Foundations on Forex - Unemployment and Inflation [part 2]

In the first part of this series, we talked about the importance of filtering information on the market. Today, however, we will focus on other economic aspects, published data and how they shape exchange rates. We invite you to read.

Be sure to read: Foundations on Forex - Introduction. Interest rates and GDP - Vol. 1

Data on unemployment

In this topic we will find two key indicators. They relate to employment, i.e. the percentage ratio of the number of employed to all those able to work, and unemployment, i.e. the percentage ratio of the number of unemployed (importantly registered) to all able to work. There is therefore a general relationship regarding the development of courses based on these readings.

• decrease in unemployment rate -> increase in the national currency rate
• increase in unemployment rate -> decrease in the national currency rate

If the currency exchange rate remains high for a long time, this will indirectly lead to an increase in unemployment in the domestic industry, which focuses on the export of goods due to an increase in the prices of domestic products abroad and a decrease in the prices of foreign goods. Of course, the high level of the national currency must persist for a longer period of time, where a strong native currency will clearly become a burden for exporters. It is not worth considering this indicator separately or making investment decisions solely on its basis. Very often unemployment data are simultaneously considered with data on import / export or industrial PMI. They are a good complement to them. The above dependencies can also be broken up, as we have done below:

• Export Industry:

• • increase in the national currency exchange rate -> increase in the prices of exported goods (for foreign recipients) -> decrease in the level of exports -> increase in unemployment
  • decrease in the domestic currency exchange rate -> decrease in the prices of exported goods -> increase in exports -> decrease in unemployment

Why is the general relationship given above not applicable here? For a simple reason. The high level of the exchange rate of the national currency may contribute to a decrease in exports, while it is very good information for importers. So there are companies that will benefit from poor information for exporters. Therefore, it is very important to consider employment data in the context of their broad impact on specific areas of economic activity. Let's look at the situation in the domestic industry.

• Domestic industry:

• • increase in the national currency -> decrease in import prices -> increase in import level -> increase in unemployment rate
  • decrease in the national currency -> increase in import prices -> decrease in import level -> decrease in unemployment

The process associated with an increase or decrease in unemployment is cyclically associated with the national currency. Consider the last part from the domestic industry, where the decline in the national currency leads to a decrease in unemployment. Taking the general assumption that low unemployment is causing a rise in the national currency, the reverse is followed. Hence, we can somewhat speak of the cyclical nature of this process.

Inflation

Inflation is undoubtedly one of the best-known, market-relevant and "catchy" indicators. The level of inflation or depreciation of a national payment unit is measured by the rate of price increase, as the above indicator illustrates. There are two types here:

• PPI (Producer Price Index), otherwise say Production Price Index. We read from it the price changes that occurred in  production goods.
• CPI (Consumer Price Index), that is, the index of prices of goods and services, which illustrates the changes in prices of consumer products.

Core inflation is an alternative to CPI. Usually, the publication of this data appears on a semi-annual and then quarterly basis. The general relationship between inflation and currency is as follows:

• drop in inflation -> increase in the national currency rate
• increase in inflation -> decrease in the national currency rate

Considering the imports discussed above, the following relationship also arises:

• increase in the national currency exchange rate -> lower import costs -> drop in inflation
• decrease in the domestic currency exchange rate -> higher import cost -> increase in inflation

Why does the decline in the national currency rate cause inflation to increase over time? In most cases, this is due to the fact that importers have to pay more in foreign currency for goods imported from abroad with weaker native money. Since they pay more, the goods they import become relatively more expensive. Therefore, an increase in this price causes an increase in inflation.

The relationships between inflation and the national currency rate presented above should be confirmed by the closely related export / import factor, which, as you can see, helps to filter out incorrect market signals.