Short-Term Factors Driving the Foreign Exchange Market

When it comes to short-term market movement, day traders closely observe economic data from the major economies, regardless of whether they are technicians or fundamentalists. Although many technicians say they dont factor in economic indicators, nearly everyone takes those in consideration one way or another. Because important economic data are accompanied by large volatility and usually cause sudden and wide price spikes (climaxes), technicians who favor range trading for example tend to stay out of the market at the time around the release. In contrast, a technical breakout trader would favor exactly those market conditions, capitalizing on the huge volatility and price swings. At the same time, economic data is definitive for traders using automated systems with strategies based on data releases.

Logically, the economic figures that tend to affect currency pairs the most are the ones from the U.S. This is due to the greenbacks status of reserve currency and the United States being the worlds largest economy, including a major importer and exporter of raw materials, finished products and services.

According to the Triennial Central Bank Survey by the Bank for International Settlements, as of April 2013 the greenback stood on one side of 87% of all trades on the Foreign Exchange Market. Thus you can imagine the impact an indicator such as the U.S. Nonfarm Payrolls has all over the world. If you want to learn more useful statistics regarding Forex, read our article “What Does Forex Stand for?”

Some US economic indicators have a huge impact on the currency pairs, with sentiment shifts lasting for days, while other data may as well have little-to-no significance. In addition, over the years some of the releases have become more important for currency traders on the back of others, especially when central banks monetary policies get tied to a certain economic activity gauge. We will get to that part a bit later.

Utmost importance

The most important economic indicator from the US remains the Nonfarm Payrolls. The reason behind its huge market-moving ability is that it is indicative for the strength of the US labor market, thus for the US economys recovery pace. Moreover, US policy makers have tied the health of the countrys labor market to the Federal Reserves unprecedented Quantitative Easing program, which was injecting $85 billion in the economy each month via bond purchases before it was trimmed in January 2014. Job creation growth has a positive relation to consumer spending and retail sales and leads to tighter monetary policies. Conversely, an unhealthy labor market would hurt consumer sentiment and economic activity, introducing the need of lower interest rates, which depreciates the currency.

Nonfarm payrolls were and remain the biggest market mover, followed by FOMCs interest rates decision, consumer inflation (Consumer Price Index), retails sales, producer inflation (Producer Price Index) and housing data, led by new homes sales.

PMI readings

Among the most important indicators are also the ISM Manufacturing and Nonmanufacturing Reports on Business. The manufacturing data is more widely followed compared to the figures released by Markit Economics (the US Manufacturing PMI).

However, the non-manufacturing data has an even greater impact on daily price movement as the services sector accounts for almost 80% of the countrys GDP, compared to the industry sectors 19% contribution and around 1% by agriculture. What is more interesting is that the non-manufacturing report has a more muted effect on the markets right after the release, but causes a strong move on daily basis. Both ISM reports have a large number of underlying components which require more time to be made familiar with and thus factor in what the Federal Reserve might decide on its next policy meeting based on that data. The ISM figures are also very closely observed for the employment component, which provides a preliminary insight on the labor market ahead of nonfarm payrolls, thus it is a leading indicator.

Some economic indicators have grown in significance in the last decade due to the shifts in the US economys state, while others importance has significantly receded. One of the strongest market movers in the 1990s was the US trade balance, while currently it has fallen out of the top ten. Trade data may be of importance when a country is running a large trade deficit, but as economic conditions are changing focus falls on different sets of data, which are more indicative for its recovery. For example, the Federal Reserve tied the reduction of its monthly bond purchases to the US economys performance, and mainly the health of the labor market. Even as it began to gradually trim its Quantitative Easing program, policy makers have vowed to keep interest rates at historically low levels before the unemployment rate reaches a sustainable low level. For the same reason consumer sentiment indicators also affect the US dollar. They are seen as leading indicators for the direction of household spending, which makes up 70% of the countrys GDP.

A very interesting shift in significance has underwent the Gross Domestic Product. Although it was ranked as the fifth most significant market mover in the 1990s, it now has very little effect on the US dollar for several reasons. First, the figure is published quarterly, as opposed to the most important indicators monthly release. Moreover, the reading is based on data which is released on a monthly basis within those three months, thus investors have enough accurate information ahead of the GDP publishing, which is already priced in, and there are rarely surprises. Moreover, because a GDP figure can be boosted by factors with different effect on the US dollar, it is often misinterpreted. Strong exports boost GDP and raise the dollars value as more people buy the greenback in order to conduct payments for goods produced in the US. In contrast, GDP growth based on an inventory buildup, such as Q3 2013, may be seen as negative for the dollar as it may be followed by stalling growth in the next quarters.