Economic Indicators: What Central Banks Watch
Now that you understand interest rates are the #1 driver and central banks control them, you're ready to learn what data central banks use to make their decisions. Economic indicators are the statistics that tell central banks whether to raise rates, cut rates, or stay put.
Each indicator below matters because of how it influences central bank policy. When these numbers are released, markets immediately react—not just to the data itself, but to what it signals about future interest rate decisions.
Understanding Indicator Types
As you read through these indicators, you'll see references to "leading indicators". Here's what that means:
• Leading Indicator: Data that tends to change BEFORE the economy changes—giving early warning signals of what's coming. Example: If businesses start ordering more equipment, it signals they expect growth soon.
• Current Indicator: Data that tells you what's happening right now in the economy. Example: Current employment numbers show how many people are working today.
Growth Indicators
These measure the overall health and expansion of an economy:
GDP (Gross Domestic Product)
High ImpactWhat it measures: The total value of all goods and services produced by a country in a specific period (usually quarterly).
Why it matters: GDP is the ultimate scorecard of economic health. A growing GDP signals a healthy economy, which typically strengthens the currency.
Example: US GDP grows 3.2% vs expected 2.8% → USD typically strengthens because the economy is doing better than expected.
Industrial Production
Medium ImpactWhat it measures: The output of factories, mines, and utilities.
Why it matters: Shows how much the manufacturing sector is producing. Rising production suggests economic expansion.
Durable Goods Orders
Medium ImpactWhat it measures: Orders for products designed to last 3+ years (cars, appliances, machinery).
Why it matters: A leading indicator of manufacturing activity. Rising orders suggest businesses are confident about future demand.
Employment Indicators
Employment data is crucial because jobs = income = spending = economic growth:
Non-Farm Payrolls (NFP)
Very High ImpactWhat it measures: The number of jobs added or lost in the US economy (excluding farm workers).
Why it matters: This is THE most important forex market mover. Released on the first Friday of each month at 8:30 AM EST. Can move USD pairs 50-150+ pips in minutes.
The mechanism: Strong job growth → Businesses compete for workers → They offer higher wages to attract employees → Workers have more money to spend → Prices rise (inflation) → Central bank must raise rates to cool things down
This is why strong NFP numbers often strengthen the currency—markets expect the central bank to raise rates to keep inflation under control.
Example: NFP shows +250,000 jobs vs expected +180,000 → Stronger labor market → Fed may need to keep rates high or hike further → USD strengthens.
Unemployment Rate
High ImpactWhat it measures: The percentage of the workforce that is unemployed and actively seeking work.
Why it matters: Released alongside NFP. Falling unemployment typically strengthens a currency (healthy economy); rising unemployment typically weakens a currency (struggling economy).
Average Hourly Earnings
Medium ImpactWhat it measures: How much workers are being paid per hour, on average.
Why it matters: Rising wages mean workers have more money to spend on goods and services. When workers spend more, demand increases and sellers raise prices—that's inflation. Central banks watch this closely because rising wages often lead to rising inflation, which may require higher interest rates. Released with NFP.
Jobless Claims
Medium ImpactWhat it measures: The number of people filing for unemployment benefits for the first time (Initial Claims) and continuing to receive them (Continuing Claims).
Why it matters: Weekly data that provides a timely snapshot of labor market health. Rising claims = weakening job market.
ADP Employment Report
Medium ImpactWhat it measures: Private sector job growth based on payroll data.
Why it matters: Released 2 days before NFP, it's often seen as a preview—though it doesn't always predict NFP accurately.
Inflation Indicators
Inflation is how fast prices are rising. Central banks watch it closely because they often have an inflation target (usually around 2%):
CPI (Consumer Price Index)
Very High ImpactWhat it measures: The change in prices for a basket of consumer goods and services (food, housing, transportation, etc.).
Why it matters: This is what central banks watch most closely for their inflation targets (usually 2%). When CPI is too high, central banks raise rates aggressively. When CPI is falling toward target, they may cut rates or pause hikes.
