Fundamental Analysis: Macro Factors

The rapidly growing global interconnectedness means that the health of one country’s economy can impact the world markets. As a result, traders generally follow the economic calendar to ensure that they do not miss out on any relevant indicators that may signal a move in the financial markets. In this article, we are going to review some major macroeconomic factors.

Economic Growth

It is essential to understand how an economy grows to recognize the current economic environment in which an individual is investing and to predict how the market will move. In broad terms, economic growth is mainly driven by:

• Consumer Spending
• Business Investment

Economic Growth is widely measured by Gross Domestic Product (GDP) which is defined as the total value of goods and services provided in a country during one year.

If the health of the economy is robust, individuals and investors feel confident about the economy, which will likely boost consumer spending and business investment.

If the economy is weak, individuals would most probably save rather than spending to prepare for difficult situations. Similarly, investors will be more cautious and show some reluctance in investing in riskier assets. They will also likely seek safety with safe-haven assets.

Recently, we saw that as and when economic indicators fueled the fears of a global economic slowdown, investors seek safety with gold or other safe-havens.

Employment

Another significant economic data release is the Labour report. Every month, investors look at the three main components of the employment report to gauge the strength of the economy:

• Jobs creation: The number of new jobs created helps to assess whether the economy is growing. Generally, a large number of new jobs is positive and is a sign that the economy is flourishing. When the numbers begin to fall, it can signal a slowing economy.

• Unemployment rate: Rather than the actual monthly figure, analysts normally will observe the trend in the rate to see if the labour market is contracting or expanding. Unemployment rate helps to determine the inflationary and interest rate expectations. For example, any figure below the Non-Accelerating Inflation Rate of Unemployment (NAIRU) level will force the markets to begin to factor in a higher inflation rate.

• Wage Growth: Wages are the biggest indicator of consumer spending but do also have a flipside. It can be a significant cost for a business, but it is also a source of spending and consequently means revenue and profit for a business. Even though analysing its effect on the economy can be complexed, traders tend to monitor wage growth to gauge future interest rate expectations.

Inflation

Inflation is an important economic concept. It is a sustained rise in overall price levels. For trading purposes, we will try to keep it simple. The rate of inflation is important as it depicts the rate at which the real value of an investment is eroded and the loss in spending or purchasing power over time.

High inflation normally signals that the economy is overheating, while moderate inflation is often associated with economic growth as it means businesses and consumers are spending more money on goods and services.

Consumer Price Index (CPI) and Producer Price Index (PPI) are the most followed indicators aside from other inflationary pressures widely monitored by traders.

Interest Rates

Interest rates can have a rippling effect on the economy, which is why investors generally focused on forecasting any changes in interest rate to make better financial decisions. Any changes in interest rate can cause an immediate reaction in the financial markets even though it may take time to see the actual effects on the economy.

To understand the various economic impacts, we will analyze the effects of raising interest rates in relation to consumer spending and investment. Higher interest rates mean:

• Higher borrowing costs
• Higher mortgage repayments
• More incentive to save than to spend
• Reduced consumer and business confidence. Both consumers and investors are less willing to spend and invest in riskier assets.

All in all, a rise in interest rate will reduce consumer spending and investment. Inflation and economic growth will, therefore, tend to be lower. Hence, central banks will use the interest rate as a tool to curb or boost inflation to reach the desired level of economic growth.

Investors are keen to monitor and analyze economic indicators to foresee the next move by Central banks as any changes in interest rate can create investment opportunities.

 

Ready to start trading?

Try free demo Open account