- Dollar takes a step back ahead of quarterly US GDP data
- Risks seem tilted towards stronger-than-expected report
- GDP release is scheduled for 12:30 GMT on Thursday
US economy outperforms
It’s been a solid year for the American economy, which has performed well even in the face of sky-high interest rates. Economic growth seems to have accelerated over the summer as consumers continued to spend, supported by a labor market that remains exceptionally strong.
Another factor behind this resilience has been the government’s heavy spending. The US government is running an enormous budget deficit, which at 5.5% of GDP is the largest deficit the country has ever run outside of recessionary periods or major wars.
This tremendous spending has helped safeguard economic growth, but it has also sent borrowing costs spiraling higher. Yields on longer-dated US government bonds briefly topped 5% for the first time since 2007, as the Treasury continues to flood markets with newly-issued debt to fund its budget shortfalls.
Even though it appears fiscally irresponsible, this situation has been a blessing for the dollar. The US currently enjoys the strongest growth among the G10 nations and offers the highest real yields, making the dollar more attractive both from an economic and an interest rate perspective.
Positive GDP surprise?
Turning to the upcoming dataset, GDP growth is anticipated to have reached an annualized pace of 4.2% in the third quarter, which is double the 2.1% achieved in the second quarter. Such an acceleration would be impressive, and there is even some scope for an upside surprise.
The Atlanta Fed has a model that estimates GDP in real time and it currently points to a growth rate of 5.4% for the third quarter, far higher than the official forecasts by economists. This model has a solid track record, so if there is any surprise in this dataset, it is more likely to be positive rather than a disappointment.
A GDP report that exceeds estimates could light another fire under US yields and in the process, help the dollar resume its uptrend. Looking at the euro/dollar chart, the first major obstacle for sellers to overcome might be near 1.0500. On the flipside, a disappointment in this data could bring the recent high of 1.0695 back into play.
Beyond the GDP stats, there are several other US releases that could also impact markets this week. Durable goods orders for September will be released on Thursday as well, while on Friday, the core PCE price index will hit the markets alongside personal consumption and income numbers for the same month. The core PCE index will be closely scrutinized by Fed officials and investors to get a sense of whether inflation continues to cool, as forecasts suggest.
Dollar remains attractive
All told, the US dollar seems like the most attractive major currency at this stage. It enjoys the strongest economic growth among the developed economies and also offers the highest real interest rates, a combination that is music to the ears of investors.
At the same time, there’s no real alternative in the FX market. The euro has been plagued by recession concerns, the yen has been crippled by interest rate differentials as the Bank of Japan refuses to raise rates, and the problems in China are dimming the outlook for commodity currencies like the Australian or New Zealand dollars.
Now to be clear, the US faces several risks as well. Consumer savings from the pandemic have already run out and with student debt repayments resuming too, this could dampen spending and growth next year. But even if the American economy loses steam, it would still be in better shape than other regions.
Therefore, it seems like there’s no credible alternative to the dollar for now. That’s particularly true when considering the dollar’s safe-haven qualities as well, which might come into play if the global economy continues to struggle.