Capital Properties FX
Capital Properties FX

Advance GDP and Fed Interest Rates

“All experts are experts for things that did happen. There are no experts for things that may happen.” – David Ben-Gurion

This week is all about the U.S. dollar. We have the FED interest rates decision and ISM Non- Manufacturing PMI (Purchasing Managers Index)  on Wednesday, the Non-Farm Payrolls and Ms. Yellen’s speech on Friday. Most economists and market participants believe that the FED will keep the Federal Funds Rate unchanged tomorrow but may signal a possible rate hike in June. At least, that’s what the consensus is today.

Most of the leading indicators suggest that we should see additional growth in the U.S. economy, however, the hard data is telling a different story. Last Friday we found out that the U.S. economy grew only 0.7 percent in Q1. By some opinions, that sort of growth pace is not suitable for additional tightening.

The question is, how seriously the FED is taking this slowdown. During the last Federal Reserve meetings, Ms. Yellen has been rather optimistic regarding the future outlook. While the growth rate in Q1 was slower than expected, the FED may take it as transitory effect and that everything will be much better in Q2. Hence we still have to consider the possibility that the FED interest rates are going higher in the next couple of months.

Read Also: Bank of Japan Policy Rate – April Meeting’s Outcome

Leading Indicators are Looking Good

Based on leading indicators, there are reasons to be optimistic. The ISM Manufacturing PMI came in slightly lower than expected but is still well above the 50 level. ISM Non-Manufacturing PMI currently stands at 55.2 which can be considered as relatively solid. In fact, the services sector PMI hasn’t been below the boom/bust line since the 2nd quarter of 2010. Taking into account that the U.S. economy is a service based economy, the labor market should remain in very good shape.

However, there are also reasons to be concerned. The NFP figure for March was surprisingly weak – only 98K. There’s also a chance of a revision but right now it’s very difficult to tell in which direction the revision is going to be. The fact is that for April we need a solid NFP number, well above 150K to erase all doubts regarding the health of the U.S. labor market. If for whatever the reason we should see another weak print, any additional action on FED interest rates becomes questionable.

Fed rate hike prospects may change overnight if the growth pace of the U.S. economy should decrease even more. 0.7 percent GDP growth is already very slow by U.S. standards and historically speaking, the FED has never raised interest rates under such circumstances. Nevertheless, as long as there is even the slightest hope that the FED interest rates are going up, the USD bulls should remain in control.

In FOMC calendar there are only 3 meetings left in 2017 were we also have the press conference. These three meetings are considered the likeliest meetings where the FED may take the decision to hike the rates.

Inflation Matters

Changes in inflation will have an impact on FED’s policies as well. As the U.S. inflation levels are starting to look better by the day, we should be prepared for potential rate hikes in the coming months. Currently, the yearly CPI stands at 2.4 percent which should be enough for the FED to keep on tightening. On Monthly basis, the overall CPI lowered slightly in March but for now, there’s no reason to be alarmed.

The drop in monthly CPI levels and a slowdown in job creation in March may be transitory effects. At least that is what the FED is hoping and forecasting. Tomorrow’s rate statement should bring some clarity to that subject. Most likely the FED will acknowledge the weaker GDP print but won’t consider it as a threat to the medium-term economic outlook.

April and May NFP Numbers

In many ways, the March labor market report (NFP, wage growth, unemployment rate) was rather weird. The NFP missed the forecast by miles and the previous figure was revised lower. In the same time, the unemployment rate dropped from 4.7 to 4.5 percent and the wage growth remained strong. Put it all together and you have the perfect storm. The question now is, was that an anomaly or indeed the U.S. economy is starting to cool down?

That question should be answered shortly. We have two more NFP releases before the June meeting and both of them carry a lot of weight. For the FED, the labor market has always been a priority and a sudden slowdown in job creation may raise some concerns. Also, wage growth is something that deserves additional attention from now on.

While the overall inflation levels are on the rise, the increase is largely fueled by higher energy prices. What we need now is a solid, steady growth in salaries to make sure the two percent inflation is sustainable and has a healthy effect on the economy.

Capital Properties FX
May 2, 2017

Read Also: PPI in the United States – Why it Matters for FX Trading

Related Reading
Rising interest rates: Nothing to fear but fear itself” – Allianz SE, Munich, Apr 26, 2017
News announcements, market activity and volatility in the euro/dollar foreign exchange market” – Bauwens, L., Omrane, W.B. and Giot, P., 2005. Journal of International Money and Finance, 24(7), pp.1108-1125.