As a trader, we are familiar with the terms GDP, Inflation, Unemployment and Interest Rates. All news relating to a country’s macroeconomics must be related to these four issues. The question is how the influence of the four economic indicators for forex traders? How to connect the results of the four releases with forex trading?
Before answering the questions above, let us first look at the understanding of the four indicators. GDP or Gross Domestic Product is the sum of all goods and services produced by a country in a certain period (usually within a period of one year). Another term that is commonly used is Economic Growth. Of course we are often hear that our country’s economic growth in 2014 – 2019 is always at 5%. This figure is meant by GDP.
The second is inflation. The general definition of inflation is a decrease in the value of a currency against goods and services over a certain period of time. This decline occurred continuously, because the nature of currency is printed more than the number of goods and services available. The experts then divide this inflation into 4 types, namely:
- Low inflation, where the inflation rate in the one year period is below 10%
- Moderate inflation, where the inflation rate in the period of one year is between 10% – 30%
- High inflation, where the inflation rate in the one year period is above 30% – 100%
- Hyperinflation or inflation is very high, where the inflation rate in the period of one year is more than 100%
For example, inflation in Indonesia in 2018 was around 3%. This meant that inflation in Indonesia was classified as low. Compare with inflation of Turkey which was above 12%, meaning that inflation was moderate category or inflation in Venezuela which is said to be called at 1,000,000% in 2018. Inflation in Venezuela was classified as hyperinflation or very high inflation.
Next is the unemployment rate. The unemployment rate by definition is a person who is in the productive age but does not work or is looking for work but has not found a job. The unemployment rate is calculated based on the number of labor force, ie the number of people who are in productive age (18-64 years) compared to unemployment.
For example, the unemployment rate in a country is 5% and the population of productive age is 100 million people, then the number of unemployed is 5 million people. Another example, if the number of unemployed is 3 million out of a population of 60 million, then the unemployment rate is at 5%. So, keep in mind that the comparison factor is not the total population, but the population in the productive age / labor force.
Interest rate is the amount of interest determined by a central bank or monetary financial institution of a country. The interest rate is regulated and determined based on various kinds of economic data, and has different objectives. Some are set to spur economic growth and the real sector, but there are also precisely to reduce the speed of the economy.
These interest rates have broad and interrelated impacts on life. Because commercial banks set interest rates for loans and deposits in their places based on the central bank’s interest rate. If the central bank’s interest rates rise, it is usually followed by an increase in lending rates to customers at commercial banks. Conversely, if central bank interest rates fall, it is possible for commercial banks to reduce their loan interest rates to customers.
After knowing these four things, then we go into discussion into forex. Of course there are other factors that can influence forex movements, but we will focus on the four indicators above.
In short, the release of positive GDP data will also have a positive impact on a currency. A growing economy means that economic activity is going well and inviting foreign investors to invest in a country. The entry of foreign funds will have an impact on the high demand for local currencies, so that the local currency can strengthen against other currencies.
Meanwhile, rising inflation will be positive for a currency, as long as it is controlled. Inflation that rises in a controlled manner, together with an increase in GDP growth means that consumer demand in a country is good. A strong public demand for a country shows that demand for goods and services is also strong, so investors are optimistic by investing their money. This investment will be profitable because the people’s purchasing power is there.
Low unemployment rate, will have a positive impact on the currency. The low unemployment rate is related to the inflation factor, because people who have an income will be able to spend their income in the form of goods and services. In the end, it will increase economic growth in a country.
The most important of all, is the interest rate. Short-term investors, including investors in the currency market, are always watching interest rate movements. Investors tend to choose countries that have high interest rates but their countries are stable. So, it is not only the factor of high interest but also the security factor that influences. Whether a country’s economy is safe or not is usually seen from credit ratings from well-known institutions such as Moody’s, Fitch or S&P.
This phenomenon related to interest rates is often referred to as risk on / risk off or also carry trade. Carry trade is the activity of investors borrowing money from low-interest countries and then investing it in countries with higher interest. This difference in interest rates is called a swap, which is what many investors are after. Swaps usually use the London Interbank Offering rates (Libor), which are updated daily.
For example, the interest rate on 10-year Indonesian debt is 7.5% while the 10-year USA debt is 2.5%. This 5% difference is what investors are looking for, because by borrowing dollars and then investing in the Indonesian market, the dollar that only produces 2.5% profit turns into 7.5% (assuming the exchange rate does not change).
Combination of all of them, growing GDP, maintained inflation, low unemployment and high interest rates, in general, can make investors enter the financial markets of a country or its real sector. In the end, these incoming funds can make the currency strengthen in the long run, as long as all these things are maintained. If one starts to change, the investor also starts to calculate his investment, it is not even possible to get out of a country’s market.
The relationship of these four indicators is as appropriate as mentioned above. But sometimes when a positive news release, the currency concerned weakens. Here, many traders who may be confused even give up on learning fundamentals further. Then, an understanding developed that fundamental learning was difficult. As already mentioned, there are many other factors that take into consideration forex movements other than just better or worse data. Therefore, we should keep learning and understanding every market reaction to news releases.