What matters changes with the cycleKnow the phase before you read the number.
The same release can be the most important number of the month or almost irrelevant. Which data rules depends on where the rate cycle stands, so you need to know the phase before you judge a number.
One number, very different weight
Earlier lessons showed that the market only weighs a few numbers at a time, and that its focus moves with the economic cycle. This module is about context, and the rate cycle is the first layer of it. An inflation report that moves a currency hard in one phase can pass almost unnoticed in the next.
Financial markets move in cycles: growth and slowdown, rising and falling inflation, and central banks tightening, which means raising interest rates, and easing, which means cutting them. In each phase the market cares about different things, and the logic it uses to read the data changes with it.
Rate hikes: inflation data rules
During a rate hike cycle, central banks are trying to stop the economy from overheating. Their next step depends on inflation, so every inflation report and every wage number can move price. Each release of the consumer price index, CPI, the main measure of inflation, can drive the market.
Wage numbers matter for the same reason, because rising wages feed into prices. The question behind every release in this phase is simple: how high will rates go?
Late in the cycle: can the economy take it?
High rates work slowly. After a while the economy starts to crack under them, and that is when the focus shifts. Jobs and growth data take the front seat, and the question changes from how high rates will go to whether the economy can survive them.
A weak jobs or growth number now carries a different message. It can be the first sign that the central bank has gone far enough, and the market starts to price that in.
Easing: the market prices the future
When central banks pivot towards easing, the market starts to price the future instead of the present. Leading indicators matter more: numbers that hint at where the economy is going next, such as the business surveys called PMIs and data on lending. Lagging data, which confirms what has already happened, loses weight.
Once cuts are coming, traders want to know how many and how fast, and that depends on where the economy is heading. A PMI that points to a recovery can matter more than last quarter’s growth figure, because it says something about the next decisions.
| Phase | The market asks | The data that rules |
|---|---|---|
| Rate hikes | How high will rates go? | Inflation reports and wage numbers |
| Late in the cycle | Can the economy survive this? | Jobs and growth data |
| Easing | Where is the economy going next? | Leading indicators: PMIs and lending data |
2 questions before you trade a release
The biggest mistake traders make here is treating every data point as equally important all the time. Gross domestic product, GDP, means little if the central bank isn’t watching it, and an inflation beat can be ignored when falling inflation is the dominant theme.
So before you trade a release, ask 2 questions. Where are we in the cycle? And is this the number the central bank is watching? If the answer to the second question is no, even a big surprise might barely move anything.
A number only matters if the market cares about it now, at this stage of the cycle.
In short
- The same number can matter a lot or barely at all. It depends on where the economy and the central bank are in the cycle.
- During hikes, inflation data rules. Late in the cycle, jobs and growth take over, and once easing starts, leading indicators such as PMIs and lending data matter most.
- Before you trade a release, ask where we are in the cycle and whether this is the number the central bank is watching.
Questions
How do I know where we are in the cycle?
Look at what the central bank is doing and saying: raising rates, holding at a high level while the economy weakens, or cutting. Its statements also tell you which data it is watching.
When does the focus move to the next phase?
When the central bank changes its tone. A first hint of a pause or of cuts often reorders the market’s priorities, and from that point jobs, growth and the leading indicators deserve more weight.
Key terms
- Tightening and easing
- Tightening means raising rates or reducing the money supply. Easing means cutting rates or adding money to the system.
- Leading indicator
- Data that tends to change before the wider economy does, such as business surveys or new orders.
- ISM and PMI
- Surveys that ask purchasing managers whether business is getting better or worse. Above 50 means expansion, below 50 contraction. A leading indicator.
- Inflation
- The rate at which prices rise. Central banks usually aim for about 2% a year.
- Economic cycle
- The repeating pattern of growth, peak, contraction and recovery that every economy goes through.