A Guide to GDP and Forex Trading

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 healthand potential growth of a country.Consequently, greater volatility in the forex market is closely observed during the GDP release.

What forex traders need to know about GDP

What is GDP?

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 periods: monthly, quarterly and annually. This enables economists and traders to get 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 (C) + 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):

• A lower than 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

• A higher than projected GDP reading will tend to strengthen the underlying currency versus other currencies (

  USD

  appreciating against

  EUR

  ).

EUR/USD chart: High GDP data release

GDP reports do not always have the same or expected effect on currencies. This 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.

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

• 
  ISM data
  

• 
  PPI data
  

Analysing GDP data to inform currency trading decisions

GDP,

Inflation

and Interest Rates

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 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

in a moderately growing economy,

interest rates

can be maintained around 3%. However, a reading above 6% GDP would show that the US economy is endanger of overheating which can, in turn, spark inflation fears.

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

GDP should not be high enough to trigger inflation or too low where it could lead to recession. 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.

Forex traders are most interested in GDP as it is a complete health report card for a country’s economy. A country is ‘rewarded’ for a high GDP with a higher value of their currency. There is usually a positive expectance for future interest rate hikes because strong economies tend to get stronger creating higher inflation. This, in turn, 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 hike

expectation. In fact, the

central bank

of a country that has two consecutive quarters of

negative GDP

may even choose to stimulate their economy by cutting interest rates.

Trading currency pairs using GDP data

Quarter-on-quarter figures tend to produce much more variable changes in the overall trend – e.g. Positive GDP figures beating estimates QoQ may be fleeting when taking into consideration year-on-year (YoY) data. 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. This chart expresses the variation in short term QoQ data against the longer-term YoY trend.

GDP and economic data: Top tips for FX traders

• If you’re

  new to forex

  trading, our

  
  New to Forex trading guide
  

  covers all the basics to help you on your journey.

• 
  CPI
  

  is released monthly by most major economies to give a timely glimpse into current growth and inflation levels.

• Fundamental traders monitor economic data releases, and many do so with the intention of

  
  trading the news
  

  
  .
  
  It is essential that traders adopt sound

  
  risk management
  

  when doing so as volatility can spike immediately after important releases.