The U.S. Dollar: Fed Comments Offer Support but the Economy Just Handed One to the Bears

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- USD supported by Federal Reserve comments and events elsewhere.

- But industrial data suggests U.S. GDP growth slowed rapidly last quarter.

- Data vindicates gloomy consensus as 'green shoots' appear elsewhere. 

The Dollar was buoyant Tuesday following 'hawkish' comments by a Federal Reserve (Fed) rate setter and amid weakness elsewhere but industrial production figures released during the noon session suggest that during the first quarter the U.S. economy handed one to the consensus view on the greenback.

Industrial production fell -0.1% during March according to Federal Reserve data released Tuesday, reversing a 0.1% gain from February, when financial markets had been looking for growth of 0.2% that month.

Manufacturing output was unchanged in March after a -0.3% decline in February and mining output was -0.8% lower too, although the utilities sector eked out a small increase in production given adverse weather. 

"Overall, the data are a few ticks weaker than consensus expectations (which were at 0.2%), and below our forecast. The goods sector looks to be essentially flat for the first quarter as a whole, and is consistent with our below consensus outlook that Q1 GDP will be below 1 1/2%," says Avery Shenfeld, chief economist at CIBC Capital Markets. 

The data is significant for the Dollar because of what it means for U.S. GDP growth, and given the market's current view of the global economy. CIBC's Shenfeld says it means the economy likely grew even slower than the market has anticipated for the first quarter. 

Any faster-than-expected U.S. economic slowdown would be coming at a time when analyst commentaries are awash with references to "green shoots of recovery" in the global economy. And growth differentials are important to the market because of their significance to the relative interest rate outlook. 

An anticipated divergence in growth between the U.S. and rest-of-world economy is the starting assumption that underpins the bearish consensus view on the Dollar this year. The Dollar index converted a -4% first quarter loss into around a 4% gain last year following the tax cuts implemented in January 2018. 

"Relative growth differentials and sentiment have dictated terms in global FX markets this month," says Elliot Clarke, an economist at Westpac, in a recent note to clients. "US growth outperformance, both with respect to potential and against key trading partners such as Europe, is central to this US dollar rally."

The consensus is that a U.S. slowdown will simply encourage the market to be on Federal Reserve rate cuts at a time when a recovery elsewhere is keeping hope alive among investors that the likes of the European Central Bank (ECB) will some day manage to lift their own rates.

The Pound-to-Dollar rate was -0.41% lower at 1.3045 Tuesday but is still up 2.39% for 2019, while the Euro-to-Dollar rate was -0.18% lower at 1.1284 and has fallen -1.58% this year.

"Support area around the psychological level of 1.30 is also crucial to watch," writes Piotr Matys, a strategist at Rabobank. "While it was pierced on a few occasions since early March on an intraday basis, GBP/USD has not closed below the 1.30 threshold since early February. Therefore, a break lower would be a strong bearish signal."

The Dollar index was 0.11% higher at 97.04 during the noon session Tuesday, with the greenback up against many low-yielding currencies but lower relative to commodity units like the Canadian Dollar and Norwegian Krone. It has risen 1.08% this year.

"We think the broad USD has peaked and should begin declining soon. There are signs that the global economy is not only stabilizing but rebounding are growing, as seen in China PMIs and global trade volumes. Meanwhile US data continue to soften and US nominal and real yields remain under pressure," writes Gek Teng Khoo, a strategist at Morgan Stanley, in a recent note to clients. "DXY faces resistance at the previous high of 97.10."

Federal Reserve rate setters moved to the sidelines in January after an economic slowdown in Europe and China, as well as volatility in emerging world financial markets, stoked concerns about the U.S. economic and inflation outlook. Now the U.S. economy appears to be slowing. 

Tuesday's data suggests strongly that the consensus for annualised GDP growth of 1.5% in the U.S. during the first quarter is under threat, which means the Dollar could be in danger of a turn lower over the coming weeks, particularly if markets continue to believe that "green shoots of recovery" are really appearing elsewhere. 

It will be the end of August before advanced economies have reported official growth figures for the second quarter, and those are what's needed for markets to be certain whether growth in the U.S. and rest-of-world economies will have diverged. Most economies are expected to have slowed in the first quarter. 

Those figures could always reveal a further slowdown elsewhere in the world, which would be an entirely different story for the Dollar, but until then there is a danger the market soon starts buying 'green shoots' and selling Federal Reserve speakers rather than the other way around. 

"The Pound has held up well in the face of some broad US Dollar bids into Tuesday, after Fed Evans was out with some hawkish leaning comments," says Joel Kruger, a strategist at LMAX Exchange

Charles Evans, president of the Chicago Federal Reserve, did after all deliver a wide-ranging speech on the economy and monetary policy to the New York Association for Business Economics late on Monday.

Evans made many comments during the address but some were perceived as hawkish and cited as the reasons for the Dollar's buoyant performance overnight and into the Tuesday session. 


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