Last Updated on June 8, 2021
Interest in the calculation and comparison of GDP figures is not limited to the realm of professional investing. It’s an indispensable tool for the political and economic elite as well. GDP measures the combined market value of all final goods and services produced in a region. However, the sum total is always of less interest than the changes therein. The most common use of GDP is expressing its change in percentage against the previous time period. The direction and extent of that change tend to be at the center of analysis.
Many institutions prepare GDP forecasts. Their frequency can range from one to three years. Usually, the ones with the final say are the official national statistical services. The figures in their reports are always the ones quoted as fact. While the markets seem more interested in forecasts than facts, governmental bodies, and especially central banks, put a great deal of stock in these reports when modeling their own expectations. These expectations form the basis of fiscal policy and government budget.
You might also enjoy:
- Leading and Lagging Indicators – What Are They? Examples and Definition
- What is Tape Reading and How Does it Work
Government Forecasts Versus Central Banks’
The government does create its own projections. These include potential changes to taxation and government spending, both of which directly affect GDP. Compared to governments, central bank projections are typically less politically motivated. That’s why it’s worth taking a close look at how and why the two differ when they do. International organizations have less insight into the economic policy of individual countries. In return, they have a global perspective on the flow of goods and capital. Those two factors have at least as much effect on GDP as government policy and often and even more pronounced ones.
The assorted methods and organizations outlined above showcase just how diverse the application of GDP is. Depending on what assets or companies a given investor has a stake in, they may find some of these projections more significant than others.
How GDP Predictions Affect the Forex Market
In the currency and foreign exchange markets, central banks are definitely the focus of traders’ attention. These banks determine the base interest rates for individual currencies, directly affecting their relative value compared to other currencies. In theory, they’re independent of state governments. However, in reality, they face increasing political pressure. Presidents in the past have often tried to influence the Fed. President Trump, for example, has repeatedly expressed his disapproval for their repeated interest rate hikes. The constant strengthening of the US dollar combined with the rising corporate and retail interest rates cuts against the President’s economic policy goals.
It’s also worth noting that the Fed’s projections for economic growth have turned out to be less than accurate. This is in part due to the global economic effects of the unexpected tariff raises. Now that GDP growth has slowed down, they have less reason to keep raising the base rate. Furthermore, the Fed may have to consider instead slowly turning to programs that increase liquidity. Even though the Fed is somewhat unique when comparing it to most central banks, it still serves the same core purpose. Said purpose is to keep the country’s currency stable rather than aid any current administration’s economic policy.
The Effect of GDP Forecasts on Publicly Traded Companies
Publicly traded companies on the stock market typically contribute a significant portion of GDP. Hence it’s no surprise when even the slightest mention of slower GDP growth is enough to make stock traders nervous. The 2018 Q4 flash report result was that companies lowered their revenue forecasts for 2019 by 1% versus the previous year. This doesn’t necessarily mean that the country’s GDP would decline by 1% as well. However, it does strongly indicate the likely real direction it’ll go. The more closed an economy, the larger the effects government policy has on the companies’ performance operating there. Based on this logic, it’s safe to say that government GDP projections should be the primary focus for those looking at the stock market.
When the government expects a notable increase, it’s typically a powerful indicator that suggests stock prices will rise. Meanwhile, downwards projections can easily signal the opposite. The European Union is a good example of that. The European Commission expected GDP to rise by 1.9% in November of 2018. They lowered their expectations to 1.2% in February of 2019. The result was European stock indices dropping immediately and closing at 3% minus the announcement day. The price of the Euro, on the other hand, remained largely unaffected by the announcement.
When deciding which institution’s stats to believe, there’s no single answer that fits all sizes. It’s not a matter of credibility as much as a matter of where each market participant’s interests lie.
