The IFO Business Sentiment (or IFO Business Climate Index) is an economic indicator which can impact (and often does move) currency prices.
Which currencies are affected by this indicator?
How can I trade this indicator to make some pips?
And last, but not least, what on earth is this IFO Business S?
The IFO Business Sentiment is an index compiled and published by the CESifo group (part of the Center for Economic Studies, CES, in Munich, Germany).
What type of index?
It measures business confidence in Germany.
You’ve probably heard of consumer sentiment surveys.
This is just the same, but the surveys are sent to business owners and business-people in different sectors of the economy.
The idea is that asking business owners will give us a different lens than that of asking consumers.
Also, many would argue (convincingly) that business people are on average much more informed than your everyday consumer.
Not only are they consumers themselves, but they have access to insider information, and can predict trends in their industries more accurately.
As such, by compiling the opinions (with numbers, of course) of a representative sample of business people, we can get an idea of how the economy will do.
How the economy will do?
Yes. The survey asks about how they see things going in the future (6 months down the road, etc.).
The sample takes 7,000 responses across all major industries, according to some sources.
Why does this index matter?
We gave a slight preview before (similar to consumer sentiment), but the gist of it is this:
By measuring how producers are doing, and how they expect business to go in the future, we get a preview (some call it leading indicator) of how things will go.
As an FX trader, why do I care about how “things will go”, isn’t that too abstract?
I will cover this in the next section (don’t jump).
How often is the IFO Business Sentiment released?
It is released monthly. Which means you’ll have plenty of opportunities to trade it in a year, especially if it misses expectations and surprises the markets.
Why do we care about Germany?
I mean… if it’s a Germany indicator, and we’re talking currencies… then we’re talking about price moves in the Euro, aren’t we?
Yes, that’s right.
But there are reasons Germany and France’s economic indicators affect the Euro (especially Germany’s).
Why do you think that is?
If you make the math, that’s 30.9%.
Yep, you heard that right.
Germany accounts for 30% of the Eurozone’s economy (GDP, nominal terms, 2016, my own calculations based on data from the ECB and the IMF).
This number is huge!
But we also have to factor in Germany’s geographic location.
European countries are very open to international trade.
Their major partners? Each other.
Since Germany is so big, and it’s at the center of the action, its economy has a direct effect on other eurozone countries.
If demand in Germany slows down, suddenly they stop importing (buying) those goods made in France…
Some people decide not to buy those Italian Ferrari’s…
I think you get the picture.
The reverse is also true (few things are 100% true, all the time, and this is no exception). A strong German economy picks the others up through trade.
That’s why Germany’s economic indicators, including the IFO Business Sentiment, affect the Euro.
What’s good for Germany is good for the Eurozone (please don’t fork me, hahaha).
As I promised, first we will go over why on earth FX traders care about this indicator.
If business owners are excited about the economy picking up, then it’s because they expect demand of their product to pick up.
Such increase in demand will have them produce more (which means more demand, since they have to pay for more materials or labor) or…
They can increase prices (or a combination of both things).
All else equal, such a pickup in economic activity brings growth, and growth means higher demand for the currency.
Wait… why is that the case?
Economic growth means more products and services are being produced and sold, right?
Individuals and organizations need money to purchase those goods and services.
To be more precise, a country (and foreigners) need the country’s currency to purchase those goods.
And as we all know, higher demand for the same supply = higher price.
Thus, a pickup in economic activity is usually a “good” thing for a currency.
Note: “good” because it appreciates the currency against others, which is good in a few ways (imports less expensive), but bad in others (our exports are more expensive for others to buy, if exports fall, so does our income).
End of note.
This is why strong GDP figures strengthen the currency in question.
Traders anticipate the increase in currency demand and jump in for quick profits.
Secondly, an increase in economic activity (and the price increases we mentioned) can often lead to a general increase in prices.
But a general increase in prices is what we call inflation.
Haven’t we heard a lot about inflation before?
Yep, and as you should know by now, every Central Bank on the face of the earth has the mandate to keep inflation in check.
Thus, if prices increase too fast and/or too much, the Bank will curb inflation by increasing interest rates (this is a decrease of currency supply).
As we know, lower supply for the same demand (in this case, higher demand) = higher price of the good in question.
Since we’re talking currency price here (Euro, for the IFO Business Sentiment), then we have a double whammy:
1. Increased demand of Euros due to economic growth.
2. (Potentially) Fewer Euros in the economy because the ECB hiked rates.
Both of these work in the same direction: Euro going up.
Of course, the same can be said of a slowdown in the IFO Business Sentiment.
Caveat: these are the economic mechanisms linking the economy to currency price, however, this isn’t like the law of gravity (you get what I mean, right?)
No, not always.
My suggestion would be to check if the markets are particularly expectant of it on a given month.
If so, then you can definitely trade out of the event (wait for headline and trade it).
Trading out of an event has the advantage that you know the result (much less risk).
But it has the great disadvantage: it’s hard to catch the whole move, and if you hesitate for a second, you may not make money since most already got in.
Another way to go in is by trading into the event (get in before announcement).
This one is obviously riskier, but there are situations in which risk is lower.
For example: one of the currencies may be very-well supported at the time, so if the trade goes against you, its likely price will retrace soon.
On the other hand, you will make the entire move in profits if it goes your way.
There are many more caveats here, but we’ll leave it for its own page: How to Trade Into a Forex News Events (coming soon).
Hope you liked this take on the IFO Business Sentiment.
And with that, I’m off.
See you soon,
The Forex Economist
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