Fundamental Analysis: US GDP and PCE Key to Dollar’s Direction

Greetings, E8 traders! Get ready for our weekly deep dive into the world of fundamental analysis. We’ll break down the key economic events and data that moved the FX market last week, and look ahead to what’s on the horizon.  Discover how these developments could impact your trading strategies and drive shifts in currency values.

Last Week’s Highlight

The ECB stuck to their script last week and kept interest rates unchanged, just as everyone expected. They pointed to current data backing up their existing inflation predictions. Sure, some inflation numbers ticked up in May, but that was mostly due to temporary factors. Most of those numbers either leveled out or dropped back down in June. What happens next with interest rates will depend on how the economic data plays out, what’s really happening with underlying inflation, and how well their monetary policy is working. The Council is playing it cool, saying they’ll adjust rates as needed without locking themselves into a set path.

But the market wasn’t thrilled with the ECB’s less-than-dovish tone, and that led to the euro getting a bit of a boost last week. This could keep going this week, too, since there’s not a ton of major economic news coming out of the EU. The biggest wild card for the euro is still the political situation. Things are still up in the air in France, the eurozone’s second-biggest economy, and that’s making traders nervous.

Tuesday brought a mixed bag of data from Canada. The annual inflation rate cooled down to 2.7% in June, defying market expectations of a steady 2.9%. This marks a return to the three-year low seen in April, suggesting a continued trend of easing consumer prices.

However, there’s a slight wrinkle: core consumer prices rose by 1.9%, accelerating for the third month in a row. This could be a cause for concern. Despite this, the market remains confident that the Bank of Canada will cut rates again this week, potentially pushing the Canadian dollar lower. If confirmed, this downtrend could even pick up steam in the coming days.

The UK also delivered a mixed economic picture. The annual inflation rate held steady at 2% in June, matching May’s figures and staying at 2021 lows. However, this was a bit of a surprise, as forecasts had predicted a dip to 1.9%. The following day, the UK’s unemployment rate was reported at 4.4% from March to May, unchanged from the previous period and in line with expectations.

This mixed data makes it hard to predict what the Bank of England (BoE) will do at its August 1st meeting. Will they ease up and cut interest rates, or hold off again, like they did at their last meeting where 7 out of 9 members voted to keep rates unchanged? The market is leaning towards the BoE leaving rates as they are. If the data and the tone of the board members’ speeches confirm this, the pound could continue its recent upward trend.

Now, let’s shift our focus to the week ahead and explore the economic events and data that could shake up the FX market.

Flash Manufacturing & Services PMI Rally (Wednesday)

The first part of the week looks pretty quiet on the economic calendar, but Wednesday is shaping up to be a big one. Besides the Bank of Canada’s interest rate decision (more on that later), we’ll also get a glimpse of the Flash Manufacturing and Services PMI data from major economies.

The PMI data are based on surveys of purchasing managers in the manufacturing and services sectors, giving us a sneak peek into how businesses are feeling right now and what they expect for the future. This helps companies and policymakers make smarter decisions. A PMI reading over 50 means things are growing, while anything under 50 signals a slowdown.

These numbers pack a double punch for the market. In the short term, they can cause immediate volatility if they don’t match up with what the market was expecting, especially if they cross that crucial 50 mark. This can create some exciting trading opportunities. But they also tell a deeper story about the health of the economy. They reveal how active and healthy the manufacturing and services sectors are, giving us clues about where the economy might be headed.

Flash Manufacturing & Services Releases:

• 12:00 AM – Australia
• 01:30 AM – Japan
• 08:15 AM – France
• 08:30 AM – Germany
• 09:00 AM – Eurozone
• 09:30 AM – United Kingdom
• 02:45 PM – United States

Bank of Canada Interest Rate Decision (Wednesday)

As we’ve already touched on, the market is buzzing with anticipation for the Bank of Canada to deliver its second rate cut this Wednesday, especially after last week’s softer inflation reading of 2.7%. Even though the market didn’t react immediately to the inflation data, the following day saw one of the steepest drops in recent weeks. This was likely a preemptive sell-off as the market started pricing in the likelihood of a rate cut.

While the odds are heavily in favor of a rate cut, nothing is set in stone. If the BoC does follow through, the key question will be the tone they set during the press conference 45 minutes after the decision.

The most likely scenario is that the BoC will adopt a cautious “wait-and-see” approach, typical of central banks after a rate cut. They’ll probably be watching for the Federal Reserve to also ease up, so as not to weaken the Canadian dollar too much against the US dollar.

GDP Growth Rate in the US ( Thursday)

Thursday will bring another crucial piece of data when the U.S. Bureau of Economic Analysis unveils the advanced economic activity report for the second quarter of 2024. In the first quarter, the US economy grew by an annualized 1.4%, slightly above the second estimate of 1.3%, but still the slowest pace since the contractions in the first half of 2022.

The current consensus forecast is for a 1.9% growth rate, which would signal a significant improvement in US economic activity. This GDP report is particularly important as it could give the Federal Reserve more leeway to keep interest rates steady while grappling with persistent inflation. GDP growth is one of the key economic indicators that the Fed considers when shaping monetary policy, so we can expect some increased market volatility around this release.

Core PCE Index and Consumer Behavior in the US

Arguably the most critical data release this week is scheduled for Friday, when the U.S. Bureau of Economic Analysis unveils the PCE Price Index, the Federal Reserve’s go-to gauge for tracking inflation trends. This comes ahead of two significant Fed meetings. The first, at the end of this month, is expected to result in unchanged rates at 5.5%. However, the September meeting could be a different story.

According to the CME Group, the probability of a rate cut in September now exceeds 90%. To maintain this trajectory, the Fed needs to see continued easing of inflation. That’s why the PCE Price Index report is so crucial. The US core PCE price index, which strips out volatile food and energy prices, ticked up by 0.1% in May and is expected to repeat that modest increase in June. If this consensus is met, the Fed is likely to stay on a dovish path toward a rate cut. However, any deviation from market and Fed expectations could create uncertainty among board members regarding achieving price stability, potentially leading to a more hawkish stance that could strengthen the US dollar.

At the same time, traders will be closely monitoring the latest changes in Personal Income and Spending in the US. Stronger-than-expected income and spending figures are considered inflationary and could influence future inflation readings, ultimately impacting the Fed’s monetary policy decisions.

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