Trading the US GDP: USD bulls 'just' need an upward revision

The US Q2 GDP report second estimate is scheduled for release on Thursday. The preliminary estimate released in July had shown the economy expanded at an annualised rate of 2.3% in Q2, which was slightly short of the consensus estimate of 2.6%. Still, the data did confirm the marked slowdown in the Q1 is history.

The second estimate due for release on Thursday is expected to show an upward revision in the GDP to 3.2%. The report is likely to garner lots of attention since the Fed is still widely expected to raise rates in 2015; at least once if not twice.

Heading into the data, we have..

1. September fed funds futures showing around 25% probability of the rate hike happening in September. That’s down from 45% last week and around 55% earlier this month

2. Equity markets across the globe volatile, in stabilization phase

3. China cut interest rates (fifth since November), a sign the country willing to do more if needed

4. EM FX trading at multi-year lows

5. Other central banks in Asia and Europe worried about falling CNY hurting their exports

In FX majors

1. Safe havens on retreat after Monday’s gains

2. EUR/USD and GBP/USD below Monday’s opening price

3. The 2-yr treasury yield (which mimics rate hike bets) back in the 0.65%-0.75% range

4. Gold down by more than $40 from Monday’s high of USD 1169.80/Oz

The decline in the September rate hike bets indicates the markets turned pessimistic about the US economy due to the turmoil in the financial markets. Chinese slowdown has been evident since last few years and the drop in Shaghai merely represents equities falling back in line with the slowing economy. However, the markets are worried that the turmoil in the financial markets would force the Fed to delay its rate hike – a sign that US economy is not strong enough to withstand external shocks.

Given the pessimism in the markets, even a slight upward revision of the GDP could be enough to strengthen USD and stabilize risk sentiment. Consequently, we chose to note only two scenarios – Upward revision of the GDP and Downward revision of the GDP

Upward revision of GDP could strengthen USD and stabilize risk sentiment

The consensus estimate of 3.2% could be ignored so long as the actual figure is above the previous estimate of 2.3%, mainly because the markets appear to have priced-in a slowdown in the economy due to external shocks and the resulting delay in the Fed rate hike. Thus, a number above 2.3% could be enough to push up September rate hike bets and strengthen the USD.

In case the GDP is revised higher, but a weaker-than-expected 3.2%, the initial reaction could be USD weakness and risk aversion. However, the markets may recover quickly and push USD higher as the threat of slowdown due to external shocks is already priced-in.

Serious risk aversion in case GDP is revised lower

A downward revision of the GDP could trigger serious risk aversion. Moreover, the recovery in the US and Fed rate hike bets (net positive for US and global economy) kept investors buoyed since Q3 2014 despite hiccups in the Eurozone and China. Hence, a downward revision of the GDP would mean the only bright spot no longer exists and the flight to safety would resume. In such a case, the markets could push rate hike bets to Q1 2016, helping the EUR/USD pair re-test Monday’s high at 1.1714.

The least expected third scenario of a better-than-expected GDP figure – above 3.2% is likely to convince markets that Fed would hike rates in September itself. Consequently, a sharp rally in the USD as well as US stocks can be expected. The EUR/USD could take a dive to 1.10 levels, while GBP/USD could drop below its 200-DMA at 1.5370.

EUR/USD – Downside exposed ahead of US GDP

• Euro’s rise to 1.1714, followed by a drop below weekly 50-MA at 1.1551 and extension of losses to trade below May 2015 high of 1.1467 indicates the EUR bears are gaining strength.

• The spot risks falling to 1.11 (10-WMA) levels, in case the US Q2 GDP is revised higher.

• The downward revision of the US GDP could see the spot re-test 1.1551 levels.

GBP/USD – Breakout failed ahead of US GDP report

• Sterling’s breakout from the multi-week range of 1.5460-1.5690 lasted just one day, as the GBP/USD pair fell back below 1.5690 and extended losses to trade at 1.5568 (38.2% of Jul 14-Apr 15 plunge).

• The fakeout has increased the probability of the spot falling to its 200-DMA located at 1.5370 , especially in case the US GDP is revised higher.

• On the other hand, the downward revision to the US GDP could see the spot make another attempt to successfully break above 1.5690.