Profile of the Euro – Characteristics and Major Economic Indicators

In the previous article we spoke about the euros increasing popularity as a reserve currency, fueled by the European Unions major role as a global trade partner. In the current article we will turn our attention toward the specifics surrounding this new currency and its trading, as well as the most important economic indicators which affect its exchange rates.

One of the reasons you might want to trade the euro as a day trader is that its share on the Forex market is quite large – 33% as of April 2013, putting it on the second place after the US dollar. That said, the EUR/USD pair is the most actively traded, but generally all major euro crosses are very liquid.

Liquidity is important because it ensures that you can get your investment out of the market (you can exit your position), since there will be a large enough number of traders who would want to buy when you are selling, and vice versa. Higher liquidity causes prices to change gradually and trends to develop incrementally, as opposed to quickly occurring price changes at times of low liquidity and high volatility. Hedge fund speculators tend to act aggressive during periods of low liquidity, forcing other participants to do the same, thus rapidly moving the price. While this might be in favor of some trading strategies, for others it is not. As a freelancing day trader, you are more likely to prefer high liquidity conditions where institutional investors will have diminished effect on the overall market.

The EUR/USD pair is used as the primary gauge measuring the performance of the European and US economies – as we know, the worlds two biggest ones. Thus, strengthening in the euro leads to a weakening of the US dollar, which is widely referred to as the “anti-dollar”. We know from the article “US dollar index” that the euro has a 57.6% weight in the measuring of the US dollar index and moves with a correlation of -0.941 to the USDX.

The EUR/GBP, EUR/JPY and EUR/CHF pairs are also good trading alternatives which measure the performance of the respective countries. They rarely gap and have tight spreads as well.

Specifics and risks

However, apart from the common Forex trading risks, the euro suffers from some specifics ones. The first thing that comes in mind is that because the euro is currently the currency of 18 different countries, it is exposed to risks from each one of them. Thus, if Germanys economic growth is accelerating, but France and Italy are losing momentum, the euro wont appreciate as it would if each state was achieving progress, or it might even depreciate.

Another problem the euro faces is that although the number of euro area members is expected to grow as the European Union expands, if any country drops out of the Eurozone and reverts back to its original currency, this would hammer the euro and compromise the stability of the entire region. Such an event would question the reputation of the ECB, its policys effectiveness and intentions. This is one of the reasons for the support Greece received, when suspicions arose it might drop the euro and readopt the Greek drachma.

Indicative for sentiment on the euro, particularly against the performance of the US dollar, can be the difference between the 10-year US government bonds and the 10-year German bund rates, which are deemed the benchmark bonds for the euro area. If bund rates (the German word for “bond”) are higher than the Treasury rates and the difference between them widens, this is considered bullish for the euro, and vice versa.

Key economic indicators

As we said, because the euro is the common currency for the Eurozones eighteen member states, each significant piece of data would play a part in its valuation. Eurostat regularly releases overall figures for the Eurozone as a single entity, which tend to have the strongest effect on its currency. However, figures out of the blocs major economies (Germany, France and Italy) naturally have a huge impact on price movement as well. Lets begin with the major Eurozone indicators.

– Gross Domestic Product – as a measure of growth of the economies within the European Monetary Union, the Gross Domestic Product is, as usual, an indicator of great importance for the euro. The GDP growth rate is released by Eurostat and is considered as a broad measure of the Eurozones economic health and primary indicator of economic activity. It is calculated on a quarterly and annual basis for the respective quarter, with the annual one having a larger impact on the euro. The annual value is estimated as a simple sum of the members national GDP, but some countries are not included in the preliminary reading because they dont produce such data or it is significantly delayed. Same goes for the quarterly readings.

There are three readings of each three-month periods performance – two preliminary and one final value. The first preliminary reading is released with a delay of 1-1/2 months, followed by the second preliminary estimate in the next month and the final one in the following. For example, the first preliminary estimate of the Q4 GDP growth is published in the middle of February, followed by the second preliminary reading in the beginning of March and the final reading in the beginning of April. Generally, an improvement from the previous period, and especially a better-than-expected reading is seen bullish for the euro and vice versa.

– Harmonized Index of Consumer Prices – the HICP is an economic indicator constructed to measure the changes over time in the prices of consumer goods and services acquired by households within the Eurozone. It is designed and used for international comparison. Data is derived from each national statistics agency, which are required to provide Eurostat with the 100 indexes used to calculate the HICP. The national HICPs are summed by Eurostat as a weighted average of these sub-indexes with country-specific weight.

Apart from the broad HICP, there is a core value which excludes volatile components like food, energy, alcohol and tobacco. Both HICP and core HICP are calculated on a monthly and annual basis, with more significance being put on the annual values. There is also a preliminary value, which is released at the end of the month, for which it is calculated. The final value is published in the middle of the month following the reference period (e.g. the preliminary April readings are released at the end of April, while the final values are published around May 15th).