Headline vs Core: Headline CPI includes all items. Core CPI excludes food and energy (which are volatile). Central banks often focus on Core CPI for policy decisions.
The central bank connection: US CPI comes in at 4.5% vs expected 4.2% → Inflation still too high → Fed likely to keep raising rates → USD strengthens.
PPI (Producer Price Index)
Medium ImpactWhat it measures: The change in prices that producers receive for their goods (wholesale level).
Why it matters: A leading indicator for CPI—if producers pay more, they eventually pass those costs to consumers.
PCE (Personal Consumption Expenditures)
High ImpactWhat it measures: Another measure of consumer inflation, but calculated differently than CPI.
Why it matters: This is the Federal Reserve's PREFERRED inflation measure. Core PCE is what the Fed targets at 2%.
Consumer Indicators
Consumer spending drives about 70% of the US economy. These indicators show how confident and active consumers are:
Retail Sales
High ImpactWhat it measures: Total receipts at stores that sell goods directly to consumers.
Why it matters: Shows if consumers are spending money. Strong retail sales = healthy economy = stronger currency.
Consumer Confidence
Medium ImpactWhat it measures: Survey-based measure of how optimistic consumers feel about the economy and their finances.
Why it matters: Confident consumers spend more. It's a leading indicator of future spending.
Michigan Consumer Sentiment
Medium ImpactWhat it measures: Survey from the University of Michigan measuring consumer attitudes and expectations.
Why it matters: Similar to Consumer Confidence—another gauge of how consumers feel about spending.
Business Activity Indicators
These surveys ask businesses about current conditions and future expectations:
PMI (Purchasing Managers Index)
High ImpactWhat it measures: Survey of purchasing managers about new orders, production, employment, and deliveries.
Why it matters: A reading above 50 indicates expansion; below 50 indicates contraction. Very timely data.
Types: Manufacturing PMI (factories), Services PMI (service sector), Composite PMI (combined). Services is typically more important for developed economies since they're service-heavy.
ISM Manufacturing / Services
High ImpactWhat it measures: Similar to PMI but specific to the US, from the Institute for Supply Management.
Why it matters: The most watched business survey in the US. Same 50 threshold applies.
Housing Indicators
Housing is a major part of the economy and often a leading indicator of overall economic health:
Housing Starts & Building Permits
Medium ImpactWhat it measures: The number of new residential construction projects started and permits issued.
Why it matters: Building permits are a leading indicator (plans for future construction). Housing Starts show current activity.
Existing & New Home Sales
Medium ImpactWhat it measures: The number of previously-owned and newly-built homes sold.
Why it matters: Shows consumer confidence (big purchases) and overall economic health. Sensitive to interest rates.
Trade Indicators
These show how a country trades with the rest of the world:
Trade Balance
Medium ImpactWhat it measures: The difference between a country's exports and imports.
Why it matters: A surplus (exports > imports) is generally positive for a currency. A deficit can weigh on it long-term.
Current Account
Lower ImpactWhat it measures: A broader measure that includes trade balance plus income from investments and transfers.
Why it matters: Shows overall flow of money in and out of a country. Large deficits can pressure a currency.
Quick Reference: High-Impact Indicators
You don't need to track everything. Focus on these major market movers:
• NFP - First Friday of each month (US)
• CPI - Monthly, around mid-month (all major economies)
• PCE - Monthly, end of month (US - Fed's preferred inflation measure)
• GDP - Quarterly (all major economies)
• Central Bank Rate Decisions - Scheduled meetings
• PMI/ISM - Beginning of each month
• Retail Sales - Monthly
How Indicators Connect
Economic indicators don't exist in isolation—they're all connected in a logical chain. Understanding these connections helps you see the bigger picture and predict what might happen next.
Here's how the economy actually flows, and why certain data points matter more than others.
The Economic Flow
Everything in the economy connects in a chain:
Why NFP matters so much: Jobs are at the START of this chain. More jobs → more income → more spending → stronger economy. This is why employment data is a leading indicator.
