Fundamental Analysis: Economic Cycles and Indicators
To understand the economic conditions of a country, the fundamental analysis examines various factors. These include economic growth, inflation rates, interest rates, industrial productivity, unemployment rates, political stability, and statements from central bank managers like Jerome Powell (Federal Reserve, USA) and Christine Lagarde (European Central Bank, EU). This analysis relies on economic indicators, statistics, and surveys found in the Economic calendar.
It’s important to consider all these factors as the economy can grow in one sector while declining in another. By studying these factors, we can gain a comprehensive understanding of the economic situation and its position within the stages of economic cycles.
What is the economic cycle?
Economic cycles pertain to the rise and fall of economic conditions, which encompass five stages:
Recession. It comes with a decline in economic growth, a rise in unemployment, and reduced spending and investment.
Recovery. The stage where the economy begins to stabilize and return to normal growth rates, with improvements in spending, investment, and employment.
Expansion. During the expansion stage, there is a significant increase in economic growth, leading to a rise in spending, investment, and employment rates, eventually reaching their highest point.
Peak. The peak stage marks the final phase of the economic growth cycle when the economy experiences its highest levels of growth, spending, and investment. Typically, this is accompanied by an upsurge in interest rates and a tightening of monetary policy.
Depression. The recession is a phase where the economy experiences a decline in growth, a rise in unemployment rates, and a decrease in spending and investment.
And the cycle begins again…
Economic stages are identified through a range of indicators, including economic growth rates, unemployment rates, spending and investment rates, and interest rates.
These stages occur regularly in all global economies and are analyzed to inform sound financial management and investment decisions.
The most important economic indicators
There are different ways to classify economic indicators. We will cover six groups of indicators you should pay attention to.
Balance of Payments Indicators. They measure the volume of trade and investment transactions with other countries. An example of this is Trade Balance.
Production Indicators. They measure the overall level of production in a country.
Gross Domestic Product (GDP) is a significant example. GDP calculates the total value of goods and services produced within a country’s borders in a specific period. It helps to understand the size and growth of the economy.
Other Production Indicators include Industrial Production Index and Manufacturing Production Index.
Governments, investors, and market participants use Production Indicators, such as GDP, to determine the size of the economy and predict future growth and investment trends.
Confidence and sentiment indicators. They are used to measure the level of confidence, optimism, or pessimism among different groups that make up the economy.
Examples of these indicators include Consumer Confidence, the Ifo Business Climate Index, the Michigan University Consumer Sentiment Index, and the ZEW Indicator of Economic Sentiment.
These indicators are based on surveys conducted among companies, consumers, and investors. The surveys are then translated into indicators that express feelings and confidence in the current and future economic situation.
By analyzing these indicators, individuals can make appropriate financial and investment decisions and predict future economic trends. Typically, an increase in confidence indicators indicates optimism about the future economic situation, while a decrease in those indicators reflects pessimism and a lack of confidence in the future economic situation.
Inflation indicators. The levels of inflation in the economy are measured through various indicators such as price, wages, and sales.
One commonly used indicator is the Consumer Price Index (CPI), which calculates the changes in the prices of goods and services regularly purchased by consumers, including food, rent, clothing, transportation, and healthcare. This index provides insight into inflation rates and their impact on the economy and consumers.
Other important indicators include the Wage Index and Retail Sales Index. They help to understand the size of wages and sales in the economy and identify changes that may affect consumption and inflation. These indicators are crucial for governments, investors, and market participants as they aid in making informed financial and investment decisions.
Housing indicators. The primary indicators include:
- New Home Sales: This gauge reflects the monthly sales rate of newly-built homes in the United States.
- Building Permits: This metric shows the monthly number of permits issued for building construction in the United States.
- Existing Home Sales: This indicator presents the monthly sales rate of previously-owned homes in the United States.
Reports on fiscal policy and interest rates. These are crucial indicators that reflect the actions taken by central banks to address various economic conditions. These reports encompass monetary and stimulus policies, as well as interest rates, aimed at stimulating the economy and achieving financial stability. Examples of such reports include those issued by the central bank and the US Federal Reserve.
The movements of central banks and fiscal policies significantly affect financial markets, as fluctuations in interest rates can impact borrowing and investment costs, as well as inflation. These indicators can help individuals understand the direction of the central bank and predict the impact of these movements on the economy and financial markets.
Overall, reports on financial policy and interest rates are important indicators for governments, investors, and financial market dealers.
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