices. Conversely, weakening retail sales numbers are usually bearish for the country’s currency. However, it is important to note that this report only gives a nominal value, which means it’s not adjusted for inflation.
9. Home sales
The real estate market is a vital sector in any country’s economy. Therefore, trends in real estate more often than not reflect the state of the economy.
Typically, home sales data is released in the form of new home sales and existing home sales. New home sales represent those residential abodes that have just been built or are being built, on which buyers have signed sales agreements or have put down a deposit. Existing home sales are a measure of the sales made on pre-owned and pre-occupied homes. Like new home sales, they do not necessarily have to be paid in full.
There are three factors that affect home sales; disposable income, unemployment levels, and interest rates. When home sales are rising steadily, it means that the citizens have more disposable income and hence can afford to buy homes. This is caused by low unemployment levels, which also means they can qualify for mortgages. Additionally, when interest rates are low, people can afford to pay mortgages, which translates to increased home sales.
Therefore, an increase in home sales points to a thriving economy, which is bullish for a country’s currency. On the other hand, a decline in home sales points to a struggling economy. When the economy is in decline, governments usually step in with expansionary monetary policies to prevent recessions. This leads to the depreciation of their currency relative to other currencies.
10. Building permits
For any building to be erected, it needs a permit from the relevant government office. These permits are used to gauge the health of the real estate sector, and by extension, the health of the economy.
Building permits are closely related to and often confused with housing starts and housing completion reports. Building permits are a leading indicator, which signals the health of the economy in the near future when the buildings will be constructed. Housing starts is a coincident indicator that measures the number of houses whose construction has already started. The housing completion report is a lagging indicator that tells the number of houses whose construction is complete.
Construction of buildings often entails employing a labor force, purchasing raw materials and construction items, hiring engineers, and the like. All these activities inject money into the economy. Further, most construction projects are done using bank loans and mortgages, which points to increased disposable income and low-interest rates.
Therefore, an increase in construction permits is bullish for a country’s currency, while a decrease in these permits points to a declining economy which weakens the currency.
The long and short of it
In a nutshell, fundamental indicators can provide a forex trader with insights into a country’s economy. This is especially useful because the value of a country’s currency is highly dependent on the state of its economy. Therefore, an understanding of these fundamental indicators is vital for a successful career in trading forex.
