Order Flow Boot Camp

Economic Indicators

What do they indicate?

Every week there are dozens of economic surveys and indicators released, which shape market sentiment and direct price flows. We will explore how to exploit market Sentiment later in the program. For now, we need to get acquainted with the main economic indicators that can have a huge impact on the market.

1. Information Dissemination

Nowadays, traders live in very fortunate times. Up until the widespread use of the Internet, industry professionals had a distinct advantage with regards to information: with their fancy Bloomberg or Reuters terminals, they were receiving data in a timely fashion. Fortunately, the emergence of the internet has changed this situation and now even a trader at home can benefit from the same professional services that the interbank loop uses.

So receiving the data in a timely fashion is no longer an issue. Where there still IS a difference is knowing how to interpret and analyze the data. So in this article, we'll cover some of the most important economic indicators, where to find them, how to read them and what they can tell you.

Typical snapshot of an economic calendar with some of the releases for the day.

2. Economic Indicators for the US

a) Beige Book

Official Site: http://www.federalreserve.gov/monetarypolicy/beigebook/

The Beige Book was first published in 1983 and actually represents the Summary of Commentary on Current Economic Conditions by Federal Reserve District. It’s particularity is the more conversational approach of the report. The Beige Book is published eight times per year, just before each FOMC meeting and it is one of the indicators that the FOMC uses in it’s economic assessment. In this sense, it is an interesting report.

The Beige Book aims to give to give a broad overview of the economy, bringing many variables and indicators into the mix: labor markets, wage and price pressures, retail and ecommerce activity manufacturing output. Hence, the Beige Book will contain comments that look to predict trends and anticipate changes over the next few months or quarters but it is NOT a forward looking indicator.

Importance for traders: the Beige Book does not usually have much of an impact on the market, mainly because it does not contain any new data that can force shifts in sentiment. Rather, the Beige Book can give some insight as to the tone of the upcoming FOMC meeting, depending on the outlook on inflation, growth, employment mainly.

Bottom Line: the Beige Book contains forward-looking comments and gives traders a “man on the street” perspective of economic health by taking first-hand accounts from business owners and economists and speaking in common language as opposed to numbers. Unfortunately specific conclusions are difficult to extract from the report.

b) Philly Fed

Official Site: http://www.phil.frb.org/research-and-data/regional-economy/business-outlook-survey/

The Philadelphia Federal Reserve’s Business Outlook Survey (more commonly referred to as the "Philly Fed") is a monthly survey of manufacturing purchasing managers conducting business in Pennsylvania, New Jersey and Delaware. The survey questions voluntary participants about their outlook on things such as employment, new orders, shipments, inventories and prices paid. Answers are given in the form of better, worse or same as the previous month, and just like the PMI reports, the results are diffused into an index which has a median value for expansion of 0. Hence, The Philly Fed signals expansion when it is above zero and contraction when below 0.

The survey has been around since May 1968 and to this day is considered one of the most valuable regional purchasing manager indexes as it also has a high correlation to the subsequent PMI report (which is even more influential, as we will see). What this means is that the Philly Fed is not a great market mover in itself, but if it sends out a message that is quite distant from the consensus, quick-thinking investors may anticipate similar changes to the PMI and make market moves accordingly. Once again, it takes a correct read of market Sentiment to interpret things correctly. Read our Mindset Lessons to learn the dynamics of Sentiment Reading.

Bottom Line: the survey is very timely, often incorporates special questions regarding things like prospects for company sales, or commodity and energy prices (in particular at the end of each quarter and the end of the year); however, it only covers the manufacturing sector in 3 states and the data can be very volatile.

c) Consumer Confidence Survey

Official site: https://www.conference-board.org/data/consumerconfidence.cfm

The Consumer Confidence Survey is a monthly release from the Conference Board, a non-profit business group that is highly regarded by investors and the Federal Reserve. The report is really unique, as it is formed from survey results of more than 5,000 households and designed to gauge the relative financial health, spending power and confidence of the average consumer.

There are three separate headline figures: one for how people feel currently (Consumer Sentiment), one for how they feel the general economy is going (Current Conditions), and the third for how they see things in six months (Consumer Expectations).

The consumer confidence survey can easily influence market sentiment The idea behind consumer confidence is that a happy consumer is more likely to spend more and make bigger purchases. And given that the US economy (just like the other G8 economies) relies heavily on consumption, this is an indicator to pay attention to. However, being a survey it is subjective and the results should be interpreted as such. In general, however, rising consumer confidence will go hand in hand with rising retail sales and other consumer-driven indicators.

