Track Course Progression:
17d - Economic Indicators
We now move on to some economic indicators that show how well an economy is performing in terms of the things it produces. This follows along nicely seeing as we just looked at data concerning employment and the money that workers earn for creating goods. Now we look at the numbers that concern the things these hard working people have created.
In this Article:
- Producer Price Index
- Industrial Production
- ISM Manufacturing Index
- Durable Goods Orders
- New Home Sales
- Housing Starts and Building Permits
Producer Price Index (PPI)
PPI is a family of indexes that measures the average change in selling prices received by domestic producers of goods and services.
PPI measures the price percentage change from the perspective of the seller of the goods. This differs from other indicators such as CPI which measures price change from the perspective of the purchaser or consumer.
The PPI looks at three areas of production: Industry –based, commodity-based, and commodity-based demand. However, the headline number takes all these into calculation as equally important so we as traders only need to focus on the headline reading rather than the individual components because they are all equally weighted.
Traders follow the trend in the PPI numbers which are released monthly. If we see that PPI is increasing steadily over several months it is reasonable to believe that the economy is performing well and that future interest rate hikes might be in the cards. This could create demand for the currency.
On the other hand, if PPI is showing that it is trending lower over several months then the central bank may become concerned about inflation. If other inflation related indicators start showing weakness then the market might start to think that interest rate cuts are in the future. This could devalue the currency.
This indicator tends to have a lot of revisions. This is because it takes into account seasonal food price fluctuations and the highly unstable nature of energy prices such as oil.
This measures the monthly raw volume produced by industrial firms such as factories, mines, and utility companies.
This indicator is a bit different in that it has a “reference year”. The reference year for this economic indicator is from 2002. This means that every new reading we get will have its levels compared to 2002. Full industrial production within an economy is pegged at a reading of 100. So the closer the reading is to 100 the better the economy is performing.
Industrial production can reflect the tone for the overall economic activity in most modern nations. A positive reading is generally considered to be a good thing for the local currency while a negative reading tends to be not so good.
Industrial production is related to capacity utilization and is considered to be a coincident indicator. This means that changes in the levels of these indicators usually reflect similar changes in overall economic activity very close to the time it is released. It is a more efficient indicator than other lagging indicators.
ISM Manufacturing Index
ISM stands for Institute of Supply Management. This is a U.S. data point only. The ISM Manufacturing Index is one of the first pieces of news released each month, so it has the potential to influence the tone of investor and business confidence.
The purpose of this index is to monitor employment, production inventories, new orders, and supply deliveries. This information is then interpreted into a “composite diffusion index” that monitors overall conditions within the industrial industry.
Whoa, nerd word alert! Diffusion index simply means that it shows how all of the indicator components are moving together with the overall indicator index. It is a way of visually smoothing out an index that has many moving parts to it which ISM manufacturing does.
This is important to Forex market because it’s composed of a survey of more than 300 large and important manufacturing companies. This gives a very good overview of how manufacturing companies are feeling about the current economic climate.
It’s also a survey of the purchasing managers who have control and influence of their companies' supply chains. Manufacturers need to respond quickly to changes in demand because they need to ramp up or scale back purchases of the stuff they need to make their products to match the current demand from the market. They do this to ensure the company’s continued profitability. As a result of their position in the company, they are perhaps better positioned than anyone to speak to the ebb and flow of current business conditions.
The reason that traders watch this indicator carefully is because the Federal Reserve tends to place great value on it at certain times in the economic cycle. This indicator becomes more widely watched when the economy is trying to get moving after a slowdown. The Fed uses this information to form part of its opinions which leads to central bank decisions and actions on monetary policy.
Durable Goods Orders
Durable goods are generally considered to be something that has a fairly long and useful after being purchased. For example, cars, trucks, and washing machines could be classed as durable goods because they are something that people use for many years.
Think about durable goods like this; a car is a durable good because it is meant to last many years. The gasoline you put in the cars tank is a non-durable good because it has a very short usable life. If you turn on the car and drive a couple miles then you have burned off some gasoline but the car will show almost no worse for wear as a result.
This is an economic indicator that is released monthly by the Bureau of Census. It reflects new orders placed with domestic manufacturers for delivery of these durable goods in the near term future.
Durable goods come in two releases per month: the advance report on durable goods and the manufacturers’ shipments, inventories, and orders of durable goods.
The problem with durable goods is that it can be quite volatile and tends to see plenty of revisions. In the short term it can impact the markets and move prices but typically only if the Fed is paying close attention to manufacturing. For this reason you should keep an eye on these data points and understand where the country is within the economic cycle.
Housing Starts and Building Permits
Housing starts are the number of new residential construction projects that have begun during any particular month. The New Residential Construction Report, commonly referred to as "housing starts," is considered to be a very important indicator of economic strength.
Housing start statistics are released on or around the 17th of each month by the U.S. Commerce Department. The report includes building permits, housing starts and housing completions data. Surveys of homebuilders nationwide are used to compile the data and are cross referenced from the permits that have been issued by municipalities.
Building permits are a type of legal authorization that must be granted by a government or another regulatory body before the construction of a new or existing building can take place. The U.S. census bureau reports the finalized number of the total monthly building permits on the 18th work day of every month.
These particular figures are heavily influenced by the level of mortgage interest rates. Mortgage rates are largely influenced by central bank interest rates. This will be watched carefully by FX traders to see if there are any trends in place or developing over time.
New Home Sales
As the name implies, new homes sales is an economic indicator that measures sales of newly build homes. This includes houses, condos, town homes, and any structure that requires a permit to allow people to live in them.
It’s released monthly by the U.S. Department of Commerce’s Census Bureau and includes both quantity and price statistics.
It’s considered to be a lagging indicator of demand in the housing market because permits are issued a long time before the structure is finally completed and sold.
High readings are considered indicative of a strong and growing economy. Low readings can indicate that the economy is stalling out or even moving into a recessionary period within the economic cycle.
You will also see this positive or negative tone reflected in the prices of home building stock. If there are plenty of sales then the home building stocks will likely have a strong balance sheet which would boost the share price as investors buy them up to join in on the positivity.
Next we will wrap up our learning on economic indicators with some index and surveys, as well as some ad hoc economic indicators that you need to be aware of when trading certain currencies.