Dollar Pares Gains in "Buy the Rumour, Sell the Fact" Response to Blowout GDP Report

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The US Dollar pared earlier gains Friday in a classic "Buy the Rumour, Sell the Fact" response to second-quarter GDP numbers that showed economic growth picking up sharply, although analysts are growing doubtful about the prospect of further outperformance from the world's largest economy in the quarters ahead.

US GDP growth rose at an annualised pace of 4.1% during the three months to the end of June, up sharply from the upwardly-revised 2.2% pace of growth seen at the beginning of the year, but marginally below the economist forecasts for a 4.2% increase. 

Consumer spending and strong export trade growth were the main contributors to the uptick in US growth, although federal and local government spending were also flagged by the Bureau of Economic Analysis as key drivers behind the upturn too. 

The personal consumption expenditures price index, which is the Federal Reserve's preferred measure of inflation, was shown to have risen at a rate of 2% during the second quarter. This is on the button as far as the Fed's target goes and supports market expectations of further interest rate rises to come.

"Growth flowered in the spring, but there were plenty of reasons to think that the US economy can't sustain anywhere near that pace head," Avery Shenfeld, chief economist at CIBC Capital Markets. "Overall, these are definitely big numbers, but not unexpectedly so, and should not alter views on the Fed or the second half outlook much."

Trade data for the second quarter, released on Thursday, showed a marked increase in US exports during recent months and so had pointed toward a strong GDP number Friday. And this was when markets were already anticipating an upturn given solid levels of consumer spending revealed in the monthly data. 

"Nominal GDP rose at a startling 7.4% rate - great for corporate earnings, given slow growth in unit labor costs," says Ian Shepherdson, chief US economist at Pantheon Macroeconomics. "The Q2 number means that next week's monthly data for June will be soft, and the May and/or April numbers will be revised down. This won't change the Fed's policy outlook, but it will give doves a bit more room to breathe, for now."

The US Dollar index was quoted 0.06% higher at 94.81 following the release after paring back an earlier 0.09% gain while the Pound-to-Dollar rate was 0.04% lower at 1.3003 and the Euro-to-Dollar rate was 0.02% lower at 1.1640. Both Sterling and the Euro also pared losses against the greenback following the report.

"The 4.1% annualised gain in second-quarter GDP should ensure that the Fed continues to hike its policy rate once every quarter, particularly as core PCE consumer prices increased by 2.0% annualised," says Paul Ashworth, chief US economist at Capital Economics. "Helped by the massive fiscal stimulus, the economy enjoyed a strong first half of this year but, as the stimulus fades and monetary policy becomes progressively tighter, we expect GDP growth to slow markedly from mid-2019 onwards."

Currency markets care about the GDP data because it reflects rising and falling demand within the US economy, which has a direct bearing on consumer price inflation, which is itself important for questions around interest rates. And interest rates themselves are a raison d'être for most moves in exchange rates.

The Federal Reserve has raised interest rates seven times since the end of 2015, taking the Federal Funds rate range to between 1.75% and 2%. Many economists expect it to raise rates so that the top end of that range hits 3.25% around the end of 2019.

Changes in interest rates, or hints of them being in the cards, are only made in response to movements in inflation but impact currencies because of the push and pull influence they have on international capital flows and their allure for short-term speculators.

"There’s no doubt the US economy is strong – especially given where we are in the cycle – and today’s 2Q18 GDP release should in effect confirm this strength. But if anything, our message to investors today is to warn against extrapolating a potential 4% quarterly annualised growth figure," says Viraj Patel, an FX strategist at ING Group. "Today’s US GDP print is not the start of a new economic norm; the circa 4% figure is distortedly high due to base effects (soft 1Q), some tariff-related trade activity and high inventories."

Patel says it is essential not to confuse "optically high" quarterly numbers with annual economic growth, the pace of which is expected to come in at a much lower 2.8% - 3% this year, given the importance of GDP growth differentials for exchange rates.

Most analysts now agree that superior levels of US economic growth have bolstered the case for the Federal Reserve to keep raising its interest rate, at a time when the interest rate outlook elsewhere in the world has deteriorated, which has incentivised traders into selling other developed world currencies and buying US Dollars.

Eurozone economic growth nearly halved in the first quarter, falling from a quarterly pace of 0.7% to just 0.4%, and so too did growth in the UK. Second quarter data is yet to be released for the Eurozone and UK, although neither has benefited from the short-term boost delivered to the US economy by President Donald Trump's tax cuts.  

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