Bottom Line: The Consumer Confidence Survey is of few indicators that reaches out to average households and has historically been a good predictor of consumer spending. However, it is subjective.

d) University of Michigan Consumer Sentiment Index

Official Site: http://www.sca.isr.umich.edu/

The issue with the Conference Board Confidence Survey is the lack of an index or historical robust data. The University of Michigan has overcome this obstacle. The UoM Consumer Sentiment Index is important to retailers, economists and investors, and its rise and fall has historically helped predict economic expansions and contractions.

Similarly to the Conference Board Survey, the UoM Index consists of at least 500 telephone interviews posed to a different cross-section of consumers in the continental U.S. each month. The survey questions consumers on their views of their own personal finances, as well as the short-term and long-term state of the U.S. economy. Each survey contains approximately 50 core questions, and each respondent is contacted again for another survey six months after completing the first one. The answers to these questions form the basis of the index.

Bottom Line: the UoM Index has grown from its inception to be regarded as one of the leading indicators of consumer sentiment in the United States. The Michigan Consumer Sentiment Index has provided a relatively accurate forecast of future consumer confidence and spending for the past several decades. It is something to watch closely when it hits the markets.

e) Consumer Price Index

Official Site: http://www.bls.gov/news.release/cpi.toc.htm

The Consumer Price Index (CPI) is the benchmark inflation guide for the U.S. economy. It uses a "basket of goods" approach that aims to compare a consistent base of products from year to year, focusing on products that are bought and used by consumers on a daily basis like milk, eggs, energy prices, gasoline prices, televisions, etc. The most watched metric is the Core CPI (with food and energy prices removed).

The CPI is an extremely detailed and important release, with breakouts for most major consumer groups (such as food and beverage, apparel, recreation, etc.) and geographical regions, which are supplied by the "CPI U.S. City Averages".

The CPI is probably the single most important economic indicator available, because many other indicators derive most of their value from the predictive ability of the CPI, and the CPI is one of the main building blocks for Monetary Policy.

Bottom Line: the CPI gives most insight into future FOMC decisions and is highly watched and analyzed in the media. However, it is volatile month to month and has certain biases (new product, substitution), which can distort results. Exclusion of food and energy is a debatable measure of inflation since gas prices do affect household expenditure, sometimes to a large degree. This is a market moving event which can shape sentiment.

f) Durable Goods Report

Official Site: http://www.census.gov/manufacturing/m3/

The Advance Report on Durable Goods Manufacturer's Shipments, Inventories and Orders (better known as the Durable Goods Report), provides data on new orders received from more than 4,000 manufacturers of durable goods like cars, semiconductor equipment and turbines. More than 85 industries are represented in the sample, which covers the entire United States.

The headline figure will often leave out transportation and defense orders, as they can show higher volatility than the rest of the areas. The importance of durable goods is in who uses them the most: businesses! Capital goods represent the higher-cost capital upgrades a company can make, and a higher number signals confidence in business conditions, which could lead to increased sales further up the supply chain and gains in hours worked and non-farm payrolls.

Bottom Line: Durable Goods has a good industry breakdown, provides forward-looking data such as inventory levels and new business, which count toward future earnings. However, it is highly volatile and an average measure might be more adequate.

g) Existing Home Sales

Official Site: http://www.realtor.org/topics/existing-home-sales

The Existing Home Sales Report is an indicator which is released every month and states the number of existing homes that were closed during the survey month, as well as the average sales prices. The data is collected and released by the National Association of Realtors.

While the other real estate indicator, Housing Starts, deals with construction levels and is therefore a supply-oriented housing indicator, existing home sales are much more about aggregate demand. Existing home sales are considered a leading indicator because higher levels are typically reached when the economy is coming out of a recession.

Because of the lag between when a sale is made and when closing occurs, the report is not as timely as the Housing Starts Report, but the sample size is larger and less likely to have large revisions. Also, condominium sales are included in this report, but not in the starts report.