The Inflation Chain
Inflation flows from producers to consumers to central bank response:
Why PPI "leads" CPI: If factories pay more for raw materials (PPI rises), they eventually pass those costs to consumers (CPI rises). Watching PPI helps you anticipate CPI moves.
The Economic Cycle
Economies move through predictable phases in a continuous cycle. Understanding where we are helps you interpret data correctly:
↻ The cycle repeats continuously
Expansion
GDP rising, unemployment falling, confidence high
CB: Raising rates to prevent overheating
Peak
Max capacity, inflation rising, assets expensive
CB: Aggressively raising rates
Contraction
GDP falling, unemployment rising, confidence low
CB: Cutting rates to stimulate growth
Trough
Economy bottoming, low inflation, cheap assets
CB: Rates low, possible stimulus
The Policy Feedback Loop
Central banks respond to data, and their responses affect the economy, which creates new data. It's a cycle:
Inflation rises → Central bank raises rates
Higher rates → Borrowing becomes expensive → Economy slows
Economy slows → Less spending → Inflation falls
Inflation falls → Central bank cuts rates → Economy accelerates
Cycle repeats
Why This Matters
When you see one indicator move, think about what comes next in the chain. Strong NFP → likely wage growth → likely inflation → likely rate hike → likely currency strength. This chain thinking separates informed traders from those who just react to headlines.
Knowledge Check: Interpreting Economic Data
Economic data never exists in isolation. Test your ability to analyze indicators in context and predict central bank responses.
Question 1:
The US releases NFP showing +350,000 jobs (vs +180,000 expected) and unemployment falling to 3.5%. The same day, Average Hourly Earnings rise 5.5% year-over-year (vs 4.0% expected). The Federal Reserve has a dual mandate. Based on this data combination, what is the Fed most likely to do at their next meeting, and explain your reasoning through the full chain of events.
Reveal answer
The Fed is very likely to raise interest rates, possibly aggressively.
Here's the complete chain of reasoning:
Employment situation: +350,000 jobs vs +180,000 expected means the labor market is extremely hot. Unemployment at 3.5% is near historic lows—almost everyone who wants a job has one.
Wage pressure: Average Hourly Earnings at 5.5% (vs 4.0% expected) is the critical piece. This means:
• Employers are competing fiercely for workers → raising wages to attract talent
• Higher wages → workers have more money → consumers spend more → demand increases
• Businesses facing higher labor costs → pass those costs to consumers via higher prices → inflation
Fed's dual mandate dilemma:
1. Employment goal: ✓ Already achieved (near full employment)
2. Inflation goal: ✗ At risk (wage-driven inflation is building)
Since employment is already strong, the Fed doesn't need to cut rates to boost jobs. In fact, the labor market is too hot—it's creating inflation via wage pressures. The Fed must prioritize cooling inflation before it spirals.
Expected action: Rate hike of 0.50-0.75% to slow hiring, reduce wage growth, and cool consumer spending before inflation becomes entrenched. USD should strengthen significantly on this data.
Question 2:
Germany (part of the eurozone) releases PMI data: Manufacturing PMI falls to 42 (below 50 = contraction), Services PMI falls to 47. At the same time, German CPI rises to 5.0% year-over-year. The ECB has a single mandate focused on price stability. What is the ECB facing, and what makes this situation particularly difficult?
Reveal answer
The ECB is facing "stagflation"—the worst possible scenario for a central bank.
Breaking down the data:
• PMI below 50 = contraction. Both manufacturing (42) and services (47) are contracting → the economy is shrinking
• CPI at 5.0% = high inflation → prices are rising fast despite weak economic activity
Normally, you have one of two scenarios:
1. Strong economy + high inflation: Central bank raises rates to cool both (straightforward)
2. Weak economy + low inflation: Central bank cuts rates to stimulate (straightforward)
But this is weak economy + high inflation (stagflation):
• If ECB raises rates to fight 5% inflation → they'll make the recession worse (businesses will cut more jobs, consumers will spend even less)
• If ECB cuts rates to help the struggling economy → inflation will get worse (more spending → higher prices)
ECB's single mandate makes this even harder: Unlike the Fed (dual mandate: jobs + inflation), the ECB is legally required to prioritize price stability above all else. They must fight the 5% inflation even if it means deepening the recession.
