If you’re looking for a likely catalyst for the Greenback before the trading week ends, then heads up because the advanced Q3 GDP report will be released tomorrow at 12:30 pm GMT. And it just so happens that I have an Event Preview for it.
Oh, for the newbies out there. The U.S. GDP report is the most comprehensive report on the performance of the U.S. economy, so it’s important to forex traders and policy makers alike.
And it comes in three flavors: (1) the first or advanced estimate (2) the second or preliminary estimate, and (3) the third and final estimate. And the GDP report scheduled for release tomorrow is, as the title says, the advanced or first estimate.
The advanced estimate tends to get revised as new data come to light, but since it gives the earliest glimpse of the U.S. economy’s performance, it also usually triggers a reaction upon release.
What happened last time?
- Advanced Q2 U.S. GDP (q/q annualized): +4.1% vs. +4.3% expected, +2.2% previous
- Q2 GDP Price Index (q/q annualized): +3.0% vs. +2.3% expected, +2.0% previous
The advanced estimate for U.S. Q2 GDP growth was released way back on July 27.
And unfortunately for USD bulls, the report revealed that U.S. GDP only expanded by 4.1% quarter-on-quarter annualized, which is weaker compared to the consensus for a +4.3% reading.
But on the bright side, the +4.1% reading is the strongest since 2014. Also, the GDP price index was able to beat expectations by printing a 3.0% increase (+2.3% expected, +2.2% previous).
Looking at the details of the GDP report, growth was driven mainly by the 4.0% increase in private consumption (+0.5% previous) and the 9.0% surge in exports (+3.6% previous).
But on a downbeat note, private investment contracted by 0.5% (+9.6% previous), which is the first negative reading after six consecutive quarters of growth.
Overall, the Q2 GDP report was actually somewhat positive. The headline reading did miss expectations, though, so the Greenback slumped across the board as a knee-jerk reaction.
However, bulls tried to fight back and limited the Greenback’s losses. After all, the GDP report still painted a generally positive picture of the U.S. economy.
What’s expected for Q3’s advanced GDP report?
- Advanced Q3 U.S. GDP (q/q annualized): +3.3% expected vs. Q2’s final estimate of +4.2%
- Q3 GDP Price Index (q/q annualized): +2.1% expected vs. Q2’s final estimate of +3.3%
The general consensus among most economists is that U.S. GDP only grew by 3.3% quarter-on-quarter annualized in Q3 2018. This is obviously slower compared to Q2 2018’s final estimate of +4.2%.
Not only that, the GDP price index is also thought to have slowed down from +3.3% to +2.1%.
Economists therefore think that the U.S. economy remained robust but was a bit weaker relative to Q2 2018.
So, what do the available components for GDP growth have to say?
- Retail sales for all of Q3 2018 is 1.25% more compared to Q2 2018, so consumer spending will likely have a bigger contribution to GDP growth.
- Trade is still incomplete because the September trade report hasn’t been released yet. But so far, the available data for July and August point to a larger trade deficit in Q3 since exports fell by 0.99% in July and 0.78% in August, while imports increased by 0.84% in July and 0.60% in August. Trade was therefore likely a drag in Q3.
- The trade reports show that imports of capital goods increased by 0.4% in July and then surged by 6.9% in August, which point to stronger business investment.
- However, building permits issued were 4.14% less in Q3 compared to Q2.
- Also, the number of housing starts in Q3 is 3.41% less compared to Q2, so residential investment was likely a drag as well.
- Overall inventory levels in Q3 appear to be higher compared to Q2, which may also translate to stronger reading for the business investment component.
Let’s now move on to components of the the GDP price index. We still don’t have most of the report for September, so we don’t have the complete picture yet.
- With that said, housing prices increased by 0.4% in July and 0.3% in August.
- The PCE price index, meanwhile, increased by 0.1% month-on-month in July and August, with an average of 108.41 index points, which is higher than Q2’s average of 108.05.
- The PCE price index does not always follow CPI, but CPI increased further by 0.1% month-on-month in September.
What about historical tendencies? Do they offer additional insights?
Well, there is a historical tendency for Q3 GDP growth to be stronger compared to Q2 GDP growth, which goes against consensus. However Q3 did print weaker readings from 2014 to 2016.
Economists tend to be too pessimistic and undershoot their guesstimates for Q3 GDP growth, though, since there are lopsidedly more upside surprises than downside surprises.
As for the GDP price index, the Q3 reading also tends to print a stronger reading relative to Q2, which also goes against consensus.
Moreover, economists also have a strong tendency to undershoot their guesstimates for the GDP price index.
To summarize, the available GDP components showed that consumer spending was stronger in Q3, but trade will likely be drag.
Private investments, meanwhile, paint a mixed picture since residential fixed investment weakened but imports of capital goods strengthened and inventory levels were higher overall.
Consumer spending accounts for the bulk of U.S. GDP growth, though, so the available GDP components seem to point to stronger GDP growth in Q3, which goes against the consensus view.
As for the GDP price index, the available components point to a stronger reading in Q3. However, this also goes against the consensus for a weaker Q3 reading.
Looking at historical tendencies, they go against the consensus since the GDP growth and GDP price index readings for Q3 tend be stronger compared to Q2.
Also, economists have a tendency to undershoot their guesstimates for both GDP growth and the GDP price index, which skews probability more towards a possible upside surprise.
But as always, just keep in mind that we’re playing with probabilities here, so there’s always a chance that both readings may surprise to the downside instead.
At any rate, do note that traders usually have a knee-jerk reaction to the actual reading for GDP growth. And the Greenback’s bearish reaction to the Q2 GDP report is a textbook example of this.
However, the GDP price index is also worth paying attention to in order to gauge if there may be follow-through buying or selling. After all the GDP price index is more directly linked to rate hike expectations.
Anyhow, just keep in mind that if news trading ain’t your thing or if high volatility makes you uncomfortable, then just remember that you always have the option to sit on the sidelines and wait for things to settle down.