The American economy in the first quarter was disappointing, but the dollar strengthened its positions across the market, including the EUR/USD pair. After an impulsive growth to the middle of the 10th figure, the EUR/USD pair turned 180 degrees and headed south. The bears tested the nearest support level of 1.1000, corresponding to the Tenkan-sen line on the daily chart. Such an anomalous, at first glance, reaction of the greenback is due primarily to the strengthening of hawkish expectations regarding the Federal Reserve's further actions. The dollar is growing amid the threat of stagflation in the US, as the latest report shows that consumer spending is still strong, and inflationary pressure remains at an unacceptably high level.
In the language of dry numbers
US GDP growth in the first quarter of this year was almost twice as bad as expected. According to forecasts, the US economy was supposed to grow by 2.0%, reflecting a downtrend (in the fourth quarter of 2022, growth was recorded at 2.6%). However, GDP volume increased by only 1.1%, which is much lower than economists' expectations.
Notably, after the release, the likelihood of a quarter point rate hike in the Fed's interest rate at the May meeting rose to 82%. The market is confident that the central bank will raise the rate to 5.25% next week, despite the "red hue" of the headline indicator in the latest report.
As they say, the devil is in the details. The report shows that the US economy is slowing down amid high inflation. For example, the GDP price deflator in the first quarter increased by 4.0% YoY, while economists expected this component to grow by 3.7% YoY (I recall that in the fourth quarter, the indicator grew by 3.9% YoY). The core GDP price deflator in the first quarter was also in the "green," rising by 4.9% YoY, with a forecast of 4.7% YoY growth (fourth quarter result – 4.4% YoY). That is, consumer spending, which accounts for a large part of GDP, grew at the highest rate since the second quarter of 2021; the volume of government spending increased at the highest rate since the beginning of the year before last.
What the report says
Remember that the core Consumer Price Index (CPI) excluding food and energy prices in March started to gain momentum again. In annual terms, the indicator rose to 5.6% in March. Over the last five months, the core CPI had been declining – from 6.6% (in September 2022) to 5.5% (in February 2023). For the first time in the last six months, the growth rates of the core index accelerated. At the same time, overall inflation, the producer price index, the import price index – all these inflation indicators came out in the "red," reflecting active downward dynamics.
In other words, all conditions for another round of the Fed's interest rate hike have been met today. The "last puzzle" will be the core PCE inflation indicators (the release is scheduled for Friday, April 28). If Friday's numbers also come out in the green zone, the results of the May meeting will be virtually predetermined.
Indirect support for the greenback was provided by the latest US labor market data. It turned out that the number of initial jobless claims increased by 230,000 last week. The indicator showed an uptrend for two straight weeks (+240, +246,000), but a decline was recorded today.
However, the US housing market continues to disappoint dollar bulls. We found out that the volume of pending home sales in the US in March fell by 5.2% (in monthly terms), with a forecast of 0.8% growth. In annual terms, transactions fell by 23.2%, compared to analysts' forecast of a 22.8% decline. I recall that earlier released reports in this area also reflected negative dynamics. In particular, the volume of home sales in the secondary market in March decreased by 2.4% (the weakest result since November 2022). The indicator of building permits issued in the US in March fell by 8.8%, indicating that the high cost of borrowing is putting pressure on this sector of the economy.
Conclusions
The GDP report reflects the threat of stagflation in the US: the country's economy is growing at a weak pace, while inflationary components are gaining momentum. Therefore, the report ended up on the dollar's side, as it strengthened investors' confidence that the Fed will decide on another rate hike.
At the same time, this fact is already largely priced in, so the current strengthening of the greenback is likely to be temporary.
Remember that ahead of the May meeting, another bank in the US (with a market capitalization of $1.06 billion) was on the verge of collapse. First Republic, whose stocks fell by almost 50%, risks repeating the fate of Silicon Valley, Signature Bank, and Silvergate. The bank reported that clients withdrew $100 billion from accounts, and deposits decreased by more than 40%. In light of such news, the Fed is unlikely to be aggressive next week, so as a result of the May meeting, the dollar may come under strong pressure, even despite the fact of a 25 basis point rate hike.
Thus, in my opinion, it is advisable to use bearish price pullbacks on the EUR/USD pair to open long positions with the first target at 1.1050 (upper Bollinger Bands line on the daily chart) and the main target at 1.1100.
