Intermediate

Fundamental analysis

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Gross domestic product (GDP)

2.5 minute read

Let’s take a closer look at some of the key economic indicators and announcements that forex traders should look out for. Starting with one of the biggest of all, gross domestic product (GDP).

What is GDP?

GDP is the market value of all goods and services produced by labor and property within a given economy. The Bureau of Economic Analysis (BEA) says it’s “the most closely watched measure of the US economy.”

According to the BEA, the United States had a GDP in excess of $23.3 trillion in 2021.

Gross domestic product data is commonly used by economists to assess the level of growth and economic health in an economy. And, because it’s important for economists, it stands to reason that it’s important for the financial markets, including forex currency pairs.

According to the one-page explainer The Making of GDP, provided by the BEA, US GDP “helps Americans see historical trends, make projections about the economic future, and compare their economy to other nations”.

The data is collected through various agencies at different times, and the BEA makes adjustments as necessary to ensure the data is consistent. GDP movement is usually given as a percentage, as in the rate that GDP grew (or shrank) from one quarter compared with the previous quarter. 

What is the ideal GDP growth rate?

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 economists across jurisdictions can draw meaningful conclusions when making comparisons with other nations’ performances.

GDP is usually released on a regular basis. In the US, for example, the BEA published GDP data 19 times in 2021.

The cycle started on January 28, when the 4th Quarter and Year 2020 advance estimate was made public and finished on December 23, when GDP by state for the third quarter was revealed.

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The full schedule is available from the Bureau of Economic Analysis website and many forex traders will save the individual dates to their calendars to help formulate and guide their activity. You can also plan your trading around global GDP releases using the FOREX.com economic calendar.

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.

What price action can GDP trigger?

The price action that a trader can expect to see when GDP data is released can be placed into three different categories.

  1. 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
  2. A reading that comes in within the expected bracket requires careful consideration. In this scenario there likely won’t be dramatic action. You’ll want to compare the current reading to the previous quarter's reading, as well as the same quarter from the previous year, and consider US data in relation to other countries’ contemporaneous data
  3. 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 (which we’ll cover in the next lesson) 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.

GDP_Growth_Rate_Chart

The Eurozone 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 the 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 hit, the effects were worse in the US, enabling EUR/USD to reach an all-time high in July 2008.

FXUS-Fundamental-Analysis-EURUSD-Monthly-Chart-2004-2017

However, as soon as it became evident that the financial crisis was primed to be just as devastating to the Eurozone 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 on 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 in the US.

Then, a new 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 could 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.

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