Some years ago, when it was pointed out that City analysts had, for more than a year, consistently called the path of UK interest rates wrongly, a senior economist working for a commercial bank shrugged it off. The inaccuracy of the forecasts did not really matter, he said, because they still gave dealers “something to trade on”.
Economic data provides “something to trade on”, month in, month out. Figures on growth, inflation, employment, prices, retail sales and the rest, pouring forth from America’s Bureau of Labor Statistics and Bureau of Economic Analysis, from Britain’s Office for National Statistics, from Eurostat and elsewhere.
And trade they do, although less flamboyantly than in the days of open-outcry dealings, when dealers in striped jackets would fly into a frenzy at the announcement of US trade deficits or Japanese surpluses.
Indeed, the lengths to which some traders have gone in the past to obtain official data a few moments before their rivals have strayed into illegality, certainly in the UK, with allegations of insider dealing.
It is deplorable, of course, but it does at least suggest that the traders concerned see a real value in the figures. But are they right to do so?
The argument against trying to trade the economy, as opposed to trading individual assets or asset classes, would start with the fact that, in the absence of inside information or of any special insight into the economic issues in question, you would be trading on the same data as everyone else and probably reacting in the same way. That is not how to generate good returns.
These are not unusual happenings.
A third reason not to try trading the economy, is that the figures are all backward-looking, by definition. Does it really help a trader to know where the British unemployment rate stood a month ago?
Finally, there is the whole question of effort and reward. A trader can build up knowledge and expertise regarding one or more shares, or currencies, or commodities. But the national and global economy is a huge subject that can defeat university professors and professional economists.
Timing the exit
What chance does a trader have in trumping their efforts?
The response from those who favour trading the economy would pick up the first point and turn it round. What does it matter if you react to the data in the same way as everyone else? If “the trend is your friend”, why should it matter?
Yes, official data can be unreliable, but why would that trouble a dedicated trader? Both the initial figures and the revisions provide trading opportunities for the nimble-footed. To take an absurd example, economic data that never changed would provide none.
Nor is there any reason to disregard economic information on the basis that it is backward-looking. In the absence of a crystal ball, all data is backward-looking, given that tomorrow’s figures have yet to be collected.
Finally, no-one needs be an expert in economics to be able to trade the economy successfully. What is needed is a feel for how the market will react, based on past reactions, of the type that can be depicted on charts, and on expectations in the market.
All that said, the successful trader will be cautious and selective in terms of trading the economy. They will see little benefit in treating each piece of data on its own, and will instead pursue a joined-up approach, looking at the links between different sets of figures and between official numbers and real-world outcomes.
For example, rising unemployment combined with falling inflation would be likely, all things being equal, to stay the hand of the central bank in terms of raising interest rates and may even prompt a cut. This, in turn, would be likely to give a lift to stock-market indices but reduce the value of the national currency.
A cautionary tale
In contrast, of course, a buoyant employment scene and rising inflation may well signal a tightening of monetary policy, supporting the currency and casting a shadow over equity prices, especially the price of stocks issued by heavily borrowed companies.
Such joined-up thinking is key to trading the economy successfully. It takes full account of all the moving parts in the economy and how they affect each other.
Trading the economy is not for everyone, but can be highly rewarding for those suited to it. The best of these will be constantly aware of the danger of assuming conventional thinking about forthcoming data is correct, and illustrated by this cautionary tale.
America’s trade deficit was a huge issue in the late Eighties, and the latest monthly numbers were eagerly awaited. Two British journalists, warning readers not to put money on an extreme outcome, gave an example of the sort of hugely exaggerated figure that would cause them loss.
One reader misunderstood the advice, put money on such an outcome and was immensely grateful to the journalists when this “impossibly large” deficit was announced.