The Dollar ended the week in a positive fashion on Friday after the US GDP report beat expectations printing at 2.1% compared to the predicted 1.8% reading. We said in our previous note that a reading above the 2% mark would drive investors to doubt whether the Fed will continue easing policy during the rest of the year - after this week’s meeting - and it seems that this is the case. As a result, the greenback is trading higher this morning against its peers and this should continue to be the bias leading into the FOMC meeting on Thursday.
The important question though is what happens next. We think it’s clear that the US central bank will ease policy by 25bps and we believe they will send a message that any further action will depend on future data - a conservative “one and done” approach. And this is due to two reasons: one, the next meeting will be in September, which will allow the Fed time to see how the economy fares over the next few weeks and whether the signs of weakness will erode or become more pronounced. And two, much of the reasoning behind the Fed’s decision is based on the geopolitical uncertainties caused by the trade war with China. And given that the two sides are restarting talks this week, there’s still hope - very small in our opinion - that there will be a breakthrough.
Moving forward, the Dollar should retain its bullish bias into and after the FOMC meeting. We think that the tone coming out of the Fed decision will be conservatively positive, despite the various bearish signals. So we remain in favor of more gains for the US currency both in the near and the medium-term. However, we believe that we need to clarify our thesis at this point: we do expect the Fed to cut interest rates again this year and we do think that it’s necessary to do so. The various signs of slowdown are obvious to those willing to dig deeper and we will mention last week’s GDP printing as a simple example: even though the headline, quarter-on-quarter reading came in better than expected, the yearly change in domestic growth declined from 3.2% to 2.3%, which again portrays the decline in productivity. Furthermore, we see little chance of an improvement in relations with China and this will continue weighing down on the US economy, making an easier policy even more necessary.
However, we don’t expect lower interest rates to drive the Dollar lower in the medium term and here’s why. Currencies trade in a relative fashion and it’s not like the US economy is slowing when the rest of the world does great. As such, even if the greenback would yield less in the months to come, we expect the same to happen for the likes of the Euro, the Pound and the commodity currencies. We see Europe as weak and the ECB ready to ease policy there as well, we see the odds of a hard Brexit mounting and the bias on Sterling growing more bearish and China’s domestic productivity struggles weighing down on the highly correlated Aussie and Kiwi. The instruments of choice in the medium term are the Japanese Yen, Swiss Franc and Gold.
The yellow metal continues to oscillate around the $1,420 level prolonging the period of lack in direction. In the short term, we expect this sideways fashion to continue at least until we hear from the Fed. Prices are supported by the $1,412 level from the downside and a break lower could clear the path towards the $1,400 area while to the upside the $1,435 mark caps any gains.
Finally, equities closed in the green on Friday but this morning futures in Europe and the US are trading with a minor bearish bias. Despite the US Treasury Secretary Steven Mnuchin and Trade Representative Robert Lighthizer heading to Shanghai today, investors are keeping their guard up as there’s a lot of speculation that China would rather drag their feet over the next few months. Until we get some information on the tone during these first exchanges, equities would probably continue treading water.
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