Today’s Q2 US GDP data were positively received by the market – EURUSD fell to around 1.09 in the hours after the release (although it subsequently bounced back a little). That initially sounds surprising given that the 2.3% qoq(a) outturn undershot market expectations of 2.5%. But there are positives in the details of the release, although there are also negatives buried even deeper. Overall USD’s glass half full reaction, reflecting yesterday’s FOMC language change, suggests that the bar for data to support further USD strength is not particularly high (although market risk appetite will also be important). The market will be particularly focussed on the 7 August Employment Situation (payrolls) report.
The first piece of positive news in the detail was that the 2.9% qoq(a) consumer spending outturn was stronger than the 2.7% expected, as the savings rate fell to 4.8% in Q2 from 5.2% in Q1. Indeed, the 1.99pp GDP contribution accounted for most of GDP growth, with the split looking relatively healthy (with goods consumption bouncing back from Q1 weakness to account for a little over half, relatively evenly split between durables and non-durables). So this suggests that the recent puzzle of consumers not spending the effective tax cut of lower gasoline prices is ameliorating. Of course, the corollary is that the other GDP components were weak. In particular:
• Fixed investment contributed only 0.14pp to GDP qoq(a), continuing the recent downward trend and the weakest since Q3 2011 (see chart). Within that, non-residential equipment falls outweighed slightly less bad non-residential structures investment and residential investment weakened (relative to the upwardly revised Q1 figure).
• Net exports contributed a measly 0.13pp to GDP growth (see Chart) – traders may have been relieved that the exports made a positive (0.67pp) contribution to GDP given USD’s strength. But given that the Q1 figure was held back by the port strike the limited bounceback looks fairly disappointing. The positive net trade contribution was also helped by imports being pretty weak (rising only 3.5% qoq(a)) – probably surprisingly so given the supposed strength of domestic demand and so a candidate for a future upward revision which would pull GDP down.
But the second pieces of positive news was that the core PCE deflator was stronger than expected (1.8% qoq(a)) and the Q1 figure was revised up to 1.0%. That said, the yoy core PCE deflator remained fixed at a relativelt low 1.3% so not all brilliant news. The third, and probably biggest, piece of upside news was that the Q1 GDP figure was revised up to a slightly more respectable +0.6% qoq(a) from the previous -0.2% (which was indeed -0.7% in an earlier release). According to BEA this “primarily reflected upward revisions to nonresidential fixed investment, to private inventory investment, to residential fixed investment, and to federal government spending that were partly offset by a downward revision to PCE”. That’s obviously still not great in the scheme of things though.
And it only tells part of the story with the revisions. In particular, the BLS also handily included three years of revisions in today’s release. And these revisions knocked 0.3pp off average 2011-14 growth (which is now 2.0% rather than the previously-estimated 2.3%) so the recovery now looks even less impressive. And given that this won’t have shown up in the right-hand column of Bloomberg WECO pages, unlike the positive Q1 revisions, traders may have missed it in the detail (it may only start showing up in prices when their economists tell them all about it). That said, the biggest downward revisions are in 2013, so traders may be rightly treating it as old news. And a USD-bullish argument is that if they indiacte lower trend US growth that raises the chances of a September Fed rate hike as the output gap will be smaller (and Yellen referenced the output gap in her June press conference comments). Equally, however, they can remind us that the latest data can be revised further (down) in due course.
But the main lesson from today seems to be that the market seems to took a glass half full view of the GDP data. That in turn seems to be because yesterday’s FOMC addition of the word “some” to the preconditions for raising rates (i.e. “when it has seen some further improvement in the labour market and is reasonably confident that inflation will move back to its 2 percent objective in the medium term”) has been interpreted as setting a reasonably low bar for a rate rise. While that is clearly placing a large weight on a single word if that market interpretation continues (not disturbed by data/FOMC comments) it increases the chances of a reasonably-good payrolls report next Friday further boosting USD i.e. a stellar report won’t be required to keep alive hopes of a September FOMC rate rise.
At the margin, suspicions that FOMC’s would prefer to avoid raising rates in the low liquidity environment just before Christmas may also encorage hopes of a September rate rise, athough in principle FOMC could delay until October (and presumably organise a press conference at short notice). But overall high data dependency seems likely over the coming six weeks. A further channel is that strong US data outturns will likely support market risk appetite and hence push down on EURUSD (given the EUR’s funding currency status in the post ECB QE world). Conversely, a bout of risk aversion e.g. driven by adverse Chinese developments would likely support EURUSD while also tending to boost USD against commodity currencies (if commodity prices are consequently undermined).
As an aside, the overall minor changes to the press release (uprating of the backward-looking assessment of the economy more in line with Yellen’s stated views and dropping the text on energy prices having stabilised) was pretty much what I anticipated in my preview.