The Statistical Fog
Nothing charges the volatility of the currency markets like an unexpected result for a well regarded economic statistic.
A decade ago the United States International Trade Balance was the premier instigator. The Friday morning session when it was released was known and feared among traders as 'New York Friday' because of the violent gyrations following the release. Only a few other American statistics, unemployment, GNP (as GDP was then called) and CPI competed with the trade balance for market impact. For most traders the US statistical regime was limited to a few major national statistics collected by the US government.
These statistics were released and dominated trading then, as they do now, once a month. For the rest of the time markets were moved by trading flows and speculative interest. Ten years ago no one was betting their profits on the Chicago Purchasers Index or Housing Starts; the Institute of Supply Management (ISM)) Non-Manufacturing Index was wholly unnoticed.
Times change. With the growth of the financial media, the internet and the explosion of interest in online trading the statistical spotlight has become much wider. Second and third tier statistics now garner the type of interest and comment that used to be reserved for GDP or Non Farm Payrolls (NFP). The US economy is the most reported and measured economy in the world. There are easily enough PPI, Industrial Production, Consumer Sentiment, Durable Goods, Retail Sales, ISM, NAPM, TICS, NAHB and Redbook numbers issued each month to keep an army of analysts busy. How can traders judge which statistics deserve attention?
Aside from economy wide measures like NFP, most statistics record activity in a specific industry or economic sector or for a limited time period. The usefulness and predictive ability of these secondary indicators is strongest when they are combined with other measures or when part of a trend.
As a general guide to their trading value we can divide these indicators into three groups: trend, situational and headline. Each is distinguished by the quality of their information and the type of influence they exert over the currency market.
Trend statistics are most valuable when they are exhibit a consistent pattern. Because these indicators depict conditions in a relatively restricted area of the economy or for a short amount of time individual releases can be misleading or simply outliers. It is risky to base an economic assessment on the return of a single trend statistic.
Different indicators from the same sector can give an accurate glimpse of that particular economic sector but not necessarily of the economy as a whole. If several housing statistics depict the same conditions then the picture is probably accurate. But even when different monthly statistics from the same sector point in a similar direction only several months of releases can establish a trend.
A drop in the monthly capacity utilization figure or a rise in the Conference Board Consumer Sentiment measure by itself provides limited information to the trader. But if in a week Consumer Sentiment, Factory Orders and ISM all gain after a string of losses there is at least the potential for a change of economic direction. Traders should be alert to these shifts. When properly utilized trend or secondary statistics can supply invaluable clues to economic strength and to the timing and direction of currency moves; but their greatest value lies in combination with other similar indicators
Situational statistics are indicators elevated in importance by particular circumstances. One could also call these central bank or crisis indicators. These are the numbers used by central banks in their own economic analysis or they depict conditions in a crucial economic sector, such as housing or unemployment claims. The relevance of these statistics can change over time. Unless the next financial crisis has its roots in sub-prime housing, there will be a new crucial indicator when it strikes.
Federal Reserve Chairman Bernanke has been particularly forthcoming about his statistical interests. The PCE Deflator is the Fed's prime measure of inflation and it has largely replaced CPI in market attention. The ECB's favored inflation statistics are the Harmonized Index of Consumer Prices (HICP), and the M3 Money Supply. Earlier leaders of these institutions preferred different measures or refused to say what measures they considered important.
The collapse of the American housing market has given all statistics associated with housing and home construction substantial import. But the housing crisis will not last forever and as it ebbs so will the importance and influence of its indicators.
Headline statistics are economy wide numbers that give the broadest picture of economic conditions. They are the only statistics that by themselves can change the market's view of an economy. Non Farm Payrolls and GDP are the best current American examples.
These statistics have a history of volatility and of defying market predictions but they also carry pertinent information about the overall economy. The NFP number in particular relates directly to the dominate percentage of the American economy derived from consumer spending and thus to continued economic health.
There is however, another reason for the volatility that often accompanies the release of these figures. These statistics are the basis for large amounts of speculative positioning, both prior to release and immediately after.
The larger the difference between the expected number and the actual statistic the greater the volatility as traders adjust their position to the new parameter. Even when a headline number is as predicted it can produce violent reactions as those positions based on the expected number are turned into profit.
Over time headline numbers go in and out of fashion. Ten years ago the trade balance produced volatility even greater than NFP does today. But twenty years of ever worsening numbers have drained the suspense and traders have noted that the dire predictions for the American economy from permanent trade deficits have amounted to very little
Today's global economy is an entirely different creature than it was twenty years ago. Instantaneous global financial flows, international manufacture and trade and a 24 hour media have spread the potential and danger of trading markets to every corner of the world economy. The speed with which the bankruptcy of Lehman Brothers undermined financial markets around the world was unprecedented, but it should not have been unexpected
Are there indicators that better reflect the new global economy and that could become the new trading headliners? Prediction is hazardous but my nominee for the US is the Treasury International Capital System Report (TICS) of the Treasury Department. This statistic tracks foreign investment in the American economy, the purchases of American stocks, bonds and Treasuries. With the Federal deficit largely funded by foreign capital what could be more important?