There are many ways to trade financial markets. Some traders get their signals from fundamental data, some use technical analysis. However, some traders trade newsflow and economic data.
Understanding the influence of the most important events on the economic calendar (known as tier-one data) can have a decisive impact on the profitability of traders that trade the news. These are the events that markets are most attuned to and will move the most from.
I’m going to take you through the most important data that moves markets. Being the largest economy in the world (albeit not for long) the US economic data is unrivalled in its ability to move the most important financial markets such as US bond yields, the US dollar and Wall Street.
- Why the Federal Reserve is key for traders
- The importance of inflation in the Fed’s monetary policy decisions
- Employment data is also key
- Looking at the PMIs as a lead indicator for growth
Even if you prefer to trade using fundamental and technical analysis, it is always good to know what could scupper the trades you are looking at. So, with a hectic week of data on the calendar, I will also take a look at some of those crucial tier-one data announcements that traders need to be aware of.
Why the Federal Reserve is key for traders
The Federal Reserve (also known as the Fed) is the central bank of the United States. The US is the largest and most dominant economy in the world. Also, the US dollar is the world’s primary reserve currency. Subsequently, the Federal Reserve holds a critical position as the most significant financial institution worldwide.
The mandated objective of the Federal Reserve is to stabilize the US economy through its monetary policy.
- If the US economy is overheating, where inflation is too high, the Fed will move to tighten monetary policy by raising interest rates and/or selling bonds on the balance sheet.
- Alternatively, if the US economy is contracting due to low inflation and/or high unemployment, the Fed will loosen monetary policy by lowering interest rates or buying bonds.
The Fed plays a crucial role in pricing US assets
Monetary policy in the United States is set by the Fed. The policy decisions that it makes become the basis for pricing US Treasury bonds, widely acknowledged as a “risk-free” asset. Treasury bonds are subsequently used as a benchmark for pricing other financial instruments, such as loans, mortgages, and corporate debt.
However, due to the international use of the USD and investment in US Treasury bonds, the impact is felt in the pricing of risk for assets around the world.
So when the Fed changes policy, or makes an unexpected move, markets around the world take a jolt.
How doe the Fed operate?
The Federal Reserve has a dual mandate which is to achieve maximum employment and price stability. As a result, any US data that paints a picture of the outlook for the US labour market, of US inflation, can influence Fed policy.
Subsequently, markets sit up and take notice of the data that feeds into the Fed’s decision-making.
The decisions of the FOMC meeting
The Federal Reserve’s monetary policy is decided every six weeks (eight times a year) by the Federal Open Market Committee (FOMC). The FOMC currently has 18 members.
- There are six board members – including the Fed Chair and a Vice Chair. The board members hold a permanent vote on policy decisions.
- Twelve regional Fed presidents vote on a rotation basis. The selection of regional voters is rotated every year.
The monetary policy decision of the FOMC is made by the six board members plus five of the twelve regional presidents. They set the interest rate level, which is called the Fed Funds rate. They can also decide to adjust the assets on the Federal Reserve’s balance sheet by purchasing or selling bonds.
The monetary policy decision also includes providing data on economic projections and the so-called “dot plots”. This information is provided every second meeting and gives an idea of where the committee sees vital economic data such as inflation, unemployment, growth and crucially interest rates in the coming years. The “dot plots” of interest rate projections are taken by traders as a key market-moving event.
Don’t forget the ECB, BoJ and BoE
It might seem to some traders that the Federal Reserve is all that matters, but there are some other central banks that are also worth keeping an eye on:
First of all, there is the European Central Bank (ECB). The ECB is responsible for setting monetary policy in the Eurozone. Its remit covers an economic area that is roughly two-thirds the size of the United States. As a significant market to trade with, changes in the ECB’s monetary policy can have an impact on the US economy. Therefore, crucial decisions by the ECB can influence the key US markets.
Secondly, there is the Bank of Japan (BoJ). Japan is the largest holder of US debt outside of the US. Therefore, any changes made to the BoJ’s monetary policy could have an impact on these holdings. This would therefore play into the outlook for US Treasury yields, the outlook for the US dollar, and US equities.
Finally, the Bank of England (BoE). The UK is still the world’s sixth-largest economy in the world (having recently been overtaken by India). But it is also a major financial hub and the decisions of the BoE can affect global markets.
Inflation data drives the Fed
Maintaining price stability is one of the Federal Reserve’s dual mandates, which essentially means preventing inflation from spiralling out of control. Inflation refers to the increase in prices over time, which consequently leads to a decrease in purchasing power. As inflation goes up, the ability to purchase a basket of goods declines and the same unit of currency can buy fewer goods or services than before. Thus, the value of money diminishes over time.
Inflation can be measured in several ways, with the CPI (Consumer Prices Index) being the most widely followed measure by central bankers, economists, and markets. The CPI tracks the change in consumer prices of a basket of goods and services that are representative of the entire economy.
However, the Federal Reserve has its preferred measure of inflation, known as the PCE (Personal Consumption Expenditure), which measures consumer spending in the US and accounts for approximately two-thirds of domestic spending in the country.
