Last Friday, the market was treated disappointing news from the U.S. in the form of the Advanced GDP report. According to the data, the U.S. grew only 1.3% during the second quarter of this year, significantly below the 1.7% increase initially expect. To make matters worse, the first quarter reading was revised down to just 0.4%!
Normally, poor data from the U.S. actually has a positive effect on the dollar due to risk aversion. This time around, however, it was the fundamentals that dominated. After the numbers came out, everything that had to do with the U.S. dollar was sold-off, and anything that didn’t include the dollar was bought up!
EUR/USD rose 130 pips while GBP/USD soared to new 2-month highs. Gold also skyrocketed by $10 to $1,626. At the same time, U.S. equities plummeted with S&P 500 clocking in a 0.79% loss for the day.
Being one of those “gloom and doom” economists is not my thing, but looking deeper into the GDP report just reveals more bad news.
Fixed investment, for instance, dropped by a huge margin. It fell by a whopping 56 billion USD, signalling that businesses aren’t growing despite the ultra-accommodative monetary policy stance of the Federal Reserve.
Outside the GDP report, another negative piece of data is the rising inflation rate. The core personal consumption expenditure, the Federal Reserve’s preferred measure of inflation, showed a 2.1% rate as increased oil and food costs pushed the prices of other goods and services higher. The Fed expects inflation to stabilize at around the top of their target band at 1.7% to 2.0%.
Inflation isn’t necessarily bad, but if you combine it with weak growth, the U.S. could end up having a nasty case of stagflation.
Consequently, the disappointing report has gotten a few market junkies sticking their tongues out to the Federal Reserve saying that QE2 didn’t work. Told ya so!
It has also made investors worried about the direction of the economy in the coming months. If it was already struggling even when there was government stimulus, could it head back into recession or maybe stagflation without any support from the Fed? Some analysts think so. They predict that the U.S. would head back into recession in Q4 2011 or Q1 2012. Yikes!
As for the dollar, the report only weighed it down even further on the charts. At the wake of its release, the currency got sold off against its counterparts as it would be one more reason for the Fed to keep interest rates at record lows. Of course, it also didn’t help that U.S. with policymakers were still unable to make any significant progress on raising the debt ceiling.
For the coming week, I think that the jobs report due on Friday will be the dollar’s only ticket back into the bulls’ turf. But keep in mind that the NFP report for July could also backfire. If the actual figure comes in below the 91,000 consensus, the U.S. dollar index may just test its previous low around 74.000 and maybe this time, support won’t hold there anymore. It may just be the final nail in the dollar’s coffin.