Even though the information is already partly available by countries before the general euro area index is released, it is still of major importance because it serves as the reference inflation figure which the ECB takes into account and compares to its 2.0% inflation target. Generally speaking, a high reading should be taken as a bullish sign, because central banks tend to intervene when inflation accelerates too much by hiking interest rates (hawkish attitude), while consistently low readings are battled with dovish measures.

– Retail Sales – released by Eurostat, this indicator measures sales changes in the euro areas retail sector, assessing its performance in the short term. It is the most important indicator of consumer spending, which itself is the foremost driver of economic activity.

The indicator is calculated on both monthly and annual basis with one month of delay, e.g. the reading for March is released in the first week of May. In case the index of retail sales rises at a faster-than-projected pace, this would have a bullish effect on the euro, and vice versa.

Sentiment

– ZEW Economic Sentiment – the Zentrum fur Europaische Wirtschaftsforschung (ZEW) Economic Sentiment Index measures the sentiment among institutional investors, calculating the difference between the share of investors that are optimistic and the share of analysts that are pessimistic. It rates the relative six-month economic outlook for the euro zone, thus it is a leading indicator of economic health. It is released in the second or third week of the reference month. A better-than-expected reading is considered as bullish for the euro, whereas a pessimistic view is considered as negative (or bearish).

– Sentix Investor Confidence – a monthly survey conducted among 2 800 investors and analysts (more than 500 of which institutional) which rates the current economic conditions, as well as the relative six-month economic outlook for the euro zone. It is released within the first ten days of the reference month by Sentix GmbH and comprises 36 different indicators. A reading above zero indicates optimism and below – pessimism. Although it is deemed an indicator with low-to-medium market influence, it is important due to its role as a leading indicator and better-than-expected readings are regarded as bullish, while worse-than-expected as bearish.

– Other key Eurozone indicators – there are also unified economic indicators that influence the euros movement, which like in any other economy cause high volatility. These are the manufacturing and non-manufacturing PMIs, industrial production, unemployment rate, producer inflation, trade balance, and of course the ECBs interest rate decisions and speeches of the banks president – currently Mr. Mario Draghi.

Apart from the euro areas generalized indicators, key readings from the EMUs biggest economies, especially Germany and France, also tend to be major market movers. Among these are the German unemployment change and unemployment rate released at the end of the reference month, retail sales (released at the end of the next month), GDP, manufacturing and non-manufacturing Purchasing Managers Indexes etc.

German data

Another set of crucial data for the euro are the German industrial production and the Ifo Business Climate Index.

– German industrial production – released by the Statistisches Bundesamt Deutschland, the German industrial production measures the change in the total inflation-adjusted value of output produced by manufacturers, mines, and utilities. Changes in the industrial sector are broadly followed as a major indicator of strength or weakness in the countrys manufacturing sector.

The data is seasonally adjusted and comprises a breakdown of four aggregates – manufacturing, construction, mining and energy. The manufacturing category consists of four main product groups – basic and producer goods, capital goods, consumer durables and consumer non-durables. There are two readings – the seasonally adjusted month-on-month estimate and the non-seasonally adjusted, workday adjusted year-on-year reading. Both of them are widely tracked by investors. Germanys industrial production figures are the most important as a leading EU nation, but in some cases the French and Italian readings can cause a decent amount of volatility as well. The German data is released with a delay of 1 month, e.g. the reading for March is published in the first 10 days of May.

– IFO (Information and Forschung [research]) Survey – released by CESifo Group Munich, the Ifo Business Climate Index rates the current business climate in Germany and reflects expectations for the next six months. It is based on a survey conducted among manufacturers, builders, wholesalers and retailers. As the largest European economy, assessments of the business conditions in Germany are seen as indicative for Europe as whole. The survey is conducted on a monthly basis and encompasses the business situation assessment of over 7 000 enterprises. It is usually released in the third or fourth week of the reference month.

The release consists of the business climate headline figure and its two equally weighted sub-indexes: current business conditions (Ifo Current Assessment) and Ifo Business Expectations. Readings typically range between 80 and 120, but its month-to-month changes have a more significant impact on the euros movement. The positive economic growth expectations are bullish for the EUR sentiment, while a lower reading compared to the previous period is seen as bearish.

Apart from the multiple economic indicators being released from its members and in general for the Eurozone, the countries individual budget deficits and debt also influence the euro. According to the Stability and Growth Pact, the member countries are supposed to keep these macroeconomic categories at certain levels and failure to do so is closely monitored by investors and seen as bearish. The same counts for speculations that a member of the European Monetary Union might exit the bloc and adopt its original currency.