How GDP data helps forex traders consider the bigger picture
One of the most closely watched of the fundamental indicators used by forex traders is Gross Domestic Product.
GDP data is commonly used by economists to assess the level of growth and economic health in the United States economy. And, because it’s important for economists, it stands to reason that it’s important for the financial markets, including forex currency pairs involving the dollar.
According to the one-page explainer The Making of GDP, provided by the Bureau of Economic Analysis (BEA), it “helps Americans see historical trends, make projections about the economic future, and compare their economy to other nations”.
GDP is the market value of all goods and services produced by labor and property within the United States: in excess of $21 trillion in 2019, according to the BEA. But when people discuss and describe GDP movements, they more often use a percentage — the rate that GDP grew (or shrank) from one quarter compared with the previous quarter. The BEA says it’s “the most closely watched measure of the U.S. economy.”
The data is collected through various agencies at various different times, and the BEA makes adjustments as necessary to ensure the data is consistent.
What level of growth is a healthy economic signal?
Most economists agree that a signal for a strong and healthy economy is one in which GDP is growing at an annualized rate between 2% and 3%. A lower result can require stimulatory measures to boost the economy, while faster growth can prompt inflationary worries.
Virtually all nations calculate their GDP, so economies across jurisdictions can draw meaningful conclusions when making comparisons with other nations’ performances.
In the calendar year 2021, the BEA states there are 19 occasions when Gross Domestic Product data pertaining to the United States is scheduled for release. The cycle started on January 28, when the 4th Quarter and Year 2020 Advance Estimate was made public at 08:30 Eastern Time and finishes on December 23, when GDP by State for the 3rd Quarter is revealed.
The full schedule is available from the Bureau of Economic Analysis website and many forex traders will save the individual dates on their digital calendars to help formulate and guide their activity.
In principle, the data is released on a quarterly basis by the BEA four weeks after each quarter ends. However, there are further adjustments and revisions with the final GDP data released three months after the relevant quarter ends.
GDP data triggers three types of price action
The price action that a trader can expect to see when GDP data is released can be placed into three different categories.
- A lower-than-expected GDP reading will likely result in dollar weakness and trigger pressure on the dollar side of all relevant currency pairs. This will be exaggerated and potentially trigger more volatility if the GDP data is particularly far off the expected range.
- A reading that comes in within the expected bracket requires careful consideration by a forex investor. In this scenario, there is not likely to be dramatic action. A trader will want to compare the current reading to the previous quarter's reading and also the same quarter from the previous year’s and consider US data in relation to other countries’ contemporary data.
- A higher than expected reading will likely lead to trading support for the dollar versus other currencies. As with point 1, the higher the GDP reading is, the greater the scope is for extended dollar gains amid fluctuating charts.
How long-term GDP patterns dictate general price moves
Whereas trading on NFP data often stimulates traders to take specific action, a lot of the published advice around GDP data is to take a wider view of relevant currency pairs rather than to look for an immediate opportunity.
To this end, it is worth looking at historical examples of long-term GDP patterns, and initially the chart shown below.
Source: Forex Training Group
The Euro zone was in a healthier position than the US prior to the global financial crisis of 2007-08. Both economies fell into a recession but from 2009 all the way through to 2015 US annual GDP growth rate outperformed the European benchmark.
Now let’s look at how the information above translates into the actual relevant trading pair. The steady ascent of the euro against the dollar prior to the financial crisis can be seen in the chart below. This came about initially because GDP was on the ascent in Europe while already falling in the US, and when it did drop off, it did so only fractionally. When the financial crisis did so, the effects were worse in the US, enabling the dollar to reach an all-time high in July 2008.
Source: Forex Training Group
However, as soon as it became evident that the financial crisis was primed to be just as devastating to the Euro zone as it was in the US, it was clear that the euro was an overbought currency – hence the very steep slide in the chart.
The situation from that point until 2014 was one of high volatility, partially attributable to specific geopolitical and financial crises in Europe. The Greek debt crisis of 2010-11 was followed by deep problems for the banking sector in Italy, Spain, Ireland and Portugal.
Referring back to the GDP comparison chart, the US figures were consistently healthy from 2012 to 2015 (unlike in Europe). This was a key factor behind what proved to be a steep euro sell-off, as it tumbled from 1.39 in May 2014 to 1.26 in October of that year.
How should forex traders react to GDP data?
It is hard to give outright recommendations of how to react, as a trader, to individual pieces of GDP data. Very often there is a limit as to how much surprise factor there is, especially as much of the data tends to be revisions of previous data or widely signalled in advance.
With that said, there will be times when the data does trigger an immediate reaction. Let’s consider a scenario in which the economy is struggling to show growth, and there have been several months of disappointing GDP data.
Then, a new GDP release shows a sudden and unexpected jump.
The immediate market reaction, ranging up to a few hours, will be that of buying dollars in various key trading pairs. Certainly, some traders will feel the currency had perhaps been oversold given the new data and thus represents value.
Those traders will hope to see high prices, at least for the short term. However very often, after an initial rally, the currency’s price increase may fade and eventually recede to levels quoted before the GDP data release.
It’s essential to understand that one GDP data release, although important, is not enough to change the overall fundamental picture of the currency’s economy.
In addition, positive data that matches expectations is rarely a bullish signal for a currency and may even lead to its depreciation.
Finally, it may be prudent not to consider the dollar’s value in isolation when looking at GDP data. Certain other major currencies may have produced similar recent GDP data and also be on the same pathway. For that reason, GDP comparison graphs, as shown in the first image on this page, may prove more helpful as a guide.