Profile of the Euro – Characteristics and Major Economic Indicators

In the previous article we spoke about the euro’s increasing popularity as a reserve currency, fuelled by the European Union’s major role as a global trade partner. In the current article we will turn our attention towards the specifics surrounding this new currency and its trading, as well as the most important economic indicators that affect its exchange rates.

One of the reasons you might want to trade the euro as a day trader is that its share of the forex market is quite large – 33% as of April 2013 – putting it in second place after the US dollar. That said, the EUR/USD pair is the most actively traded; generally, all major euro crosses are very liquid.

Liquidity is important because it ensures that you can get your investment out of the market (you can exit your position), since there will be enough traders who want to buy when you are selling and vice versa. Higher liquidity causes prices to change gradually and trends to develop incrementally, as opposed to the rapid price changes seen at times of low liquidity and high volatility. Hedge-fund speculators tend to act aggressively during periods of low liquidity, forcing other participants to do the same and thus moving the price quickly. While this may suit some trading strategies, for others it does not. As a freelance day trader, you are more likely to prefer high-liquidity conditions in which institutional investors have a diminished effect on the overall market.

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The EUR/USD pair is used as the primary gauge of the performance of the European and US economies – the world’s two largest. Thus, strengthening of the euro leads to a weakening of the US dollar, which is widely referred to as the ‘anti-dollar’. We know from the article “US dollar index” that the euro has a 57.6% weight in calculating the US dollar index and moves with a correlation of -0.941 to the USDX.

The EUR/GBP, EUR/JPY and EUR/CHF pairs are also good trading alternatives, reflecting the performance of the respective economies. They rarely gap and have tight spreads as well.

Specifics and risks

However, apart from the common forex trading risks, the euro suffers from some specific ones. The first thing that comes to mind is that, because the euro is currently the currency of 18 different countries, it is exposed to risks from each one of them. Thus, if Germany’s economic growth is accelerating but France and Italy are losing momentum, the euro will not appreciate as it would if every state were making progress, and it might even depreciate.

Another problem the euro faces is that although the number of euro area members is expected to grow as the European Union expands, if any country drops out of the Eurozone and reverts to its original currency, this would hammer the euro and compromise the stability of the entire region. Such an event would call into question the reputation of the ECB, its policy’s effectiveness and its intentions. This is one of the reasons for the support Greece received when suspicions arose that it might drop the euro and readopt the Greek drachma.

Indicative of sentiment on the euro, particularly against the performance of the US dollar, can be the difference between the 10-year US government bonds and the 10-year German Bund rates, which are deemed the benchmark bonds for the euro area. If Bund rates (the German word for ‘bond’) are higher than Treasury rates and the difference between them widens, this is considered bullish for the euro, and vice versa.

Key economic indicators

As we said, because the euro is the common currency for the Eurozone’s eighteen member states, each significant piece of data plays a part in its valuation. Eurostat regularly releases overall figures for the Eurozone as a single entity, which tend to have the strongest effect on the currency. However, figures from the bloc’s major economies (Germany, France and Italy) naturally have a huge impact on price movement as well. Let us begin with the major Eurozone indicators.

– Gross Domestic Product – as a measure of growth within the European Monetary Union, Gross Domestic Product is, as usual, of great importance for the euro. The GDP growth rate, released by Eurostat, is regarded as a broad measure of the Eurozone’s economic health and a primary indicator of economic activity. It is calculated on a quarterly and annual basis, with the annual figure having a larger impact on the euro. The annual value is estimated as a simple sum of the members’ national GDP, but some countries are not included in the preliminary reading because they do not produce such data or it is significantly delayed. The same applies to the quarterly readings.

There are three readings of each three-month period’s performance – two preliminary and one final value. The first preliminary reading is released with a delay of one-and-a-half months, followed by the second preliminary estimate in the next month and the final one in the following month. For example, the first preliminary estimate of Q4 GDP growth is published in mid-February, followed by the second preliminary reading at the beginning of March and the final reading at the beginning of April. Generally, an improvement from the previous period, and especially a better-than-expected reading, is seen as bullish for the euro and vice versa.

– Harmonised Index of Consumer Prices – the HICP is an economic indicator constructed to measure changes over time in the prices of consumer goods and services acquired by households within the Eurozone. It is designed and used for international comparison. Data are derived from each national statistics agency, which is required to provide Eurostat with the 100 indices used to calculate the HICP. The national HICPs are summed by Eurostat as a weighted average of these sub-indices with country-specific weightings.

Apart from the broad HICP, there is a core value that excludes volatile components such as food, energy, alcohol and tobacco. Both HICP and core HICP are calculated on a monthly and annual basis, with more significance placed on the annual values. There is also a preliminary value, which is released at the end of the month for which it is calculated. The final value is published in the middle of the month following the reference period (e.g., the preliminary April readings are released at the end of April, while the final values are published around 15 May).

