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US Dollar Rallies on Weaker Euro, Not Better-Than-Expected GDP Report

By:
James Hyerczyk
Published: Jul 28, 2019, 04:39 GMT+00:00

If you look at the global yields you’ll see that the dollar’s rise was helped by widening yield differentials between U.S. and German debt. Spreads were holding at two-month highs at 249 basis points. The move in yields indicates investors were disappointed by a lack of policy action from the European Central Bank at its policy meeting on Thursday.

US Dollar America

Having had a day to digest the latest U.S. Gross Domestic Product report, I have to conclude that the U.S. Dollar didn’t hit its high for the year against a basket of currencies on Friday because of confidence in the U.S. economy. Nor did it reach its highest price since March 2017 because the number raises doubts about future rate cuts by the Federal Reserve. It’s because the U.S. economy is growing more consistently than most G7 economies.

Friday’s Commerce Department data showed U.S. GDP grew at a 2.1% annualized rate in the second quarter. This was worse than the unrevised 3.1% pace the economy advanced in the first quarter, but better than most economists forecast. They were looking for GDP rising at just a 1.8% rate in the second quarter.

Furthermore, if you look at the global yields you’ll see that the dollar’s rise was helped by widening yield differentials between U.S. and German debt. Spreads were holding at two-month highs at 249 basis points. The move in yields indicates investors were disappointed by a lack of policy action from the European Central Bank at its policy meeting on Thursday.

Additionally, U.S. government yields barely moved after the U.S. GDP report was released. If the report truly indicated a strengthening U.S. economy then I would’ve expected U.S. Treasury yields to rise.

Finally, if you look at the currency weightings in the U.S. Dollar Index, you’ll see that it consists of 57% Euros. So I have to conclude that the weaker Euro had a bigger influence on the rally in the dollar index than the GDP report.

GDP Report Internals

In my opinion, the strength of the U.S. GDP report is questionable. It came in lower than the last report, but better than the estimate. There’s nothing bullish there. It’s like when the stock market dropped 45% in 2009 and some portfolio manager who lost 44% advertised, “We beat the stock market”.

According to reports, the government’s latest update on economic output, the GDP, shattered the Trump administration’s longstanding hope for 3% GDP growth in 2018.

Taking the advance estimate a step further, we see that the Commerce Department’s report showed that gross domestic product expanded 2.5% on a fourth-quarter-over-fourth quarter basis last year and 2.9% from the prior year. That markets a downgrade to a previous estimate of 3% and an upwardly revised 2.8% in 2017.

We know the government data showed the economy grew at a 2.1% annualized rate in the second quarter of 2019. However, it only expanded 2.3% in the second quarter from the year-earlier period. This is the slowest rate of increase in two years.

Outlook

Not only did the economy have to deal with persistent trade war worries and relatively higher interest rates, but the effects of the 2017 Tax Cuts and Jobs Act are also wearing off. This leaves the economy to stand on its own, and what is it facing? The U.S.-China trade dispute and a weakening global economy. This could only mean the economy will weaken further this year, and economists may eventually get their 1.8% growth.

A rate cut in July by the Fed may help ease the pain from lower growth, but if the trade war continues then the Fed will be forced to make a series of rate cuts the rest of the year to keep the economy afloat.

As for the rest of the world, the Asian economy could weaken further as well as the Euro Zone. If the Euro Zone economy continues to weaken and the ECB decides to throw more stimulus at it then the U.S. Dollar Index could continue to rally, but not because the U.S. economy is getting stronger, but because the Euro is getting weaker.

About the Author

James Hyerczyk is a U.S. based seasoned technical analyst and educator with over 40 years of experience in market analysis and trading, specializing in chart patterns and price movement. He is the author of two books on technical analysis and has a background in both futures and stock markets.

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