US Dollar Extends Lead Over Rivals after Growth Revised Up to New Four-year High

-USD gains after GDP growth revised to fresh four-year high.

-Stronger business investment, lower imports, drive revision.

-But it doesn't alter Fed or USD outlook, both of which are turning.  

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The US Dollar extended its lead over rivals Wednesday after official data showed the economy expanding at an even faster pace than previously thought during the second-quarter, taking the rate of growth to a fresh four-year high.

GDP grew at an annualised pace of 4.2% during the three months to the end of June, up from 2.2% at the start of the year, when financial markets had been looking for the number to be revised downward to 4%. This is the fastest pace of growth seen by the US economy for more than four years.

The Bureau of Economic Analysis says the change results from an upward revision to the value of various forms of business investment. That was partly offset by a downward restatement of the value of exports and consumer spending during the period. The value of imports, which are a subtraction in the calculation of GDP, was also revised lower. 

This economic performance comes closely behind the implementation of President Donald Trump's tax cuts and reforms at the start of the year, which almost halved corporate taxes in the US and handed an estimated $1,200 of annual income back to the average household.

"If the US Federal Reserve needed one final economic indicator to back a move to increase interest rates further when the FOMC meet again next month, today’s GDP reading will have provided just that. With US growth now at pre-financial crisis levels (4.2%), the futures market will continue to bet on another hike come December if growth continues in Q4. Whether Washington likes it or not, September may not be the last time the Fed tightens monetary policy this year," says Anthony Kurugy, senior sales trader at international payments firm Foenix Partners. 

The US Dollar index was quoted 0.18% higher at 94.89 following the release while the Pound-to-Dollar rate was 0.04% higher at 1.3003 and the Euro-to-Dollar rate was 0.17% lower at 1.1672. 

Wednesday's numbers underline the superior performance of the US economy when compared with that of other countries around the world, with second-quarter growth more than double the annualised pace of expansion in the UK and still substantially ahead of that seen in the Eurozone.

Most analysts now agree that superior levels of US economic growth have bolstered the case for the Federal Reserve to keep raising its interest rate, at a time when the interest rate outlook elsewhere in the world has deteriorated, which has incentivised traders into selling other developed world currencies and buying US Dollars.

The Federal Reserve has raised interest rates seven times since the end of 2015, taking the Federal Funds rate range to between 1.75% and 2%. Many economists expect it to raise rates so that the top end of that range hits 3.25% around the end of 2019.

"We doubt that investors’ assessment of the prospects for monetary policy in other major advanced economies will change much this year. This means that relative rate expectations should generally move in the dollar’s favour," says Oliver Jones, an economist at Capital Economics, in a note released after the initial GDP report. "With this in mind, we doubt that the dollar will give up the gains it made earlier this year until well into 2019."

The US Dollar index is up by 2.8% for 2018 after having more than reversed a 4% first-quarter decline. Meanwhile, the greenback has pushed the Pound-to-Dollar rate to a 4.4% 2018 loss and the Euro-to-Dollar rate to a 2.6% decline. 

However, analysts are now increasingly looking for the greenback to begin handing back these gains over coming months. 

"We have seen the USD rally begin to peter out, perhaps aided by positioning. Bullish sentiment in USD is nearing contrarian overbought levels and the market is net short all G10 currencies except USD," says James Lord, a currency strategist at Morgan Stanley, in a note released after the initial GDP report. "USD is a funding currency, which implies a negative correlation to risk and positive macroeconomic outcomes in the Rest of World."

Either a slowdown in the pace of US economic growth later this year, or a pickup somewhere like the Eurozone, could be enough to reverse the US Dollar trend of recent months. While the jury is still out on the question of whether the Euro area economy will reclaim its lost momentum, some economists are becoming increasingly bold about their predictions of a turn for the worse over in the US. 

"Both markets and the consensus are still underestimating just how quickly the economy is likely to lose momentum next year, as the fiscal boost fades and monetary tightening bites. Our below-consensus forecast that economic growth will slow to just 2.0% next year is why we expect the Fed to call time on its rate hiking cycle by the middle of next year," says Michael Pearce, a senior US economist at Capital Economics. 

Pearce's call is based on the idea that President Trump's tax cuts are unlikely to be a gamechanger for the US economy over the longer term. 

"So far, the main economic impact of the recent fiscal stimulus has been to provide a one-off boost to the level of post-tax incomes and profits," Pearce writes, in a recent briefing. "There are few signs that tax cuts are providing a meaningful boost to the supply side of the economy. Business equipment investment growth has actually slowed since the start of the year. And while prime-age labour force participation has increased, that is an extension of a trend that has been in place for a few years now."

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