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EFFECTS OF ECONOMICS INDICATORS ON FINANCIAL MARKETS
Abstract
In recent years, the general public has become increasingly aware of economic activities, aided and abetted by the growing involvement of private individuals in the stock market. As decisions in financial markets have become no longer a matter of luck but based on structured decisions, the investor or adviser has been left with two options. First, decisions can be based on technical indicators or charts. This is the field of technical analysis, whose importance has steadily increased in recent times. In addition, there is fundamental analysis, which boasts a far longer history, although considered 'elitist' for a long time, whereby national economic indicators are calculated and their importance and effect explained in a somewhat cryptic form. Any investors basing their decision to some extent on economic performance should therefore have at least some idea of what individual economic indicators mean and their relation to other indicators. The effects of economic values on financial markets of fixed income markets are therefore comparatively simple. References to strong (weak) economic growth and therefore related to higher (lower) inflation have a mainly negative (positive) impact on these financial markets, as they imply higher (lower) interest and therefore lower (higher) market rates. This apparently simple link is no longer so easy to identify in relation to other financial markets. High economic growth frequently produces high inflation, which in turn prompts the central bank to tighten monetary policy more by raising interest. This, however, makes company lending more expensive, thereby narrowing the profit margin. At the same time, the higher economic growth also means that companies can sell more because demand rises. Due to the increase in demand they also probably have greater scope to increase prices. In this respect higher economic growth positively influences company profits. The question therefore remains as to the overall effect on a company and on the trend on the stock markets. The situation in the currency markets is different again. High interest rates tend to suppress economic growth. Falling growth rates adversely affect the exchange rate of a currency. High interest rates make investment in this country attractive, boosting capital inflows, thereby in principle positively affecting the exchange rate. It is not the aim of this article to explain the fundamental factors of performance and their interdependencies within the financial markets. Instead, it aims to form a basis for appreciating the fundamentals in the USA and the Eurozone, the European Monetary Union (EMU) region. This can then be taken as the starting point for fundamental analysis of these national economies and their effects on the financial markets.
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Do financial market analysts use structural economic models when forecasting exchange rates? This is the leading question analysed in this paper. In contrast to other studies we use expectations data instead of observable variables. Therefore we analyse the implicit structural models forecasters have in mind when forming their exchange rate expectations. The economic exchange rate models included in our study are purchasing power parity, the flexible-price monetary model, the sticky-price monetary model and the Mundell-Fleming model. These models are the theoretical basis for the estimation of latent structural models using the categorical expectations data of the ZEW financial market survey. The expectation variables used to explain expected exchange rates are short term interest rates, long term interest rates and business expectations. Our results show that the flexible-price monetary model is clearly rejected, but the sticky-price monetary model (in case of DM/Pound Sterling and DM/Yen) and the Mundell-Fleming model (in case of DM/US-Dollar) are both compatible with the estimated parameters.
Forecasts are an inherent part of economic science and the quest for perfect foresight occupies economists and researchers in multiple fields. The release of economic forecasts (and its revisions) is a popular and often publicized event, with a multitude of institutions and think-tanks devoted almost exclusively to that task. The European Central Bank (ECB) also publishes its forecasts for the euro area, however ECB’s forecast accuracy is not a deeply researched theme. The ECB forecasts’ accuracy is the main point developed in this paper, which tries to contribute to understand the nature of the errors committed by the ECB forecasts and its main differences compared to other projections. What we try to infer is whether the ECB is accurate in its projections, making less errors than the others, maybe due to some informational advantage. We conclude that the ECB seems to consistently underestimate the HICP inflation rate and overestimate GDP growth. Comparing it with the others, the ECB shows a superior performance, committing almost always fewer errors. So, this signals a possible informational advantage from the ECB. Since the forecasting errors could jeopardize ECB’s credibility public criticism could be avoided if the ECB simply let forecasts for the others. Naturally, this change should be weighted against the benefits of publishing forecasts.
This paper investigates to what extent daily movements in the euro/dollar rate were driven by news about the macroeconomic situation in the USA and the euro area during the first two years of EMU. We examine whether market participants reacted to news in different ways depending on whether the news came from the USA or from the euro area, and whether the news was good or bad. Furthermore, we investigate whether traders’ reaction to news has changed over time. We find that macroeconomic news has a statistically significant correlation with daily movements of the euro against the dollar. However, this relationship exhibits considerable time variation. There are indications of asymmetric response, but to different extents at different times. Our results also provide evidence that the market seemed to ignore good news and remain fixated on bad news from the euro area, as often claimed in market commentaries, but only for some time. Finally, we find evidence that the impact of macroeconomic news on the euro/dollar rate was stronger when news switches from good to bad or vice versa.
(J.E.L.: F31).
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