Bottom Line: the Existing Home Sales Report has a large sample size and (along with Housing Starts) provides a clear picture of the strength of the housing market and is considered a leading indicator. However, there is no detailed information on the types of homes, and is subject to large bouts of seasonality.

h) Factory Orders

Official Site: http://www.census.gov/manufacturing/m3/

The Manufacturers' Shipments, Inventories and Orders Report (commonly referred to as the Factory Orders Report) contains partly new and partly old information. The report contains the Durable Goods Report information, which is released about one week prior (with revisions), and introduces non-durable goods into the mix, hence including industries such as apparel and food products. The objective is to capture the overall health of the entire manufacturing sector.

The indicator derives most of its value as a supply/demand indicator and inventory levels can be compared to shipments, new orders and other indicators of consumer demand such as retail sales and gross domestic product (GDP). So Factory Orders is a more important indicator than Durable Goods. Unfortunately the report uses data that is 2 months old.

Bottom Line: Factor Orders Report is interesting on one hand, but is not really market moving.

i) Gross Domestic Product (GDP)

Official Site: http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm

The gross domestic product (GDP) is THE indicator. It is THE reason we follow other indicators: we try to assess the current conditions of the economy and position ourselves in line with it. GDP represents the market value of all final goods and services produced by the economy during the period measured, including personal consumption, government purchases, private inventories, paid-in construction costs, as well as net exports (exports - imports).

Real GDP (Nominal GDP adjusted for Inflation) is the one indicator that says the most about the health of the economy and traders follow this release very closely. But GDP is not only interesting to Global Macro traders. For example, the corporate profits and inventory data in the GDP report are a great resource for equity investors, as both categories show total growth during the period; corporate profits data also displays pre-tax profits, operating cash flows and breakdowns for all major sectors of the economy.

However, the negative aspect of he GDP release is that investors only get one update per quarter and revisions can be large enough to significantly change the percentage change in GDP.

Bottom Line: GDP is considered the broadest indicator of economic strength. Real GDP takes inflation into account, allowing for multi-year comparisons. However, it is not very timely and revisions can change historical figures measurably.

j) Housing Starts

Official Site: https://www.census.gov/construction/nrc/

The New Residential Construction Report, commonly referred to as housing starts, is a monthly report derived from surveys of homebuilders nationwide. The components of the report are: housing starts, building permits and housing completions. A housing start is defined as beginning the foundation of the home itself. Building permits are counted as of when they are granted. Traders generally pay close attention to this indicator because housing starts and building permits are both considered leading indicators. The reason is to be found in the link between monetary policy and mortgages: rising mortgage rates may be enough to convince homebuilders to slow down on new home starts.

Bottom Line: the indicator is very forward-looking, especially building permits, and tend to be a good gauge for future real estate supply levels. Also, the sample size is optimal. However, there is no differentiation between size and quality of homes being initiated, only the nominal amount.

k) Industrial Production

Official Site: http://www.federalreserve.gov/releases/g17/current/default.htm

Industrial production figures are based on the monthly volume of goods produced by industrial firms such as factories, mines and electric utilities in the US. The industrial production data is released with capacity utilization estimates.

The industrial production and capacity utilization figures are considered coincident indicators, not leading nor lagging changes in economic activity and GDP. The release can provide insight on short-term fluctuations in business cycle growth.

Traders watch this indicator closely, because the FOMC also focuses on it because inflation shows itself first at the industrial level, when supplies of basic materials get tight - either for their suppliers or clients. Fluctuations in commodity prices will show themselves first at the industrial level, before being passed on down the line. This is also why the Producer Price Index (PPI) is a tell-tail for the Consumer Price Index (CPI).

Regarding Capacity Utilization levels, figures above 80% are seen as "tight" and signal potential increases in prices and/or supply shortages. Reasonable levels are 78-80% and the further we drop, the more of a recession-type signal we get.

Bottom Line: the Industrial Production figures are closely watched by market participants, first and foremost because the data is fresh. Sector breakdown allows for inspection of the relative performance of many lines of business. However, it only deals with physical goods-producing industries, which make up less than half of economic output. Services, as well as construction production, are not included.

l) Initial Jobless Claims

Official Site: http://www.dol.gov/opa/media/press/opa/

The Initial Jobless Claims Report is a weekly release that shows the number of first-time (initial) filings for state jobless claims nationwide. Logically, week-to-week results can be volatile, so practitioners like to use a four-week moving average for interpretation of the general trend.

New jobless claims for the week reflect an up-to-the-minute account of who is leaving work unexpectedly, reflecting the "run rate" of the economy's health with little lag time. The report receives a good amount of attention from the market participants, mainly due to the simplicity of interpreting the data: more people working means more spending, which can translate into increases in GDP.

