Psychology more Important than Data in the Week Ahead

Psychology, more Important, Data, Week Ahead, Fundamental Analysis, US Dollar, USD, investors, long term, fx trader, forex

25 May 2015

The US dollar's recovery last week may not get the kind of fundamental support that medium and long-term investors would like to see to raise the confidence that the two-month correction has run its course. 

Owing to a greater deterioration of net exports and a smaller than expected inventory build, Q1 GDP is likely to be revised sharply lower. The 0.2% expansion may turn into a 0.8-1.0% contraction. Although it is backward looking, especially given that the second quarter is two-thirds when the revision is announced, it does have an important implication.

It means that rather than raise rates in June, as many of us had previously anticipated, the Federal Reserve will have to cut its GDP growth forecast for the entire year. In March, the Fed's central tendency forecast, which excludes the three highest and three lowest forecasts was 2.3%-2.7%. It is possible that growth in the first half is flat or barely positive. This means that even if growth in the second half averages 3%, GDP for the entire year would be about 1.5%. To reach the current Fed forecast, the economy would have to expand by close to 5% in H2.

The projection for growth in the current quarter could edge higher if the details of the April durable goods orders report on May 26 is firmer. The headline activity may slip on the back of lower aircraft orders. Boeing reported its April orders slipped to 37 from 39 in March. However, orders, excluding defense and aircraft and shipments of the same, which are inputs for capex and GDP forecasts, should both be above Q1 averages.

Separately, the Richmond and Dallas Fed manufacturing surveys, and the Chicago PMI and Milwaukee ISM will also likely boost confidence that the world's largest economy is not recession-bound. Whereas the Atlanta Fed's GDPNow suggests the US economy is tracking 0.7% growth in Q2, we expect the incoming data to gradually lift this estimate. The increase in aggregate income (~5% year-over-year) and the increase in savings (~$125 bln in Q1) will likely provide the fuel for stronger consumption going forward.

The economic data is one thing, but how the markets respond to it is a different matter. For the better part of the past two months, disappointing, though not always weak, US data sparked dollar selling. At the same time, the dollar was not rewarded for good news. This was broadly consistent with the dollar's downside correction after recording one of the strongest quarterly performances in many years. How the markets respond to the new fundamental news may be more revealing than the economic data itself.