Even though part of the information is already available from individual countries before the general euro area index is released, it is still of major importance because it serves as the reference inflation figure that the ECB takes into account and compares with its 2.0% inflation target. Generally speaking, a high reading should be taken as a bullish sign because central banks tend to intervene when inflation accelerates excessively by raising interest rates (a hawkish stance), while consistently low readings are countered with dovish measures.

– Retail sales – released by Eurostat, this indicator measures changes in the euro area retail sector, assessing its performance in the short term. It is the most important indicator of consumer spending, which itself is the foremost driver of economic activity.

The indicator is calculated on both a monthly and annual basis with a one month delay; for example, the reading for March is released in the first week of May. If the index of retail sales rises at a faster-than-projected pace, this would have a bullish effect on the euro, and vice versa.

Sentiment

– ZEW Economic Sentiment – the Zentrum für Europäische Wirtschaftsforschung (ZEW) Economic Sentiment Index measures the sentiment among institutional investors, calculating the difference between the share of investors that are optimistic and the share that are pessimistic. It rates the relative six-month economic outlook for the Eurozone, making it a leading indicator of economic health. It is released in the second or third week of the reference month. A better-than-expected reading is considered bullish for the euro, whereas a pessimistic view is seen as bearish.

– Sentix Investor Confidence – a monthly survey conducted among 2,800 investors and analysts (more than 500 of whom are institutional) that rates current economic conditions as well as the relative six-month economic outlook for the Eurozone. It is released within the first ten days of the reference month by Sentix GmbH and comprises 36 different indicators. A reading above zero indicates optimism and a reading below zero indicates pessimism. Although it is deemed to have low-to-medium market influence, it is important due to its role as a leading indicator; better-than-expected readings are regarded as bullish, while worse-than-expected ones are bearish.

– Other key Eurozone indicators – there are also unified economic indicators that influence the euro’s movement, which, as in any other economy, cause high volatility. These include the manufacturing and non-manufacturing PMIs, industrial production, unemployment rate, producer-price inflation, trade balance, and of course the ECB’s interest rate decisions and speeches by the bank’s president – currently Mr Mario Draghi.

Apart from the euro area’s generalised indicators, key readings from the EMU’s biggest economies, especially Germany and France, also tend to be major market movers. Among these are the German unemployment change and unemployment rate released at the end of the reference month, retail sales (released at the end of the next month), GDP, manufacturing and non-manufacturing Purchasing Managers’ Indices, etc.

German data

Another set of crucial data for the euro is German industrial production and the Ifo Business Climate Index.

– German industrial production – released by the Statistisches Bundesamt Deutschland, German industrial production measures the change in the total inflation-adjusted value of output produced by manufacturers, mines and utilities. Changes in the industrial sector are broadly followed as a major indicator of strength or weakness in the country’s manufacturing sector.

The data are seasonally adjusted and comprise a breakdown of four aggregates: manufacturing, construction, mining and energy. The manufacturing category consists of four main product groups: basic and producer goods, capital goods, consumer durables and consumer non-durables. There are two readings – the seasonally adjusted month-on-month estimate and the non-seasonally adjusted, workday-adjusted year-on-year reading. Both are widely tracked by investors. Germany’s industrial production figures are the most important among EU nations, but in some cases the French and Italian readings can also cause considerable volatility. The German data are released with a delay of one month; for example, the reading for March is published in the first ten days of May.

– Ifo (Information und Forschung [research]) Survey – released by CESifo Group Munich, the Ifo Business Climate Index rates the current business climate in Germany and reflects expectations for the next six months. It is based on a survey conducted among manufacturers, builders, wholesalers and retailers. As the largest European economy, assessments of business conditions in Germany are seen as indicative for Europe as a whole. The survey is conducted on a monthly basis and encompasses the business-situation assessment of more than 7,000 enterprises. It is usually released in the third or fourth week of the reference month.

The release consists of the business climate headline figure and its two equally weighted sub-indices: Current Business Conditions (Ifo Current Assessment) and Ifo Business Expectations. Readings typically range between 80 and 120, but its month-to-month changes have a more significant impact on the euro’s movement. Positive economic growth expectations are bullish for EUR sentiment, while a lower reading compared with the previous period is seen as bearish.

Apart from the multiple economic indicators released both by individual member states and for the Eurozone as a whole, the countries’ individual budget deficits and debt levels also influence the euro. According to the Stability and Growth Pact, member countries are supposed to keep these macroeconomic indicators within certain limits, and failure to do so is closely monitored by investors and viewed as bearish. The same applies to speculation that a member of the European Monetary Union might exit the bloc and readopt its original currency.