Key economic releases are among the most closely watched events in financial markets. Inflation figures, employment reports, business surveys and so on can all influence expectations for monetary policy and the macroeconomic outlook. Yet, markets do not always react to the data in the same way.
The key thing to understand is that financial markets are forward-looking. Asset prices reflect expectations about future economic conditions, central bank decisions and so on. It’s never about the present conditions. The market reaction to an economic release depends on whether it changes the underlying expectations.
Not every economic release carries the same importance. For example, a stronger than expected employment report might initially push bond yields higher. However, if inflation is simultaneously declining and the central bank is becoming more concerned about missing the inflation target, the employment surprise might not be enough to change expectations for interest rates.
The opposite can also happen. A relatively small inflation surprise could have a significant impact if markets think that it’s going to change the central bank’s next move.
Central banks generally determine which data matters most
Policymakers monitor a wide range of economic indicators, but the relative importance of each variable changes depending on the economic context. When inflation is the main for a central bank concern, markets become very sensitive to inflation data like CPI, PPI, wage growth and so on. When the focus shifts to the labour market, jobs data like NFP, jobless claims and so on become more important.
So, you can see that the importance changes based on the economic context and central bank’s focus. For example, if the Federal Reserve is worried about persistent inflation and has signalled that further monetary tightening might be necessary, an unexpectedly strong inflation report could trigger a significant hawkish repricing. A weaker consumer confidence report might have little to no impact because it does not address the Fed’s immediate concern.
This is why central bank’s communication matters so much for markets. Policymakers often indicate which economic variables they are monitoring most closely. Traders then adjust their focus accordingly, making certain releases more market-moving than others.
Positioning also matters
Market positioning can also determine how prices react to economic data. If traders already expect a particular outcome, a report confirming that expectation may trigger little to no reaction at all. This is what happened during the first months with the CPI reports as markets already expected inflation to jump due to the spike in energy prices caused by the US-Iran war.
This can become even more important when positioning get overcrowded. If traders are heavily positioned for a certain outcome and conditions change, the repricing of expectations can lead to big market moves as traders rush to adjust their positions.
A good example is tomorrow’s US PPI release. The report comes after two key developments have already significantly shifted market expectations for monetary policy.
First, Fed’s Waller delivered some very hawkish remarks, supporting a December rate hike and raising the possibility of a larger increase if inflation data surprised to the upside. Then, the US CPI report came in hotter than expected, sealing the case for a rate hike in December and raising the chances of a 50 bps move.
This means that tomorrow’s PPI report is unlikely to trigger a significant market reaction because it wouldn’t change the current expectations, even if the data come in above expectations. Most of the hawkish repricing has already taken place, leaving little room for further repricing.
This article was written by Giuseppe Dellamotta at investinglive.com.