Economic Growth Indicators
Understanding economic growth can tell you if an economy is growing steadily or on the verge of a recession. We'll explain how to understand announcements related to economic growth and what they can mean for your trading strategy.
In any given calendar month, there will be several releases of economic data that indicate how an economy is performing. The most widely watched indicator is Gross Domestic Product (GDP). Traders will also look to other indicators that can provide a lead on economic growth – Purchasing Managers Index data in particular.
Gross Domestic Product (GDP)
GDP is the total amount of goods and services that a country produces, calculated across a year. The percentage change from one year to the next is GDP growth and is used by central banks for calculations of economic performance.
GDP is released quarterly and usually delivered in three separate readings. The first reading usually has the most impact – though, revisions in subsequent readings are commonplace. This is because the first version tends to be released two or three weeks after the quarter-end, and is simply a flash estimate based on less than half the data necessary for an accurate measurement.
Subsequently, the second reading is released around a month later and comprises around 70% of the economy. The second reading is much more accurate than the first.
The third and final reading of GDP is released around two and a half months after the quarter has ended. This is considered to be the most accurate as the agency in charge of statistics has had time to compile all the data needed. It’s worth noting, however, that even then, final GDP can be subject to further revisions.
GDP has a significant impact on financial markets, mainly affecting the domestic currency and bond markets. However, perhaps its impact is reduced slightly by the fact that the data is considered to be reasonably backwards-looking. As previously discussed, it takes months to get a reading that is reasonably accurate and by that time the next quarter is already drawing to a close. For that reason, traders will pay a lot of attention to survey data too.
Quarterly GDP Growth
Economies to watch: US GDP, China GDP
Despite GDP being backwards-looking (even the first reading of quarterly data is almost a month old), it is still significant for central banks to regularly gauge the performance of the economy.
Purchasing Managers Index surveys: (released in the first week after the month-end)
Especially watch for US ISM Manufacturing, ISM Non-Manufacturing, China & Eurozone PMIs
The PMI surveys (Manufacturing and Services) are seen as essential data releases. They are the first important data released every month, and because they are forward-looking, they are considered to be an effective gauge of growth prospects.
Other indicators to consider:
- Factory Orders and Durable Goods Orders
- Industrial Production/Capacity Utilization
Purchasing Managers Index (PMI) surveys
PMIs are surveys conducted each month to take a snapshot of the health of economic sectors. The Manufacturing PMI is the most keenly watched and is released on the first trading day of the month. Businesses tend to react quickly to changing market conditions, and their purchasing managers hold perhaps the most current and pointed insight into the company’s view of the economy.
PMIs are compiled by questioning the purchasing managers of various companies around the country. Respondents are asked whether the business is better, the same, or worse in their industries. The survey covers five different topics important to businesses:
- New Orders
- Supplier deliveries
Pulling all the data together provides a composite view of the sector as a whole.
Why look at the PMIs?
Survey data is taken for the manufacturing and services sectors (and in the case of the UK, the construction sector). Taken together, all this data comprises the composite PMI. There is often a strong positive correlation between the composite data and the run rate of economic growth for a country.
PMI data is considered to be a leading indicator, and that makes it important to central banks when they make decisions about monetary policy. That’s why, as a trader, you should take a keen interest as well.
The PMIs are an index that provides a reading between 0 and 100:
- 50 is the NEUTRAL level suggesting the respondents are balanced on their positive and negative answers.
- Above 50 indicates EXPANSION of the sector compared to the previous month
- Below 50 indicates CONTRACTION of the sector
A number above 55 implies that the sector is in strong health, whilst below 45 and is considered to be an extremely weak indication.
KEY TIP: As ever with economic indicators, it is not only the level of the PMI but also the direction of travel.
As with most economic indicators, it isn’t just the level of the PMI, but also the direction of travel.
Who compiles the surveys?
- Financial information group Markit is the primary PMI provider, surveying internationally across over 30 countries.
- In the US, the major data provider is the Institute of Supply Management (ISM), although Markit also releases its own data in the US.
- In China, the government conducts its own official survey, while Caixin (Markit’s sponsor in China) also performs an unofficial survey. Markets consider both to be important as Government data tends to cover larger enterprises, while the Caixin data is more focused on small business and SMEs.
The impact of growth indicators on financial markets
An economy demonstrating strong growth trends (both historic with the GDP and also forward looking with the PMIs) will have a hawkish influence on central bank monetary policy. Strong growth is therefore:
- Positive for the domestic currency – it increases the potential for inflation and subsequently the need for the central bank to increase interest rates as a reaction.
- Positive for bond yields – as with the currency it increases future growth prospects and inflation expectations. Demand for bonds will suffer in this environment as they are deemed to be lower risk.
- Strong for domestic equities – a stronger market will improve the prospects for domestic focused corporates. Equities will also perform better as appetite for risk increases.