Discussion and Analysis by Charles Porter:
This afternoon, at 13:30BST, the Bureau of Economic Analysis, a subset of the U.S Department of Commerce, released economic growth data. Estimating the Real Gross Domestic Product (GDP) for the third quarter of 2017, the data release attested to an annualised rate of growth of 3.0%. Beating consensus economic growth forecasts, real GDP growth fell only slightly behind the astounding Q2 economic growth. As economic growth accelerates at the fastest rate in years, there is likely to be further upside potential within Dollar currency crosses.
Following a Dovish European Central Bank (ECB) decision yesterday and Hawkish Federal Reserve Board Chair news yesterday, the month-to-date trends of Dollar Strength and Euro retraction have gripped markets. On a trade weighted basis, the US Dollar is continuing to develop its strength, gaining considerable value within Dollar-exposed currency pairs.
The US Dollar broke into the high 1.15s within the Euro-Dollar cross rate around the time of the US GDP data release. Yesterday, a highly dovish monetary policy decision from the ECB sent the Euro on a strong decline. However, further momentum is likely to have been found on the Dollar-side of the equation, aided considerably by this afternoon’s hard GDP data. The GDP statistics mature the image of a healthy US economy which, in conjunction with an unexpectedly hawkish Fed, paves the way for a strong Dollar.
The data release comes ahead of a scheduled meeting of the Free Open Market Committee, the body in charge of setting monetary policy within the Fed. Hard data, particularly if it is of the stature of economic growth statistics, can have a positive effect upon the value of a currency. Strong GDP growth stands as testimony to the health of the economy and is indicative of the return upon investment that the economy is capable of producing.
Therefore, foreign direct investment, to name but one channel of cross-border flows of capital, is likely to tick up. Particularly if the macroscopic backdrop testifies that exportation-led growth has occurred, appreciative FX market movements are likely to prevail. By improving the base-case, underlying, performance that investors apply to economies, the domestic currency receives a tailwind. The currency market reaction in response to GDP data was likely to have been subdued by the complete discounting of a Fed rate hike at its meeting on Wednesday.
Ensuring that interest rates are not set too high so as to preclude strong and sustainable economic growth is a by-product of the price-level-based monetary policy target. Sustainable inflation, internalised at around 2% by most central banks is justified in virtue of its ability to lubricate the economy and facilitate growth. In turn, higher rates of growth as seen as highly likely to spill over into price inflation thereby increasing the pressure upon the economy to raise the rate of interest. The rate of interest explicitly rewards investors for saving money, providing an even more concrete support to the exchange rate.
The significance of 3% annualised quarterly growth should not be understated. The figure is undoubtedly a psychological threshold as well as impressive, in absolute terms, for a highly developed market economy. This growth level was down minutely from 3.1% in Q3. Moreover, it is the first time that economic growth has surpassed the 3% level for two consecutive quarters since the middle of 2014. The resurgence of economic growth could attest to a capitalisation upon the infamous global recovery and the health of the US economy.
Monday (30th October) will uncover further pieces of the economic puzzle when price level data and spending data is released. This date will also include the Fed’s preferred measure of inflation, providing important qualifications to the anticipated December rate hike.