The Gross Domestic Product (GDP) represents the monetary value of finished goods in a country’s economy. GDP is typically evaluated on a monthly, quarterly and yearly basis. With such a system, economists and traders clearly assess the overall health of an economy.
While there are several formulas to calculate GDP, the U.S. Bureau of Economic Analysis uses the so-called “Expenditure Approach”:
GDP = Consumption (C) + Investment (I) + Government Spending (G) + (Exports (X) – Imports (M))
How to Trade GDP (Gross Domestic Product) Data?
When looking at GDP data releases, investors first check whether the new data beat or dropped below the consensus estimates.
A worse-than-estimated GDP data (see the image below) usually leads to a sell-off of the national currency against other currencies. In the chart below you can see the dollar’s value declining against the euro.
Conversely, a better-than-estimated GDP data results in the national currency’s price rise against other currencies.
GDP data releases don’t always affect currencies GDP in an anticipated manner. This is something investors should be wary of before making their move. GDP numbers are usually fully or partially priced into the market. In other words, the market might react differently than anticipated following GDP data release.
Analyzing GDP Data to Inform Currency Trading Decisions
The advance GDP data announcements occur four weeks after the quarter ends while the final release occurs three months after the end of a quarter. Normally, investors are happy with the US GDP growth between 2.5% and 3.5% a year.
In a developing economy, central banks sometimes prefer keeping interest rates at about 3%, without the danger of inflation. On the other hand, GDP higher than 6% would indicate that the country’s economy is overheating which could raise inflation concerns.
If that case, the Federal Reserve may decide to hike interest rates to fight inflation and slow down an overheating economy.
Simply put, GDP shouldn’t be too high to result in inflation or too low to result in a recession. If GDP data is negative for two successive quarters, the economy is considered in a recession. This means that GDP data should keep balance, which is different for every country.
GDP data announcements are very significant for Forex traders as it clearly shows them how healthy the country’s economy is. Higher GDP data results in the appreciation of the national currency. Investors usually have positive expectations for future interest rate boosts as stable economies tend to grow, resulting in inflation.
Consequently, the country’s central bank hikes interest rates to impede the economy’s growth and control inflation. On the contrary, economies that have low GDP readings have significantly lower interest rate hike expectancies.
In conclusion, GDP data releases are of critical importance for Forex traders. Fundamentalists use the GDP data to assess the economy’s health its potential growth. As a result, Forex traders closely monitor the volatility that rises during GDP releases. GDP figures let central banks and policymakers decide whether the economy is growing or contracting and whether its growth needs to be boosted or restricted.
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