Posted on 20 September 2010.
Important economic data announcements can have significant effects on foreign exchange rates. This is evidenced by the fact that immediately preceding and following major anticipated economic events, trading becomes more volatile and price swings can be intense.
There are a number of expected economic data announcements that take place in major countries every morning. Expected events usually produce some pre-announcement speculation with trading direction determined by the overall weight of expectation among traders. If traders believe the event is likely to be positive for a given currency, it is likely to trend positively ahead of the announcements. The opposite would be true if a more negative announcement is anticipated.
Major economic data reports that are issued monthly, or in some cases weekly, in major countries include: Unemployment reports, retail sales data, housing data, durable goods and manufacturing reports, price indexes, consumer confidence readings, and more. There are also more infrequent events that can have major effects on currencies, including Central Bank board meeting announcements and rate policy changes and quarterly gross domestic product (GDP) changes.
It is extremely important that savvy traders be aware of when these major anticipated reports are expected to be issues so that you can invest accordingly in anticipation of, or response to, the news. More aggressive traders sometimes like to buy or sell into the momentum of trade following announcements. However, some prominent currency traders encourage speculators to stay away from trading around major events, and prefer to trade when exchange rates are more stable and predictable.
Looking at the results of some of these announcements, unemployment data is often a sign of overall economic direction. If jobless claims and unemployment are low, it is usually a positive for the reporting country’s currency. Manufacturing reports that show increases in orders are perceived as a sign of business growth and market expansion, also currency positive. Generally, any positive economic data report produces a positive view of that currency based on the expectation of its future worth in the successful economy.
Interest rates and monetary policy tend to have major short and long term affects on currency rates and foreign exchange rates. An economy that is perceived as being in a growth phase is anticipated to see a tightening of monetary policy to avoid inflation. Higher interest rates mean greater interest yields relative to other currencies. Conversely, a struggling economy may cause Central Bank leaders to reduce rates to stimulate an economy. This produces a lower yield for that currency.
Carry trade is when speculators use one low interest currency as leverage to buy into a higher interest yielding currency. This was especially evident during the first part of the 21st century when the Japanese Yen maintained a low to no interest policy while most other major currencies held a more significant interest yield. When the global economy is stable, speculators take on more risk and many sold off yen to buy into higher interest currencies. As the global economic finds trouble, a carry trade ‘unwind’ often results as speculators flee their risky carry trade positions producing a quick reversal of the carry trade.
Whether you choose to take on the risk of trading ahead of and into economic announcements, or simply follow them for signals of emerging or continue long-range trends, most experts agree that any foreign exchange trader should follow global economic news.