GDP, and what it does to a currency
The broadest number an economy publishes, released long after the period it measures, and still able to move a currency in the minute it lands.
Lesson 5 of 12.
The three words, taken separately
Gross domestic product is three decisions stacked into one figure, and each of them changes what the number is capable of telling you.
Product — everything produced, goods and services alike, valued at the price it sold for. Which means a figure can rise because more was made, or because the same amount cost more. That ambiguity is why the inflation-adjusted version is the one traders watch, and why lesson ten spends its last section on price indices.
Domestic — produced inside the borders, whoever owns the company doing it. A foreign-owned factory in a country counts toward that country; that country's firm operating abroad does not.
Gross — before deducting anything for the machinery, buildings and infrastructure worn out in the process. Net domestic product makes that deduction; the headline number does not, which flatters an economy running its capital hard.
What makes it rise, and what makes it volatile
Output goes up for one of two reasons: more is being produced, or what is produced is being sold for more. Only the first is growth, which is why the real (inflation-adjusted) series is the one that matters and the nominal one is close to useless for trading.
How much a country's output swings from quarter to quarter depends on what it produces. An economy that sells commodities moves with the commodity cycle and can record wide swings on no domestic change at all — which is exactly the resource-currency behaviour of lesson three, arriving in the growth statistics. An economy dominated by services is steadier, and a surprise in it therefore means more.
- Real GDP, not nominal. A nominal rise with inflation running above it is a shrinking economy wearing a bigger number.
- Quarter on quarter tells you about momentum; year on year tells you about the level. They routinely point different ways and the calendar shows both.
- The same percentage means different things in different economies. A 0.1% quarter is ordinary for a large service economy and alarming for a commodity exporter.
When it is published, and why that shapes the reaction
GDP is the slowest major release on the calendar. It measures a quarter that has already ended, and it arrives weeks after it ended — then it is revised, usually more than once, as more of the underlying data comes in.
Two things follow for a trader.
First, the first estimate moves the most. By the time a revision arrives, the market has had a quarter of monthly data — PMI, employment, retail sales — pointing at roughly the right answer. The first print is the moment the guessing stops; a revision usually only confirms it.
Second, GDP is confirmation rather than news. It is the number that settles an argument the monthly releases have been having. That is why a GDP surprise often produces a sharper reaction than its importance suggests: it does not just report growth, it tells the market its running assumption about growth was wrong.
One print, two markets, two directions
The source puts the same American release beside two different instruments. Against EUR/USD, GDP came in at 2.1 per cent against a 1.9 per cent forecast, with 3.1 and 4.8 per cent behind it. Against the Dow, the comparison is 1.9 per cent against a 1.6 per cent forecast.
Both are beats, and the two charts do not do the same thing — for the reason lesson four set out. For the currency pair, faster growth is a rate story: a hot economy brings rate rises forward, and a currency that will pay more is worth more, so the dollar is bought. For the index it is a profit story pulling one way and a discount-rate story pulling the other, and which wins depends on where the market already was.
The Canadian case, and why three prints in a row matter
Deck seven runs the same exercise on Canada against USD/CAD, and it is the more instructive one because it shows three consecutive releases rather than a single event: previous figures of 0.9, 0.4 and 0.8 per cent, forecasts of 0.9, 0.4 and 0.1, and actuals of 0.8, 0.7 and 0.1.
Read as a sequence rather than as three events, the pattern is the useful part. The first came in slightly under forecast, the second well over, and the third exactly on it. A market that had been surprised in both directions in consecutive quarters has no strong prior left, and a release that lands exactly on forecast into that situation is the definition of a non-event.
Which is worth carrying forward: the size of the reaction depends on the confidence of the position going in, not only on the size of the surprise. That is the whole subject of lesson eleven.
What to take from this one
Three things:
- Gross, domestic and product are three deliberate simplifications. Use the real, inflation-adjusted series, and know whether you are reading quarter on quarter or year on year.
- GDP is slow and revised, so the first estimate carries almost all of the reaction. It confirms what the monthly data has been implying, and it moves most when it contradicts it.
- A growth beat is a rate story for a currency and an ambiguous story for an index. Decide which of those your instrument is before deciding what a beat means.
Next: there is more than one dollar index
DXY, the Bloomberg index, the Dow Jones FXCM index and the trade-weighted index disagree because their weights disagree. Which one to watch, and against what.