Impact Of GDP On The Forex Market
GDP stands for gross domestic product, representing the total value of goods and services produced within a country.
The standard formula used to calculate GDP is the following:
Gross domestic product = Consumption + Government spending + Investments + (Exports – Imports)
We will talk further about what is included and excluded from this figure later on.
When and how?
GDP is typically reported over three different intervals, namely the following:
- Monthly, which compares the current month to the previous month.
- Quarterly, which compares the current quarter the previous quarter.
- Yearly which compares the current year’s figure to the previous year’s figure.
These will provide you with all the necessary information such as the date, time, previous figure, expected figure, and the actual data when it is released.
Why is GDP important?
Gross domestic product is a significantly important indicator of the performance of a countries economy.
The figure tells us whether the economy is expanding or contracting.
Typically, expansion is bullish for currency, and contraction is bearish. Expansion means that the country is producing more goods and services than previously, while contraction means the country is producing less goods and services than previously.
But why is a high GDP reading good? And why is a low GDP reading bad?
When GDP is high i.e. the economy is doing well, businesses can afford more workers or afford to pay their workers more (shown in NFP). This means that people have more money to spend, which is obviously good for business and the economy.
When GDP is low i.e. the economy is doing poorly, businesses cannot afford to hire more workers or cannot afford to pay their employees as much. Overall there is less money for people to spend, which is bad for business and the economy.
As discussed in the How Interest Rates Affect Forex Trading article, GDP is one of the main factors that central banks consider when making interest rate decisions.
If the economy is doing badly and GDP is low for an extended time, the central bank will likely cut interest rates. Low interest rates are bearish for a currency.
If the economy is doing well and GDP is high for an extended time, the central bank will likely hike interest rates. High interest rates are bullish for a currency.
Since currencies are traded in pairs, the comparison between the two currencies’ outlook is what matters most to Forex traders.
The effect of the release
In all honesty, it is unusual in current times to encounter high volatility when GDP figures are released. However, these numbers are still a significant consideration in currency valuations over the long term.
As with most economic releases, the expected figure versus the actual figure is what market participants react to.
A higher than expected number will usually be bullish. A lower than expected number will usually be bearish.
What is included in GDP?
- Net exports.
- Government spending.
- Business consumption.
- Consumer consumption.
What is excluded from GDP?
- Unpaid Labour.
- Illegally sold products such as drugs or black market sales.
- Resale of old goods.
- Products traded for one another.
- Goods that are not intended for sale.
Conclusion - How much should you care about Gross Domestic Product?
This depends on the type of trader that you are. If you are a fundamental trader, then GDP will be one factor at the forefront of your decision-making process. If you are a technical analyst, then GDP will not be as important.
Another consideration is the frequency of your trades. A long-term trader or swing trader will not be affected by a 20 pip move, but a scalper will have to be careful around the time when major news such as this is released.
Take these factors into account, and you can determine how much attention you need to give GDP.
See you in the next article.
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