Forex Trading Guide: U.S. Advanced Q2 2016 GDP

The U.S. will be getting the first estimate for its Q2 GDP this Friday (July 29, 12:30 pm GMT), so if you’re looking for a likely catalyst for the Greenback after Wednesday’s FOMC statement, then this is your best bet. And it just so happens that I have this here trading guide to help you out.

Why is the GDP report important?

For the newbies out there, as well as veteran technicians who are trying to integrate fundamentals into their trading arsenal, Gross Domestic Product or GDP gives the most comprehensive overview of a given economy’s performance and overall health, which is why it is vital to both forex traders and decision makers alike.

And in the case of the U.S., the Bureau of Economic Analysis (BEA) is the one responsible for compiling the official GDP report, which come in three flavors: (1) the first or advanced estimate, (2) the second or preliminary estimate, and (3) the third and final estimate. The advanced estimate is the least accurate and is often revised as new data come to light, but it does give both forex traders and decision makers alike the first ever glimpse on how the U.S. economy fared, so forex traders usually keep a close eye on it.

Aside from giving a snapshot on how the U.S. economy performed, the GDP report is also important because it is tied to monetary policy. To be more specific, the BOE’s switch to an easing bias due to the Brexit referendum has left the U.S. Fed as the only major central bank that’s still looking to hike rates. And as revealed in the June FOMC statement, Fed officials downgraded their GDP growth projections, and that, together with subdued inflation levels and worries over the labor market, convinced Fed officials to maintain monetary policy back then, so a strong rebound will very likely help to rejuvenate rate hike expectations.

How did the Greenback react to Q1 2016’s advanced estimate?

The advanced estimate for Q1 2016’s GDP growth was released in April 28, and it was a disappointment because it came in at an annualized 0.5% quarter-on-quarter, which missed the expected pace of 0.7% and is much slower than Q4 2015’s 1.4% expansion. To add salt to injury, this was the weakest pace of growth in two years and also marked the third consecutive quarter of slowing annualized quarter-on-quarter growth.

According to the details of the GDP report, the slowdown was due to consumer spending only growing by 1.9%, which is slower than the previous 2.4%, so the positive contribution from consumer spending was only 1.27% (+1.66% previous). More worryingly, business investment contracted at a faster rate (-5.9% vs. -2.1% previous), subtracting 0.76% from total GDP growth (-0.27% previous).

Overall, the GDP report was pretty bad, but the initial reaction was actually to buy up the Greenback, although the follow-through selling ultimately sent the Greenback lower. What’s up with that? Well, it’s very likely that forex traders who opened preemptive positions ahead of the GDP report were taking some profits off the table.

If you look at the chart below, I marked when the GDP report was released and when the FOMC released its press statement. The Fed tried to present a neutral tone during the April FOMC statement, which is why you can see that the Greenback had difficulty finding direction during and shortly after the FOMC statement.

USD Index: 1-hour Forex Chart

USD Index: 1-hour Forex Chart

However, the FOMC statement did give a heads up that Q1 GDP growth likely slowed down, saying that: “growth in economic activity appears to have slowed,” likely because “growth in household spending has moderated.”

As you can also see on the chart, the USD index dropped during the late U.S./early Asian session, even though there was no other catalyst for the Greenback at the time, which implies that forex traders were beginning to open preemptive short positions on the Greenback. And they then likely closed some of these positions out when the GDP report came in worse-than-expected. The overall implication of the poor GDP report was that the Fed was going to be less likely to hike rates, however, so there was some follow-through selling after the initial reaction.

How did the final estimate for Q1 2016 GDP end up?

The disappointing first estimate for Q1 2016 GDP reading was upgraded from 0.5% to 0.8%. The second estimate was, in turn, upgraded further to 1.1% for the final estimate. It’s still a one-year low, though, and it still marks the third consecutive quarter of weakening growth. The reasons for the higher final estimate were upward revisions for consumer spending as well as business investment being less of a drag. Also, trade was originally also a drag, but it was revised to show a positive contribution of 0.12%, ending two straight quarters of negative contributions from net trade.

What’s expected for Q2 2016’s advanced GDP estimate?

The general consensus among economists is that Q2 GDP will expand by 2.6% quarter-on-quarter annualized, which is a significant improvement over Q1’s 1.1%. And if the actual reading is within expectations (or better), then that will end the consecutive quarter-on-quarter slowdown in U.S. GDP growth, so many forex traders and even decision makers will likely have their eyes on the upcoming GDP report.

A faster pace of expansions sounds about right. As discussed in my latest economic snapshot of the U.S. economy, industrial production and consumer spending during the Q2 months were relatively better when compared to the Q1 months. And while trade got hit in May because of the decline in exports to the U.K. and the Euro Zone as a whole, the available data are still a bit better when compared to the Q1 months. Also, imports increased in April, thanks mainly to imports of capital goods increasing by 5.32% to a six-month high of $49.59 billion, which would hopefully translate to higher business investment.

Looking at some of the publicly available GDP forecasts from other institutions, the Atlanta Fed’s GDPNow is forecasting a GDP growth of 2.4% as of July 19, which is a couple of ticks lower than the consensus reading. The New York Fed’s NowCast is more conservative since it’s predicting a 2.2% pace of expansion as of July 15. The GDP forecast from Moody’s Analytics, meanwhile, is predicting a slightly faster-than-consensus reading of 2.8%.

Overall, the available economic reports, are pointing to a likely sharp rebound in Q2 GDP growth. In addition, GDP forecasts by some of the more respectable institutions are also pointing to a pickup in GDP growth, at least on an annualized quarter-on-quarter basis.

As usual, better-than-expected readings generally trigger a quick rally while disappointing readings cause a quick selloff, but also make sure to keep an eye out on price action after the FOMC statement since forex traders may open preemptive positions again and then use the actual event to unwind their positions.

A strong rebound will likely generate some follow-through buying, though, since that will likely rejuvenate rate hike expectations, although that would also depend on the details of the GDP report, particularly with regard to consumer spending and business investment.

What is your forecast for Q2 2016’s GDP report? Will it meet, miss, or beat expectations? Let others know what you think by answering the poll below!