The currency markets are driven primarily by macro economic news such as GDP figures, CPI data and employment reports. On the other hand, the price action in the equity markets is governed more by micro economic data such as company?s sales and profits. Yet if you think about it the macro data that influences price in the currency market is simply the sum of the many micro data points from the equity market. So, can you use the equity market to gain an edge on the currency market?
We believe it?s possible as long you know where to look. Let?s examine some recent news from the stock market to determine if it can shed some light on the broader macro economic picture that affects the currency market.
With consumption making up more than 70% of the US GDP, consumer demand is critical to gauging the health of the overall economy. Recent announcements from American Express and Countrywide Financial provided very strong clues that the US consumer was slowing down materially. American Express reported that it expects some of its clients to miss payments. The news was highly significant because American Express tends to service more upscale customers and the fact that that group is having difficulty meeting its obligations suggests larger cash flow problems for the wider US consumer base.
The credit problems at American Express were also confirmed a day later by Countywide Financial which revealed that sub-prime delinquencies worsened sharply in the last quarter, with payments being late on as many as 23.7% of sub-prime mortgages, up from 15.3% for the same period in 2006. Furthermore, Countrywide also said that a growing number of its prime customers – once considered to be good credit risks – were having trouble meeting their mortgage repayments. The lender reported that payments on 3.4% of prime first mortgages were at least 30 days late at the end of the second quarter, up from 2.1% a year earlier. Missed payments by prime second mortgage borrowers were considerably worse, with a default rate of 4.6% compared with 1.8% a year earlier.
Traders armed with this information from the stock market would have speculated that overall US consumer spending was likely to slow. Indeed a few days after those reports, the US consumer spending figures printed only 0.1% gain in comparison with 0.6% rise the month prior. This was the slowest pace of growth in nine months.
Yet did all of this data spell doom for the dollar? Not necessarily so. Employment is also a key statistic for the currency market. As long as US continues to generate jobs, the Federal Reserve Bank of New York is unlikely to lower rates even in the face of slowing consumer demand and that should prove supportive for the greenback.
So how could equity traders get a leg up on currency traders with regard to the state of employment in US? By looking at sales data from nations largest retailer - Walmart. Although Walmart also reported relatively tepid overall numbers, results from its small business unit Sam?s Club, experienced continued momentum with positive trends in both business member ticket and traffic. Since small businesses in US are responsible for generating the majority of new jobs, the Sam?s Club data served as good proxy for the overall health of the sector and therefore provided equity traders with strong circumstantial evidence that the state of US employment remained steady despite weakness in the consumption.
Currency trades are of course two way bets. The dollar for example can rise against the euro not only if US data proves strong, but also if European data shows relative weakness. To that end, the study of international stocks can also help traders gain an edge in the currency market. Traders looking at European equities would have noticed that French retailer Carrefour the world’s biggest retailer after U.S.-based Walmart reported relatively lackluster sales gains of only 0.3% in its home market. This suggested that the Eurozone recovery was not translating into better consumer demand and indeed several days later EZ Retail PMI figures surprised to the downside registering the third consecutive month of contraction. Equity traders therefore were aware of this weakness well in advance of the currency market and could have positioned themselves accordingly.
Data from retailers can be used to gauge upside surprises as well. For example fully ten days before the Australian Retail Sales data was released, Australian retailers such David Jones and Harvey Norman both posted much better than expected profits suggesting that consumer demand down under was quite strong. Sure enough Australian Retail Sales beat forecasts and the AUDUSD pair rose in the aftermath of the release.
While using the equity market to handicap currencies is in no way a full proof method of trading the FX market, this approach often provides valuable clues to the outcome of the macro economic data. Equity traders therefore may already possess effective tools to succeed in the FX market. By understanding the dynamics of individual stocks, equity traders can often obtain early warnings to the state of the overall economy and get an edge in trading the currency market which is heavily influenced by the bigger economic forces.