A Guide to GDP and Forex Trading

A Guide to GDP and Forex Trading

The GDP (Gross Domestic Product) economic data is deemed highly significant in the forex market. GDP figures are used as an indicator by fundamentalists to gauge the overall health and potential growth of a country. Consequently, the greater volatility in the forex market is closely observed during the GDP release.

WHAT FOREX TRADES NEEDS TO KNOW ABOUT GDP     

What is GDP?

It was developed in 1934 by Simon Kuznets, the Gross Domestic Product (GDP) measures the output and production of finished goods in a country’s economy. Usually, GDP is measured in three different time frames: monthly, quarterly, and annually. This enables economists and traders in getting an accurate picture of the overall health of the economy.

There are many approaches to calculating, GDP, however, the US Bureau of Economic Analysis uses the “Expenditure Approach” using the formula:

GDP = Consumption © + Investment (I) + Government Spending (G) + Exports (X) – Imports (M))

Understanding the Relationship between GDP and the Forex Market

The general rule of thumb when looking at GDP data is looking at whether figures beat or fall below estimates (see relevant charts below):

The lower projected GDP reading will likely result in a sell-off of the domestic currency relative to other currencies (USD depreciating against EUR)

EUR/USD chart: Low GDP data release

The higher than projected GDP reading tends to strengthen the underlying currency versus other currencies (USD appreciating against EUR).

The GDP reports do not always have the same or expected effect on currencies. It is important to keep in mind before committing to a trade. Often, GDP figures are already fully/partially priced into the market meaning that the market may not react as anticipated once GDP figures are released.

Moreover, related economic data reports regularly allow for the market to ascertain a somewhat accurate estimate. Data to look out for:

·         PPI data

·         ISM data

ANALYSING THE GDP DATA TO INFORM CURRENCY TRADING DECISION

GDP, Inflation, and Interest Rates

Upon the advance release of GDP is four weeks after the quarter ends while the final release happens three months after the quarter ends. Both are being released by the Bureau of Economic Analysis (BEA) at 08:30 ET. As typically, investors are looking for US GDP to grow between 2.5% to 3.5% per year.

Without the specter of inflation in a moderately growing economy, the interest rates can be maintained around 3%. However, a reading that is above 6% GDP would further show that the US economy is endangered by overheating which can, in turn, spark inflation fears.

As consequently, the Federal Reserve may have to raise interest rates to curb inflation and put the ‘brakes’ on an overheating economy. Maintaining a price of stability is one of the jobs of the Federal Reserve. The GDP must stay in a ‘goldilocks range’ not too hot and not too cold.

However, GDP should not be high enough to trigger inflation or too low where it could lead to recession. Such as a recession is defined by two consecutive negative quarters of GDP growth. The GDP ‘sweet spot’ varies from one country to another. For example, China has had GDP in double digits.

Advance release of GDP is four weeks after the quarter ends while the final release happens three months after the quarter ends. Both are released by the Bureau of Economic Analysis (BEA) at 08:30 ET. Typically, investors are looking for US GDP to grow between 2.5% to 3.5% per year.

Without the specter of inflation on a moderately growing economy, interest rates can be maintained around 3%. A reading above 6% GDP would show that the US economy has endangered by overheating which can, in turn, spark inflation of fears.

Moreover, forex traders are most interested in GDP as it is a complete health report card for a country’s economy. A country is by then ‘rewarded’ for a high GDP with a higher value of its currency. As there is usually a positive expectation for future interest rate hikes because a stronger economy tends to get stronger creating higher inflation. In turn, it leads to a central bank raising rates to slow growth and to contain the growing specter of inflation.

On the other hand, a country with weak GDP has a drastically reduced interest rate of hike expectation. In fact, the central bank of a country has two consecutive quarters of negative GDP that may even be chosen to stimulate its economy by cutting interest rates.

THE TRADING CURRENCY PAIRS USING GDP DATA

On quarter-on-quarter figures tends to produce much more variable changes in an overall trend – e.g. Positive GDP figures beating estimates QoQ may be fleeting when taking into consideration year-on-year (YoY) data. However, YoY data allows for a broader perspective which could potentially highlight an overall trend.

The chart below shows a longer time frame EUR/USD view as seen in Chart 2 above. The chart expresses the variation in short term QoQ data against the longer-term YoY trend.

GDP AND ECONOMIC DATA: THE TOP TIPS FOR FX TRADERS

  •         CPI is released monthly by most major economies in giving a timely glimpse into current growth and inflation levels.
  •         If you’re new to forex trading, our New to Forex trading guide covers all the basics in helping you on your journey.
  •         The fundamental traders monitor economic data releases, and many do so with intention of trading the news. It is essential that traders adopt sound risk management when doing so volatility can spike immediately after important releases.