Economic Policy
by Vadym Goncharenko on August 17, 2023

Why is U.S. Retail Sales Important Economic Value for the Forex Markets?

Why is U.S. Retail Sales Important Economic Value for the Forex Markets?

The forex markets’ ebbs and flows provide the volatility needed for traders to make money. Currency markets move and correct in long, medium, and short-term trends, driven by fundamental and technical forces. One of the most important currencies is the U.S. dollar which, when paired with several currencies, makes up the major currency pairs that drive the volume of forex traded daily.

The movements in dollar currency pairs are a function of either the base or counter currency that is not the dollar and the underlying trends of the U.S. dollar, which is driven by U.S. interest rates, trade flows, and sentiment. One of the essential drivers of these underlying trends in consumer behavior can be encapsulated in the U.S. Retail Sales report.

What is U.S. Retail Sales Report?

The U.S. retail sales report is a monthly economic indicator that measures the total sales of goods and services by retail establishments within the United States. The report provides insights into consumer spending, a significant economic growth driver. The U.S. Commerce Department releases the information around the 15th of each month, covering data from the previous month. The retail sales report gives us a picture of consumer trends, allowing analysts and policymakers to assess the economy’s health and make informed decisions. U.S. retail sales combine goods and services retailers sell in the United States.

In the United States, consumer spending makes up approximately 70% of GDP. Consumer spending is the total amount of money individuals spend on goods and services. Retail sales, on the other hand, specifically refer to the sales made by retailers to the final consumers.

The volume of consumer spending is often considered a reflection of consumer sentiment. Consumer sentiment refers to individuals’ overall confidence and outlook regarding their financial situation and the state of the economy.

When consumer sentiment is positive, and individuals feel optimistic about the future, they are more likely to increase their spending on goods and services. This increase in spending can be seen as a vote of confidence in the economy and can contribute to economic growth.

Conversely, when consumer sentiment is negative, and individuals feel uncertain or insecure about their financial situation or the overall state of the economy, they tend to reduce their spending. This decrease in consumer spending can harm economic growth.

Various factors influence consumer spending, including income, employment, interest, inflation, and government policies. Economists and policymakers can gain insights into consumer sentiment by analyzing consumer spending patterns and adjusting their strategies and policies accordingly.

How are Retail Sales Calculated?

U.S. retail sales are typically calculated using data collected by the U.S. Census Bureau. The Census Bureau conducts a monthly survey called the Monthly Retail Trade Report, which contains data from various retail businesses nationwide. This data includes both online and brick-and-mortar stores.

The survey covers various retail categories, such as clothing, electronics, furniture, and home improvement. It collects information on the dollar value of sales and the volume of goods sold. The data is compiled from a representative sample of retailers and then extrapolated to estimate the total retail sales for the entire country.

This data is essential for tracking the overall health of the retail sector and understanding consumer spending trends. It provides valuable insights for businesses, economists, and policymakers in assessing economic conditions and making informed decisions.

How Does Retail Sales Impact Monetary Policy

Retail sales can impact interest rates set by a central bank’s monetary policy. The Federal Reserve in the United States will monitor retail sales figures. More robust retail sales will generally drive a hawkish tone from the Fed, while weaker retail sales usually create a dovish tone. A “hawkish Fed” refers to the Federal Reserve adopting a more aggressive stance towards monetary policy. In this context, “hawkish” means that the Fed is more concerned about controlling inflation and takes a stricter approach to managing interest rates and tightening monetary conditions. A hawkish Fed typically increases interest rates more frequently or significantly, impacting borrowing costs, investment decisions, and economic growth. It often contrasts with a “dovish Fed,” which takes a more accommodative approach to support economic expansion.

How Does Retail Sales Affect Consumer Sentiment?

Retail sales can have a significant impact on consumer sentiment. When retail sales are strong and show growth, it generally signals a healthy economy and can boost consumer confidence. Increased retail sales can indicate that consumers are willing to spend more, which can lead to a positive outlook for the future. This positive sentiment can have a ripple effect on other sectors of the economy, as increased consumer spending can stimulate business activity and job growth. Alternatively, if retail sales decline or are weaker than expected, it can negatively affect consumer sentiment. This situation can make consumers more cautious about their spending, decreasing overall economic activity.

How Do Interest Rates Impact the Forex Market

While retail sales can impact interest rates, interest rates can affect the movements in forex trading. Interest rates have a significant impact on currency markets. Central banks, such as the Federal Reserve in the United States, use interest rates to control inflation and stabilize the economy. Interest rates attract more foreign investment into a country, as higher rates mean higher investment returns. This increased demand for the country’s currency can lead to its appreciation relative to other currencies.

On the other hand, when interest rates are lowered, it can decrease the attractiveness of a country’s currency for foreign investors as the returns on investments become relatively lower. This policy change can lead to a depreciation of the currency.

Interest rate differentials can lead to changes in the forex markets. An interest rate differential refers to the difference in interest rates between two countries or regions. It is commonly used in the context of the foreign exchange market to analyze the potential impact on currency exchange rates. The interest rate differential is calculated by subtracting one currency’s interest rate from another’s interest rate.

What are Interest Rates Differentials

The interest rate differential provides insights into the relative attractiveness of two currencies for investors. A higher interest rate in one country compared to another can make that currency more appealing to investors seeking higher returns. This increased demand for the currency can lead to its appreciation relative to the other currency.

Conversely, a lower interest rate in one country compared to another might make that currency less attractive for investors seeking higher yields.

Interest rate differentials can impact various financial transactions, such as carry trades, where investors borrow money in a low-interest-rate currency to invest in a higher-interest-rate currency, aiming to profit from the interest rate differential. Traders and investors closely monitor interest rate differentials as they can provide valuable insights into potential currency movements and investment opportunities.

What Does Currency Trades Drive Currency Movements

Investors engage in carry trades by borrowing a low-interest-rate currency and investing in a higher-interest-rate currency. When interest rates change, it can affect the profitability and attractiveness of carry trades, influencing currency demand and exchange rates. Higher interest rates can attract foreign investors seeking better returns, increasing capital flows into a country.

Interest rate changes can impact inflation expectations. Higher interest rates may indicate tighter monetary policy to control inflation, which can strengthen a currency. Lower interest rates can be associated with looser monetary policy and could lead to inflationary pressures, potentially weakening a currency.

It’s important to note that other factors, such as economic indicators, geopolitical events, and market sentiment, can influence currency markets. Nevertheless, interest rate differentials and expectations play a significant role in shaping currency movements.

How Does Technical Analysis Impact the Currency Markets?

Forex technical analysis is a methodology traders and analysts use to forecast future price movements in the foreign exchange market. It involves analyzing historical price data, such as charts and indicators, to identify patterns, trends, and potential trading opportunities. Technical analysts believe that past price behavior can provide insights into future price movements, and they use various tools and techniques to interpret and make predictions based on these patterns. Some standard technical analysis tools include moving averages, trend lines, support and resistance levels, and oscillators. By studying these indicators, traders aim to make informed trading decisions and capitalize on potential price movements in the forex market.

The Bottom Line

Retail sales are an important economic indicator that can profoundly impact the direction of a currency pair. Since retail sales are used to compute part of consumer spending in the United States and consumer spending makes up about 70% of GDP, changes in Retail Sales partially drive the growth aspect of the decision to alter monetary policy. Retail sales are calculated by looking at the dollar value and volumes of goods and services sold in the United States. The Commerce Department issues the report once a month, and it is an essential report to follow for those participating in the forex markets.

By Vadym Goncharenko

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