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Daily Market Report for 31 July 2014: Greenback Is Unlikely To Outperform Despite the Upswing Data

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The U.S. economy roared ahead with annualised growth of 4% in the second quarter, confirming that the weakness early this year was an aberration and the recovery is back on track. Growth beats all the expectations, with the strength of the rebound demonstrating that robust jobs data in recent months was not “fake”, and the world’s largest economy is picking up speed. UST 10 year yield rose to 2.5487 overnight despite less hawkish comment from the FOMC meeting.
The GDP data suggest that the economy has enough momentum to keep bringing down unemployment, thus adding fuel to the debate at the US Federal Reserve about when interest rates need to rise. We maintain our view that the 1st hike will be June next year. Thus we do not expect any sustainable rally of the greenback and Treasuries’ yield.

The second quarter strength comes after a dismal 2.9% annualised fall in the first quarter which was revised to a 2.1% decline with this release. The rebound confirms there was no fundamental weakness in the first quarter other than bad weather, inventory rundowns and difficulty estimating healthcare spending following the introduction of Obamacare.

The Federal Reserve’s policy committee has tuned into Chair Janet Yellen’s beat on the U.S. labour market and it’s still drawing a blur line. That’s how she has expressed repeatedly since she became chair in February. In her mid-July testimony to House and Senate committees, Yellen’s discussion of labour-market slack turned on broader indicators such as the participation rate, rather than the unemployment rate alone. It was also a signal that the committee is wary of raising interest rates too early, even with the unemployment rate.

Janet Yellen, Federal Reserve chairwoman, suffered her first dissent in favour of tighter policy as the central bank made a string of carefully balanced changes overnight to note improving US economic condition. Charles Plosser held out in a nine-to-one vote because he thought the intention to keep rates low for a considerable time after the Fed stopped buying assets did not reflect considerable economic progress.

The statement dropped a sentence that had described the US unemployment rate as “elevated”. But it was replaced with a new line that argued there was still a lot of spare capacity in the labour market. However, market did not focus much on this adjustment; probably the key adjustment market waiting for is the inflation comments. The Fed still wrote that persistent low inflation carries the risk to the long term recovery. This echoes with our previous view that dollar is unlikely to outperform in this stage.

The changes on unemployment and inflation offset each other. This hints the Fed that the downside risk to the economy is getting smaller, but that it still has room to keep rates low in order to push improvements in the labour market.

Here are key points from the data overnight:-

1) Dollar is unlikely to chase the rally, as market will return to focus on the languages from the Federal Reserve.

2) The strong 2Q GDP and personal consumption has yet to be reflected in the statement overnight. Hence, market could ignore the FOMC minutes this time. Also, there was little price reaction after the statement announcement.

3) Remaining USDJPY carries the high correlation with the U.S. medium to long term yield. Strong data could offer some buying opportunity since the market has yet to price in the Fed tightening.

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