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The “new normal” of economic growth has been around 2-2.5%. In 2016, overall GDP growth stood at 1.6%. Economic activity decelerated in the first quarter of 2015 to 1.4% annualized. The euro-zone has surpassed the US in growth.  

Everybody is expecting a pickup in the second quarter, to around 2.5% annualized, but there are reasons to curb the expectations. Retail sales have disappointed and consumption is critical to the US economy. The US dollar is in need for some cheering after the recent drops.

This GDP report is important

Economic growth now means more job gains later, and more jobs growth later imply higher inflation. For the Fed to raise rates, it needs not only CPI to accelerate, and like growth, it has been decelerating in recent months. The Fed’s favorite measure, Core PCE, dropped from a high of 1.8% to 1.4% y/y.

In September, the Fed is expected to begin reducing its balance sheet, and another hike is on the cards for December, but markets see it as 50-50. The outcome of this report could significantly tilt the odds of a hike and the US dollar.

The market impact of this report also stems from its nature: it is the first estimate out of three. The next two are revisions that look into a more distant point in the past.

EUR/USD uptrend

EUR/USD is in a clear uptrend since the beginning of the year. It reached a 14-year low at 1.0340 and has made its way to the highest levels well over 14 months. The big breakouts have been seen quite lately.

While a correction may be needed after the big moves, the euro enjoys several advantages over the dollar. The ECB’s monetary policy lags behind that of the Fed, but the direction of travel is changing in favor of the euro. Draghi has all but said that tapering is coming in the Autumn. The Fed is hesitant about inflation.

In addition, politics look much better in Europe after Macron’s win and Merkel strong lead in the polls. The high hopes for a growth agenda from Trump are gone and the President is getting into deeper trouble. The pace of news developments is accelerating.

3 Scenarios

  1. Within expectations: 2.3-2.7%: Such a growth rate would reflect a return to the new normal, but no big bounce back. The dollar is likely to wobble and resume its downward trajectory, perhaps after the weekend.
  2. Above expectations: 2.8% or above. A robust growth rate, close to the 3% that President Trump once mentioned or above this level, could serve as a turning point for the dollar, or at least a significant correction to the downtrend. EUR/USD could fall below support and wait for more data next week before deciding if this is only a correction or worse.
  3. Below expectations: 2.2% or below: A level that would leave the H1 growth rate significantly under 2%, the lower bound of the new normal, would be quite depressing. EUR/USD could break to higher ground on the announcement and continue the uptrend next week.

What do you think?

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