You're all set to go out for a leisurely walk. Weather forecasters have predicted sunny skies and warm temperatures, so you head out in shorts and leave the sweater at home. Ten minutes later a heavy thunderstorm erupts, followed by colder air. You quickly scramble back for a change of clothing, all the while cursing the forecasters. How could they have gotten it so wrong?
Money managers encounter similar experiences, except that instead of weather, they tend to rely on surveys that feature forecasts from experts on what an upcoming economic indicator will report. If the actual economic news falls in line with expectations, there is generally little market reaction to the news because investors already anticipated it. By getting it right, those forecasters demonstrated that they have a good grasp on what the economy is up to. However, had the news about the economy turned out to be radically different from what private experts predicted, money managers would have rushed in to readjust their investment positions. These abrupt moves can potentially shake up the value of stocks, bonds, and currencies. Why such violent market reactions? Any major departure from expectation means something is going on in the economy for which the experts failed to account. Naturally this brings fresh uncertainty about current and future economic conditions. The bigger the gap between consensus expectations and reality, the larger the backlash in the financial markets.
Who puts out these consensus surveys, and how are they done? Many financial wire service organizations, such as Bloomberg, Dow Jones, Reuters, and Market News International, produce their own consensus surveys by polling economists for their predictions on key upcoming economic indicators. These indicators include consumer prices, producer prices, industrial production, retail sales, capacity utilization, and others. The methodology used is fairly simple: The responses of individual business economists are basically averaged out, and that becomes the consensus forecast.