Bottom Line: The weekly jobless claims provides for timely data that can be easily digested by traders. However, summer and other seasonal employment tends to skew the results so a 4-week moving average should be used to smooth the data out.

m) Manufacturing PMI and Non-Manufacturing PMI

Official Site: http://www.ism.ws/ISMReport/?navItemNumber=4892

The Institute for Supply Management (ISM) releases the ISM Manufacturing Report and Non-Manufacturing Report on Business, commonly referred to as the Manufacturing and Non-Manufacturing PMI, each month. The ISM, a non-profit group with members engaged in the supply management and purchasing professions, initially created the Manufacturing PMI but then saw the need to represent more than just the manufacturing industry because the service sector reflects the majority of real GDP and was NOT included in the report.

The Manufacturing PMI is a composite index of many sub-sectors:

Source: http://www.ism.ws/ismreport/mfgrob.cfm

The Manufacturing PMI is very important for sentiment reading, not only for manufacturing, but also the economy as a whole because this industry is still where recessions tend to begin and end. The PMI reports are very closely watched by traders and can generate substantial market movement.

The expansion/contraction level for the PMI is 50: above 50 indicates that the industry is expanding - so things should be going well also for the economy as a whole. But of course, if the index is still above 50 but it is declining month after month, the reading cannot be interpreted so positively.

The Manufacturing PMI is considered a leading indicator for the FOMC, it is very timely and contains a load of information on the various sub-sectors. However, it only covers the manufacturing sector.

While the previously-released ISM Manufacturing PMI receives the most attention, the Non-Manufacturing Report is also a significant news release that traders pay attention to. The reason is that it represents a much larger share of the economy and, most importantly, it covers the hard-to-measure services industries.

Again, the contraction/expansion number is 50: above signals an expansion and below signals a contraction.

Bottom Line: The Non-Manuf. PMI is consistent and timely. When used with the ISM Manufacturing PMI, the two reports will capture industries making up nearly 90% of total GDP. Also, the sub-sectors analyzed can give good insight into the future data releases during the month.

n) Retail Sales:

Official site: https://www.census.gov/retail/

Retail Sales is very closely watched indicator and it is obviously able to move the market significantly. This indicator tracks the dollar value of merchandise sold within the retail trade by taking a sampling of companies engaged in the business of selling finished products to consumers.

The data released will cover the prior month's sales, making it a timely coincident indicator. But the real importance comes from the link between consumer demand and inflation: if consumers are spending, then inflationary pressure are expected to rise. This, in turn, can stimulate the FOMC to act. Vice versa, if consumers are not spending then inflation is not a problem and the FOMC might actually start to get worried. If retail sales growth is stalled or slowing, consumers are not spending as they previously were, and this could signal a pending recession due to the significant role that personal consumption plays in the health of the economy.

Bottom Line: retail sales is extremely timely and is released only two weeks after the month it covers. It's easy to understand and gets a good amount of attention from both market participants and policy makers. However, retail sales data is often volatile from month to month, which makes trend-spotting difficult, and is based on physical products, not services.

o) Trade Balance:

Official Site: http://www.bea.gov/newsreleases/international/trade/tradnewsrelease.htm

Market participants and policymakers use trade balance information to determines the health of the domestic economy and it's relationship with the rest of the world. The most important figure in the report is the nominal trade deficit, which represents the current dollar value of U.S. exports minus the current dollar value of U.S. imports.

The U.S. has been running a trade deficit for more than 20 years (and a current account deficit for some time as well), set against the backdrop of a long-term U.S. economic expansion. As a nation, the U.S. imports more than it exports. The Trade Balances Report can move the markets if the data shows a marked change from the prior period. Because of the constant trade deficit, most market participants react positively to a falling deficit (a sign of more exports and/or less imports).

Bottom Line: Trade represents about ¼ of total economic activity in the US and is a large component of GDP. So traders do pay attention to the data, even if it is not generally market moving.

To sum up: economic indicators are bits and pieces of information that shape the aggregate sentiment of the market. If you want to learn more about sentiment and how to exploit it, read through the Order Flow Lessons In this article we have explored the main economic indicators for the US economy. Of course, all other major economies produce similar statistics, and they are interpreted in the same way. So you can easily adjust to reading European releases or Canadian releases, etc.

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