Economic and Financial Factors
The periodic release of economic data allows market players to make informed decisions on the state of the economy to which the data relates. The level of impact the released figure has on the market will depend on how closely the actual results compare to economists' forecasts. If the figure is released in-line with predictions then generally a muted market reaction will be seen. However, if the economic data is considerably better or worse than analysts expect then traders are likely to see a volatile reaction in the market place.
Understanding the relationship between financial indicators and how prices can react as a result of changing economic perception gives a trader a basis from which to make a decision. For example the chart below shows how the Bund reacted to January's release of US Non-Farm Payrolls. The Department of Labour report showed a drop of 524,000 jobs in December. This was higher than the market expected and you can see that on the release of the figure at 1.30 (GMT), after initial volatility, the Bund rallied 80 points before finding a new technical range. The fundamental reason behind the rally is that the poor employment figure further increased the negative economic perception and as a result traders moved money into high quality, less risky assets such as the Bund, the 10 Yr German government bond. This fundamental move is a common known as a 'flight to quality'.
This basic example touches on the relationships that can exist between global financial instruments. However, these relationships are not always clear and a financial instrument can react very differently depending on the economic environment. An example of this was seen on 5th February 2009 when the bank of England further reduced interest rates by 0.5% to 1%. In theory an interest rate cut of 0.5% would cause the value of sterling to fall as investors that hold assets valued in pounds loose their purchasing power. However as can be seen by the graph below sterling actually rose on this occasion.
The reason for this reaction is when taken within the wider economic picture the dramatic low levels of interest rates shows that the Bank of England are taking strong action to stimulate economic growth, which in the medium term would be good news for the currency. Conversely when the ECB chose to leave interest rates unchanged at 2% the Euro initially lost ground. Therefore, the manner in which a financial market reacts to economic indicators will change depending on a number of factors specific to the economic climate when that indicator is released.
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