Why traders look at inflation
Inflation is a crucial aspect to central bank monetary policy for countries around the world. Many have targets for the levels of inflation that they are looking to achieve.
Since 2012, the Fed’s objective has been to maintain stable inflation at approximately 2%. If inflation is moving away from this target, this will illicit a response from the FOMC. For example, if inflation exceeds 2%, and the Fed believes that this will persist in the foreseeable future, it may respond by raising interest rates.
This move would have ripple effects on various aspects of the economy, including bond yields, which are used to calculate loan and mortgage rates, the strength of the US dollar, and the prospects for US equity markets.
US labour market data is also key
The Federal Reserve’s dual mandate also includes the goal of maximizing employment. As such, traders keep a close eye on various indicators related to the US labour market.
The following are the key indicators:
- Nonfarm Payrolls (known officially as the US Employment Situation report). The Bureau Of Labor Statistics publishes the jobs report typically on the first Friday of every month. It provides data on nonfarm job growth, unemployment, labour force participation, and wage growth.
- Weekly Jobless Claims. Although they tend not to be considered tier-one data, the weekly data provides a current snapshot of trends in unemployment claims. It is therefore seen as a leading indicator that can move markets.
Why traders look at Nonfarm Payrolls
If unemployment is increasing, then this would mean a move away from the Fed’s mandate and would require a reaction. The payrolls report is traditionally seen as the most important single data point of the month (alongside US CPI), leading to significant volatility across asset classes.
Economic growth data to watch
Strictly speaking, quarterly economic growth data is crucial. GDP (Gross Domestic Product) is the internationally accepted measure of economic performance. However, due to the cumbersome nature of the data, filled with revisions and taking several months to nail down, financial markets can sometimes be left unimpressed.
Instead, traders will look towards more current, leading indicators of growth. For that, the Purchasing Manager Index (PMI) data has become a key tier-one data.
The PMI (Purchasing Managers Index) data plays a crucial role in analyzing economic conditions. For the US market, traders focus on the flash PMIs and the ISM data as these are the primary indicators that drive market movements. These surveys provide insights into the perspectives of purchasing managers, which in turn offer a current view of the economy’s outlook.
There are two announcements that traders look for:
- Firstly, the Flash PMIs. These are the first set of economic activity indicators released around the final week of every month. They provide traders with a snapshot of the current month’s trends, and their impact on the market is significant. Into the first week of the next month, the final readings of the PMIs are announced, but their impact on the market is typically reduced by then.
- Secondly, there are the ISM surveys. For the US economy, the Institute of Supply Management releases official surveys on manufacturing and services data in the first week of each month, reflecting the previous month’s trends. These surveys are closely watched by markets due to their influence on market movements.
Why traders look at the PMIs and ISM surveys
These surveys are widely regarded as leading indicators, or at the very least, current indicators of major economies. They provide valuable insights into the trends in economic strength or weakness, which, in turn, help to paint a picture of how economies are developing.
The information from the ISM is critical to the Federal Reserve as it factors into their decision-making process regarding monetary policy.
The PMIs move domestic bond yields and bond markets. The ISM surveys also move international markets, but most specifically, US bond yields, the US dollar and Wall Street.
What tier-one data is on the docket this week?
The beginning of the month is always wall-to-wall tier-one data. Here’s what traders should be looking out for.
Two more central banks
Alongside the usual data, there is also the added impact of having three central banks this week. The Reserve Bank of Australia has already surprised markets with an unexpected rate hike. Now it is over to the Fed and the ECB to see what they can do.
On Wednesday, the Federal Reserve is anticipated to raise interest rates by 25 basis points. However, the Fed’s stance on further rate hikes will be critical. The prevailing sentiment is that this could be the final rate hike in the cycle. Therefore, any indications of a pause in the rate hike trajectory would impact both the US dollar and Treasury yields.
Meanwhile, the European Central Bank (ECB) is also expected to raise interest rates, but it’s unlikely to be the last. The ECB could potentially implement one or two additional hikes during the summer. Despite mixed inflation data for April, the ECB remains open to further rate hikes.
Watch for PMIs and the ISM
Yesterday’s US ISM Manufacturing survey remained below 50, indicating continued contraction in the sector. Although the outlook for new orders remained bleak, employment improved around 50, and prices paid also increased. As a result, US yields picked up and the US dollar has been supported. There may be room for this to continue if the ISM Services (due on Wednesday) also pick up.
The final readings of the Composite PMIs for the Eurozone and UK are expected to generate only minimal market impact, as they represent a confirmation of the previous flash readings.
Nonfarm Payrolls are key on Friday
The impact of the most aggressive Fed policy tightening in four decades is becoming evident in the trends of the US labour market. Nonfarm Payrolls growth is projected to moderate to less than 200,000, the lowest figure since December 2020.
Moreover, the participation rate has consistently risen over the past four months, indicating an increasing number of people in the labour force seeking employment, as inflation and high interest rates take their toll on the economy. This will likely begin to drag the unemployment rate higher in due course. If this begins to show then this will add to the mounting concerns over a prospective recession.
