Forex effect
After a period of floating, the pound joined the European Exchange Rate Mechanism ERM in , but quickly left in , and has floated freely ever since. This has meant that its value is largely determined by the interaction of demand and supply. The supply of a currency is determined by the domestic demand for imports from abroad.
The more it imports the greater the supply of pounds onto the foreign exchange market. A large proportion of short-term trade in currencies is by dealers who work for financial institutions. The equilibrium exchange rate is the rate which equates demand and supply for a particular currency against another currency. If we assume the UK and France both produce goods that the other wants, they will wish to trade with each other. However, French producers require payment in Euros and the British producers require payments in pounds Sterling.
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Both need payment in their own local currency so that they can pay their own production costs in their local currency. The foreign exchange market enables both French and British producers to exchange currencies so that trades can take place. Consumer confidence lets us know how consumers are feeling. If they're feeling secure in their jobs and are optimistic about their future economic prospects, what can we infer? It is logical to presume that they may be more inclined to go out and spend.
This will drive economic growth. Because consumer optimism or pessimism has such strong implications for the prospects of the economy, these two reports should be featured in any leading economic indicators list. The Consumer Confidence Index comes out toward the end of the month, while the University of Michigan publishes its survey twice a month. This comprises a preliminary reading on the second to last Friday of the month. A final estimate follows two weeks later. These reports tend to have the most impact on the Forex and stock markets, when the business cycle is close to a turning point.
Strong consumer sentiment points to a possible upturn for the economy going forward, which is bullish for stocks. Weak consumer sentiment presages a downtown, and is a bearish signal for the stock market. The University of Michigan survey comes out more frequently, which is useful. The Conference Board's report samples a wider body of respondents, though, which implies greater statistical reliability.
Both tend to correlate fairly well with turns in the business cycle, but they are heavily influenced by the labour market. If unemployment remains high when other parts of economy are recovering, market sentiment may remain depressed, thus behaving as a lagging indicator in such circumstances. The CPI measures the cost of goods and services, index-linked to a base starting point. This provides us with an objective handle on how fast prices are rising or falling.
As we mentioned earlier in the article, price stability is part of the FED's dual mandate. When inflation is within target levels, it is considered normal or even desirable.
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However, if inflation veers too far off target for too long, it can have very negative effects on the economy. The CPI's usefulness as a leading indicator for the economy is limited. It has proven to be a poor predictor of turning points in the business cycle, despite a natural and logical association between economic growth, demand, and higher prices.
In the s and early s, high inflation was a real issue for the US economy. In contrast, in the aftermath of the global financial crisis, there was a real danger of deflation sustained price decreases.
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Deflation hurts the economy by incentivising consumers to hold off making purchases because they will be cheaper in the future, so long as prices continue to fall. As consumer spending constitutes such a large part of GDP, this will slow economic growth, and can create a vicious circle. Because inflation feeds into monetary policy so directly, the CPI report can have a high impact on prices in the bond , FX, and stock markets.
As usual, it is diversions from expected results that tend to have the highest impact. For example, if CPI comes in much higher than expected, it will alter the perceptions that the FED will be more likely to tighten monetary policy going forward. All things being equal, this should be bullish for the US Dollar. Similarly, a CFD trader might interpret such inflationary data as being bearish for the stock market, as tighter monetary policy tends to curtail risk appetite. Since the financial crisis, we have been in a very low inflationary environment, which has forced the Federal Reserve to stick with very loose monetary policy.
This has to some degree been responsible for the extended bull-market we have seen in the US. The Industrial Production Index measures the level of US output in terms of quantity of material produced rather than Dollar amount relative to a base year over three broad areas: manufacturing, mining, and gas and electric utilities. The report is compiled by the Federal Reserve, and is published around the middle of each month.
Some of the index data comes from hard data, reported directly for certain industries from trade organisations or official surveys, but this may not always be available on a monthly basis. To fill the gaps, the FED makes estimates using proxies, such as hours worked from the Employment Situation report, or THE amount of power used in the month by the industry in question.
The full process for calculating the index is set out in the best place to look for a full rundown of the methodology involved — the FED's own 'Explanatory Pages'. There are hundreds of components that make up the index, which is then reported as an index level. For example, the preliminary release of the industrial production index for September came in at This is an expression of the current output relative to the base year. At the time of writing, the FED used as its base period. The September level of The industrial sector is important because, along with the construction sector, it is responsible for the majority of the change in US output seen in the business cycle, and can offer insights into the evolution of structural economic changes.
The Industrial Production Index is procyclical. This means there is agreement between its movements and the changes in the business cycle. The correlation between this index and economic activity is close enough for some analysts to use this report as an early signal for how GDP might be performing. This indicator gauges how the US manufacturing sector is running as a proportion of full capacity. The definition of full capacity is the greatest level of sustainable output a factory can achieve within a realistic framework.
In other words, it takes into account things such as normal downtime.
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It is calculated as a ratio of the industrial production index divided by an index of full capacity. It may also provide clues about inflation. If factories are running hot, it's a reasonable assumption that producers may raise prices.
If factories are running close to their maximum capacity, machines are likely to fail as a result of being overworked. Taking machines offline poses the risk of laying off workers at a time of high demand, which is undesirable. Accordingly, manufacturers are likely to cope with high demand by raising prices, rather than laying off workers.
This, in turn, is likely to feed through to consumer prices, leading to higher inflation. Conversely, if capacity utilisation is running at low levels, it is a signifier of economic weakness. As such, this indicator is used by the FED to gauge trends in manufacturing, the wider economy, and also inflation. This makes it an important indicator for CFD traders to follow, particularly for bond traders, but it's also a key marker for those involved in the shares and FX markets.
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Imagine that some exotic currency pair has greatly strengthened, and there are 4 traders who think this way:.
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Besides, I expect lagging pairs to repeat this move. The forth trader uses the domino effect to enhance the effectiveness of own trading in addition to having a fair bit of experience. Most Forex traders stuck to one or two currency pairs and use only inefficient indicators for market analysis so they will never be able to see the domino effect in the Forex market even if they open the required charts. It is to be concluded that you need to spend enough time to analyze numerous currency pairs on various timeframes to master the domino effect. Btw, if you are looking to upgrade your terminal with pro indicators and different utilities you can browse from variety of resources available at FXSSI Product manager.
Now consider the following situation: two-day level has been established on the charts of US dollar pairs. Afterwards, GBP comes into play and also makes a new two-day low following the London open. You can see the whole situation on the picture :.
If not, notice where USD is in every currency pair — to the left or to the right. If we put together all the currency pairs including one common currency, it would be easy to determine the lagging ones.
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