Most likely action: ECB continues raising rates despite economic weakness, because their mandate demands it. This is why EUR can actually weaken during stagflation—yes, rates go up, but the economic damage undermines confidence in the eurozone. Markets may fear that high rates + recession = prolonged economic pain.
Question 3:
The US releases GDP data showing 3.5% annualized growth (strong), but the same report shows that the growth came entirely from government spending and inventory building, while consumer spending (which is 68% of GDP) actually contracted by 0.5%. Should traders view this as genuinely positive for USD, or is there a deeper concern? Explain using what you know about GDP composition.
Reveal answer
Traders should be concerned despite the headline 3.5% growth number. This is weak, unsustainable growth.
Why the headline number looks good: 3.5% GDP growth is solid—above the typical 2-2.5% trend for developed economies. At first glance, this suggests a healthy economy.
Why the composition is troubling:
• Consumer spending contracted (-0.5%): This is 68% of US GDP. If consumers aren't spending, the economy's foundation is cracking. Consumer spending reflects real household confidence, income, and willingness to spend—it's organic growth.
• Government spending drove growth: This is artificial, temporary stimulus. Governments can't keep spending indefinitely without creating debt problems. Once stimulus ends, growth disappears.
• Inventory building contributed: This means businesses stockpiled goods, but if consumers aren't buying (spending contracted!), those inventories will sit unsold. Next quarter, businesses will slash production and reduce inventories, causing GDP to fall.
The forward-looking concern: Markets don't just care about today's GDP—they care about the trend. If consumer spending is contracting, the next quarters likely show:
• Businesses cutting inventory (GDP drag)
• Less government stimulus (GDP drag)
• Continued weak consumer spending → possible recession
Market reaction: USD might rally briefly on the 3.5% headline, but sophisticated traders will dig into the details and realize this growth is fake. Once the breakdown circulates, USD could reverse and weaken as traders price in a coming slowdown. The Fed might also see this and decide they can't raise rates aggressively if the consumer is already hurting.
Question 4:
Japan releases CPI showing inflation has risen to 3.0% (above their 2% target for the first time in decades). Normally, rising inflation would signal potential rate hikes. However, traders barely react, and the yen stays weak. Why might the market not believe the Bank of Japan will raise rates despite above-target inflation? Consider Japan's unique economic history.
Reveal answer
Markets don't believe the BoJ will hike because Japan spent 20+ years desperately trying to CREATE inflation and failed. They're unlikely to kill it now by raising rates.
Japan's deflationary history (context matters):
• From the 1990s to 2020s, Japan struggled with deflation (prices falling, economic stagnation)
• The BoJ kept rates at 0% or even negative for decades trying to stimulate spending and create inflation
• They printed trillions of yen (quantitative easing) to force prices up
• Their stated goal was to achieve stable 2% inflation
Why 3% inflation won't trigger rate hikes (yet):
1. It might be temporary: Much of Japan's inflation is imported (energy, food prices rose globally). If it's not domestic demand-driven, the BoJ won't act.
2. Fear of killing growth: Japan finally achieved some inflation and economic momentum. Raising rates could send them back into deflation and stagnation—their nightmare scenario.
3. Credibility issue: The BoJ has said for years "we want higher inflation." If they suddenly pivot and hike rates the moment inflation hits 3%, it destroys their credibility. They'd be admitting they didn't actually want what they said they wanted.
4. Political pressure: Japanese policymakers are terrified of repeating past mistakes. They'll tolerate above-target inflation longer than other central banks would.
Market reasoning: "Yes, CPI is 3%, but the BoJ will probably say something like 'we need to confirm inflation is sustainably above target before acting' and keep rates at 0%." Until traders see persistent inflation (6+ months above target) AND hawkish BoJ rhetoric, they won't price in rate hikes. Hence, JPY stays weak despite higher inflation.