Gross domestic product (GDP) is a measure of all goods and services produced inside a country’s borders. As such, it doesn’t include imports, even though imports can add to job creation and prosperity in an economy. It’s loudly discussed by all the major media outlets, and the trader needs little effort in finding and evaluating the report. There’s no need to go into the details of its calculation here, but we should briefly discuss its implications on the markets, and what a good or bad GDP number means.
GDP is valuable for the markets for a number of reasons. First, it provides the trader or analyst with a general, all-in-one snapshot of the economic situation of a nation. Without having to go through a large list of statistics, and wading through a sea of numbers to gain an overall grasp of the latest developments in an economy, the analyst finds a comprehensive report in the GDP number and its details. Second, it allows a quick and easy comparison between nations in terms of their economic prowess and health. Third, and perhaps most importantly, it tells the trader whether a nation’s economy was growing or contracting during a time period. As the overall health of an economy determines the lending policies of major banks and other financial actors, the GDP number is prone to cause periods of panic and euphoria in the market, and the patient, sensible trader can exploit these periods for his profit.
A positive, rising GDP number is a sign that the economy is growing. A positive, but lower GDP value (in comparison to the previous quarter), is a sign that GDP growth is decelerating. Finally, a negative GDP value over two consecutive quarters is usually considered a recession by economists: a period of falling demand, production, and economic activity, and a source of panic and great concern for financial markets in general.
GDP releases, along with inflation statistics (which we will discuss shortly), are some of the most important parameters that central banks use in determining their interest rate policies. GDP growth can, under certain circumstances, cause high inflation through wage growth and price rises, and central banks try to combat this development by raising interest rates (which leads to higher borrowing costs, more expensive investment, less growth and less inflation.) Conversely, a period of low inflation, or low GDP growth can lead central banks to lower interest rates with the goal of rejuvenating economic activity. Forex, and all financial markets are very responsive to changes in central bank interest rates, and the trader can keep his eyes on GDP statistics and inflation numbers as advance warning on changes in central bank policies.
Let us finally mention that fundamental “analysis” that depends merely on the headline number can sometimes be misleading. The GDP number can be flawed as an indicator of economic health for a number of reasons, but one that must be born in mind is that inventory accumulation by firms (rising stocks of unsold goods at firms’ warehouses) is added as a positive to the GDP value, and this sometimes can cause an unreasonably healthy picture to be portrayed before periods of economic slack. Since inventory accumulation can be caused by insufficient demand, the trader should always check this component of the release for anomalies before making a judgement.
Next >> Producer Price Index >>
Previous << Fundamental Analysis <<