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Understanding ‘Industrial Production Index’ & Its Relative Impact On The Forex Market

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What is the Industrial Production Index?

Industrial Production Index or IPI, as it is commonly called, is an index that tracks manufacturing activity in different sectors of the economy. The IPI number measures the industrial production for the period under consideration, usually a month. IPI is a key economic indicator of the manufacturing sector of the economy. It measures the real output in the mining, electric, and gas industries, relative to the base year.

How is IPI calculated? 

Industrial Production is expressed as an index relative to the base year, which is 2012. They do not express absolute production numbers or volume, but the percentage change in production relative to 2012. The parameter taken into account is often varied, including physical inputs and outputs such as tons of iron, or inflation-adjusted sales figures, and when these parameters are not available, hours logged in by production workers is considered. This data is obtained from industry associations and government agencies, and the index value figure is obtained after incorporating these numbers in the Fisher-Ideal formula.

Within the IPI index, several sub-indices provide a detailed look at the production levels of highly specific industries. One can find the monthly production data of residential gas sales, ice cream, carpet and rug mills, spring and wire products, audio and video equipment, and paper in these sub-indices. The indices are seasonally adjusted, and sometimes the format is unadjusted.

Limitations of the IPI

While GDP estimates show that the manufacturing sector has picked up, the IPI doesn’t. In such cases, the question arises, which of the two should we believe. The selection of items for measuring the production output has remained the same for many years. This will have implications on the index value. IPI growth will have a certain directional bias. The recommendation has always been to make it more dynamic. All they are saying is to revise it more frequently. But the officials have been only pushing the dates forward.

Another limitation is in the selection of the base year. The 2011-2012 base year series shows faster growth than the previous one, 2004-2005 base year. Therefore, it is suggested to use the old methodology alongside the new method.

Analyzing the IPI 

The IPI data is particularly useful for money managers and investors who are a part of the business. At the same time, the composite index is an important macroeconomic indicator for economists who analyze the impact of the numbers on the economy and industry. Fluctuations within the industrial sector account for variation in the overall economic growth. The monthly metric keep investors informed about the shifts in the production levels.

At the same time, IPI ignores the most popular economic output measure, the Gross Domestic Product (GDP). GDP calculates the price paid by the end-user, so it includes the value-added in the retail sector. This is ignored by IPI. Another observation is that the industrial sector is losing its share in the GDP of a country; for instance, it made up less than 20% of the GDP of the U.S. economy as of 2016.

Along with IPI, capacity utilization is another useful indicator that investors analyze to assess the demand scenario. Low capacity utilization or overcapacity, in other words, signals weak demand. Policymakers read it as a need for fiscal or monetary stimulus in the economy. Investors read it as a sign of coming downtrend for the currency and the stock market. High capacity utilization, on the other hand, acts as a warning signal that the economy is overheating, suggesting the risk of price hikes and asset bubbles. Policymakers react to such threats with interest rate hikes or fiscal austerity. There is also a possibility that this could ultimately result in a recession.

Impact on Currency

Industrial production figures are directly proportional to the value of a currency. When Industrial Production is high, it means economic activity is improving in the country that directly contributes to the GDP. A rate of GDP leads to an appreciation in the currency value. However, an effect on the overall economy is felt when industrial production is increasing each month. An improvement in the production output for one month has no impact on the currency; the average value of at least three months makes a difference. The IPI is an early indication of growth in the manufacturing sector, which is why it is closely watched by investors and traders.

Sources of information on Industrial Production Index

The Federal Reserve Board publishes the industrial production index (IPI) every month, which is released approximately in the 2nd week of the month. The revisions in the method of calculation, if any, are released at the end of every March. As it is an important indicator of growth in the manufacturing sector, most open-source economic websites keep track of their respective countries’ data.

GBP (Sterling) – https://tradingeconomics.com/united-kingdom/industrial-production

AUD – https://tradingeconomics.com/australia/industrial-production

USD – https://tradingeconomics.com/united-states/industrial-production

CAD – https://tradingeconomics.com/canada/industrial-production

EUR – https://tradingeconomics.com/european-union/industrial-production

JPY – https://tradingeconomics.com/japan/industrial-production

The Industrial Production Index (IPI) is an important economic indicator published by the Federal Reserve Board (FRB) of the United States that measures manufacturing, mining, and utilities’ real production output. The indices are computed mainly as fisher indices with more weightage on the annual estimates of value-added. The fisher methodology only preserves the growth information, which is why the value of the base year, i.e., 2012, is randomly set to 100. This index, along with other industrial output indexes and construction, accounts for the bulk of the total output variation throughout the business cycle.

Impact of the ‘Industrial Production Index’ news release on the Forex market

In the previous part of the article, we understood the significance of Industrial production fundamental indicators in an economy. Now let’s discuss the impact of the Industrial Production Index news announcement on the value of a currency and witness the change in volatility due to the news release. As discussed previously, Industrial Production measures the change in the total inflation-adjusted value of output produced by manufacturers, mines, and utilities.

For instance, Industrial Production measures the output of businesses in the industrial sector of the United States economy, where the manufacturing sector accounts for 78 percent of total production. Some of the biggest segments of this sector are Chemicals, food, drinks and tobacco, machinery, computer and electronics, motor vehicles, and others.

Now let’s analyze the Industrial Production data of the United States released in June. As we can see in the below image, Industrial Production in the United States increased to 1.4% percent in May, which was much higher than the previous month. The Industrial Production numbers in April and May are largely influenced by COVID-19. Let us find out the reaction of the market to this data.

EUR/USD | Before the announcement

Let us start with the EUR/USD currency pair witness the change in volatility due to the news announcement. The above image shows the state of the chart before the news announcement, where we see that the market was in an uptrend and recently has laid out signs of reversal.

EUR/USD | After the announcement

After the news announcement, the price moves higher, and volatility slightly increases to the upside. However, the price does not go much higher, and the major trend to the downside continues. Thus, it would be right to say that the news announcement had a positive impact on the U.S. dollar.

USD/JPY | Before the announcement

USD/JPY | After the announcement

The above images represent the USD/JPY currency pair, where we see that the market is moving within a ‘range’ before the news announcement. Just when the Industrial production numbers are to be released, the price is at the top of the ‘range,’ and volatility is high. Depending on the impact of the news release, we take a suitable position in the currency pair.

After the news announcement, the market moves lower by a couple of candles, as seen in the above image, and gets retraced by strong buyers who take the price above the ‘news candle.’ But since the price is again at resistance, it eventually moves lower and reaches the support. By this price action, we can say that the currency pair becomes highly volatile after the news announcement.

NZD/USD | Before the news announcement

NZD/USD | After the news announcement

The above price charts belong to NZD/USD currency pair, where we see that before the news announcement, the price was moving higher, and now it has displayed a strong reversal pattern in the market, indicating a reversal to the downside. If the news release does not change the underlying price action pattern, one can take a risk-free ‘short’ position in the currency pair. This is how technical analysis is used in conjunction with fundamental analysis.

After the news announcement, the price moves higher by a little, and ultimately the reversal pattern dominates the market, and price makes a ‘lower low.’ Therefore, the slight bullishness that was witnessed due to the news announcement was of significance, and the market crashed.

We hope you got the gist on what the ‘Industrial Production Index’ is and its impact on the Forex price charts after its news release. In case of any questions, let us know in the comments section below. Cheers!

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