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US GDP data may dampen rate-cut bets and lift the dollar

The first estimate of US GDP for Q2 is due at 12:30 GMT on Friday, and could be crucial in shaping the narrative over how deep the Fed will cut rates next week. While a 25 basis points (bp) cut is certain, markets also assign a ~20% chance for a ‘double’ cut of 50bp, which seems excessive. Hence, the dollar may have room to recover for now, if these aggressive bets are scaled back.

The US economy likely grew at a slower pace in the second quarter, with forecasts pointing to an annualised GDP growth of 1.8%, from 3.1% in Q1. Yet the situation isn’t as worrisome as it seems. Much of the strength in Q1 was owed to firms accumulating inventories, which usually means weaker growth in subsequent quarters as companies unwind those inventories.

In fact, even though overall growth may slow, domestic demand likely strengthened thanks to robust consumer spending in Q2, which is encouraging since consumption accounts for nearly 70% of the economy. In other words, the upcoming data are expected to show that the most important contributor to growth – the consumer – is back in the driver’s seat, even if the headline GDP rate is not as impressive as Q1.

The point is that the US economy doesn’t seem to be in dire need of monetary stimulus, even though the Fed has committed to cutting rates next week. To be fair, policymakers have acknowledged that the domestic economy is in good shape, but still, think a rate cut is needed as protection from a darkening global outlook and the uncertainty caused by trade tensions. From this point of view, a ‘preventive’ rate cut makes sense.

What makes less sense though, are the persistent market expectations for a ‘double’ cut of 50bp in July. First and foremost, it seems unreasonable for the Fed to use so much of the rate ammunition it fought so hard to accumulate in recent years, without the economy being in trouble.

Second, there’s little support for such action. Even St. Louis Fed President James Bullard, who voted for an immediate rate cut in June and was opposed to raising rates last year, recently said he would like to cut only by 25bp in July, not by 50. He is arguably the most dovish member of the Committee, so if he is against it, there’s almost no scope for such an aggressive move.

As for the market reaction, since more easing is priced in than the Fed is likely to deliver, this generates an upside risk for the dollar over the coming week. This repricing could occur on the GDP data if they are solid enough to finally dispel expectations for a 50bp move.

Taking a technical look at USD/JPY, initial resistance to advances may be met near the 109.00 level, with an upside break turning the focus to 109.90, the May 30 high.

On the flip-side, another wave of declines could stall around 107.20. If the bears pierce below that, the June lows at 106.75 may be the next obstacle.


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This information is not considered as investment advice or investment recommendation but instead a marketing communication. This material has not been prepared in accordance with legal requirements designed to promote the independence of investment research, and that it is not subject to any prohibition on dealing ahead of the dissemination of investment research.

Source: XM

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