Explaining the US Economic Data – Part 3

Besides the data presented in the previous two articles here on the Trading Academy, the US still offers much more data for interpretation. Housing data, for example, is a different item of economic information to look at and consider before interpreting the state of the economy. Nothing matters, though, more than the red-coloured data. This red data comprises not only the central bank’s decisions and the Consumer Price Index (CPI), but also data such as the following:

The above data is only a small part of the important data to be watched. These red events are the reason why the market moves. If the technical analysis shows the direction the market is moving in, the fundamental analysis tells the reason why the move started. Quite often, this reason comes from an economic news release.

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The Red Data

Economic data in this category is on the top of the Fed’s list. The examples listed above are only a few to consider, while everything related to the jobs creation and the monetary policy is of top importance. We cannot end this section related to the Federal Reserve without looking at the two red events that matter the most for traders: the interest rate announcement, or the Federal Open Market Committee (FOMC) statement, and the Consumer Price Index Release (CPI).

Federal Funds Rate

The interest rate announcement, or the FOMC statement, refers to the Federal Funds Rate. This is the name of the economic event as it appears in the economic calendar. It is scheduled eight times per year, making it roughly one release every 6 weeks. In between every two interest rate decisions, the FOMC Minutes are released as well.
US data - red data - 1
They show what the discussions were about, and are released 3 weeks after the actual FOMC meeting. The example above shows the March 2017 meeting, and this meeting’s minutes will be released 3 weeks after that date. The Federal Funds outcome is the result of a vote cast by the FOMC members on where to set the target rate. The individual votes are published in the FOMC statement. Volatility is omnipresent during such releases, as trading algorithms are programmed to buy or sell the dollar against its Forex counterparts based on the wording to be found in the FOMC statement. On a bullish change, the algos are instructed to buy, and on a bearish one, the algos are instructed to sell. This happens so fast that retail traders have a hard time following with the proper positioning.

CPI m/m

You probably know by now that the CPI is the Consumer Price Index, and in economic terms represents inflation. No Federal Funds Rate is going to change unless the inflation rate changes. A higher inflation rate will attract a hawkish Fed, leading to a rate hike, while a lower inflationary level will end up with the Fed cutting rates. The lower the inflation goes, the more aggressive the Fed’s move will be. The opposite is true as well: The higher the inflation, the more aggressive the tightening cycle is going to be.
US data - red data - 2
The CPI prices account for most of inflation, and shows the change in the price of goods and services purchased by consumers. As part of the Fed’s mandate, the target for inflation is below or close to 2%. However, a central bank, the Fed included, will never wait for inflation to come to target and then move on rates. What the central bank will do is to try to anticipate the inflation rise and be proactive rather than reactive.

A certain inflationary level is considered to be normal for an economy that is growing at a steady and stable rate. Higher inflation is easier to deal with, though, than lower inflation. A lower inflation level is met with the central bank cutting rates. This is a normal move, after all. However, when inflation is threatening to move below zero, central banks become desperate. Below-zero inflation is called deflation, and spells trouble for an economy. An economy in a deflationary spiral is one that has no active consumers. In other words, it all starts with consumers not willing to spend much and with savers dominating. Commercial banks become reluctant to lend to people or to businesses, and will start parking their excess money at the central bank. For that, they will receive an interest rate. While this interest rate is normally far lower than the potential rate the commercial banks could get from lending the money to the economy, parking the money at the central bank is less risky. To stimulate commercial banks to lend to the real economy, and hence to get the consumer to spend some more, central banks lower their rates.

Lately, because deflation is a reality nowadays in many parts of the world such as Japan, Switzerland, and the Eurozone, the central banks are embarking on extraordinary monetary policies. An example of such extraordinary policies in the United States was the Quantitative Easing programmes. The Federal Reserve cut the rates to prevent the financial crisis in 2008 from deepening further. That is a normal move to make. After that, though, to further stimulate a recovery, the central bank went into uncharted territory with regard to monetary policy: It started to buy US government bonds. For a central bank to buy its own government bonds is like printing money. The idea behind it is to get inflation higher and, along with that, the economy. There were four attempts, and the last one was indefinite, the so-called QE4-ever package, which ran for an extended period until inflation picked up. Eventually it did, and the Fed ended the extraordinary accommodation, so now rates can rise again. In a sense, looking at the current 0.75% level for the Federal Funds Rate, it is still low enough to be considered accommodative. However, when compared with the rate of a few years ago, we can say that a tightening cycle started when the Fed began to taper the quantitative easing programme. In other parts of the world, the extraordinary monetary policies were even more extreme. The  Eurozone has its interest rate in negative territory at -0.5%, Switzerland at -0.75%, and Nordic countries are following the same path. This is only meant to give you an example of how a central bank can move, and what its limitations are. What it shows, though,  is that there are none!

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