WHAT MOVES THE MARKET
For fundamental or technical traders, the importance of economic data cannot be underestimated. Even though there are many people who claim to be pure technicians, through my years in the FX market, I have to come to realize that nearly everyone will factor economic data into their trading strategies. A good technician who focuses on range trades, for example, may choose to stay out of the markets on the day that a very market-moving number such as nonfarm payrolls (NFP) will be released. A technical breakout trader, by contrast, may want to trade only on days when there is important economic data to drive some sizable price action. Incorporating fundamental analysis is particularly important for people who trade automated systems, because turning on or off their strategies based on incoming economic data can potentially have a big impact on the overall performance of the trading strategy. Fundamental traders naturally tend to thrive on economic releases, and the economic data that tend to have the biggest impact on currency rates are U.S. data. Close to 90 percent of all currency transactions are done against the U.S. dollar, which means that the greenback is either the base or counter currency for most transactions.
NOT ALL ECONOMIC RELEASES ARE CREATED EQUAL
Some economic data releases can have a very significant and lasting impact on a currency, while others may not matter at all. In the first edition of Day Trading the Currency Market (John Wiley & Sons, 2005), I looked at how various pieces of U.S. economic data impacted the dollar (against the euro) in 2004. I chose the EUR/USD because it is the most liquid currency pair in the world and tends to have the purest reaction to U.S. numbers. For this second edition, entitled Day Trading and Swing Trading the Currency Market, the study is updated using 2007 data. Not only have the rankings changed, but so have the magnitudes of the reactions.
For the purposes of this study, I looked at how the EUR/USD reacted to various economic releases 20 minutes after the number was released and 60 minutes or one hour after the number was released, and whether the move lasted into the end of the U.S. trading session. I consider 20 minutes the knee-jerk reaction time, and the pip change is based on the time at which the economic number is released and the closing price 20 minutes or 60 minutes later. This methodology may help exclude some wild swings within the first 20 minutes, for example.
As indicated the U.S. nonfarm payrolls release remains the number-one most market-moving indicator for the U.S. dollar; it topped the list in both 2004 and 2007. The reason why NFP is so important is because job growth has broad ramifications for any country. Strong job growth tends to lead to stronger consumer spending and tighter monetary policies. Weak job growth can lead to weaker retail sales, a slowing economy, and lower interest rates. Throughout 2007, on average, the EUR/USD would move 69 pips (points in FX) in the first 20 minutes following the NFP release. On a daily basis, the EUR/USD moved an average of 98 pips.
The magnitude of the reaction to nonfarm payrolls, or to any U.S. economic data for that matter, has fallen significantly between 2004 and 2007. This has partially been due to the declining volatility in the currency market; in 2006, FX volatility actually hit a record low. The liquidity in the market has also increased significantly, with volume in the FX market
TABLE MSRange of EUR/USD Following Economic Releases
close to doubling over the past three years. With greater liquidity, the market tends to do a better job of absorbing the economic release.
On the other side of the spectrum is the gross domestic product (GDP) report, which resulted in an average move of 32 pips in 2007 compared to 43 pips in 2004. On a daily basis, the reaction to GDP in 2007 was less than 90 pips, which mean that it did not even make it onto our list of most market-moving indicators for the U.S. dollar. Back in 2004, the average daily move in EUR/USD after the GDP release was 110 pips.
One of the biggest changes that we have seen over the past few years is the fact that knee-jerk reactions are more tempered. In 2004, we used to see a lot of knee-jerk spikes followed by retracements. Oftentimes this made the reaction to U.S. economic data in the first 20 minutes larger than the end-of-day reaction. In 2007, however, we saw smaller knee-jerk reactions and longer follow-through. One of the main reasons for this difference may have been the fact that the Federal Reserve was lowering interest rates in 2007. Therefore, traders needed to better assess the ramifications of the economic release for the Fed’s next monetary policy decision. According to our own analysis of 20-minute and daily reactions, we have created the following rankings for U.S. economic data:
Top Market-Moving Indicators for the U.S. Dollar (Based on 2007 Data)
First 20 Minutes:
1. Nonfarm Payrolls
2. Interest Rates (FOMC Rate Decision)
3. Inflation (Consumer Prices)
4. Retail Sales
5. Producer Prices
6. New Home Sales
7. Existing Home Sales
8. Durable Goods Orders
9. Gross Domestic Product
1. Nonfarm Payrolls
2. ISM Nonmanufacturing
3. Personal Spending
4. Inflation (Consumer Prices)
5. Existing Home Sales
6. Consumer Confidence (Conference Board)
7. University of Michigan Consumer Confidence
8. FOMC Minutes
9. Industrial Production
It is also interesting to point out that the nonmanufacturing ISM report appears prominently on the daily list and not at all on the 20-minute list. With a number of underlying components, there is always more than meets the eye when it comes to the ISM report. Traders need to look at both the employment and price components to determine which way the Federal Reserve may lean next. Service-sector ISM is extremely important nonetheless, because the employment component of the report is a very good leading indicator for the direction of nonfarm payrolls.