USD bulls were given fresh encouragement last week as the Q2 GDP figures came in well above expectations at 4.1%, registering the strongest period of economic growth for four years. What is clear from the data, is that the $1.5 trillion in tax cuts approved in December 2017 are helping boost household incomes as well as corporate cash flow, which is feeding into solid consumer spending and business capital expenditure alike. Growth rates over the remainder of the year will likely struggle to match those seen in Q2 though the economy is well on track to grow by a full 3% this year with durable goods orders reflecting healthy capex growth and consumer and business surveys continuing to print strongly.
Labour Market in Focus
Continued economic strength has seen the US labour market rising to an even firmer level. Payrolls growth has printed an average 215k jobs per month over the first half of 2018, up from the prior average of 182k per month in 2017. Indeed, the latest JOLTS data suggests that the search for qualified labour is becoming tougher as there is fewer than one unemployed person per new vacancy.
This is backed up by the most recent Federal Reserve Beige book which acknowledges the labour shortages seen in every district and highlights the increasing signs that companies are “raising compensation to attract and retain employees”. Indeed, this message is supported by the National Federation of Independent Businesses monthly survey which shows that 21% of small businesses list finding quality labour as their biggest constraint while 36% say that the number of vacancies within their firm is at its highest level in the last 45 years.
With the unemployment rate forecast to fall back below 4% on Friday, labour market tightness is set to continue which should feed into higher wage prices which, according to compensation surveys and employment cost indexes, look set to come soon.
With both headline and core inflation readings, as well as the personal consumer expenditure deflator, already above the Fed’s 2% medium-term target, headline inflation looks set to breach the 3% mark soon. If wage growth does begin to accelerate then the risk is that these inflation levels will increase further and that inflation expectations within the economy could become less well anchored.
Trade War Risks Subsiding Slightly
In light of the recent meeting between President Trump and EC President Juncker, fears of an escalating trade war between the US and the EU have subsided significantly, with both sides agreeing to work together to dismantle tariffs and barriers. While tensions remain at elevated levels between the US and China, the developments with the EU and US have reassured the market about the US’s openness to negotiations. Furthermore, the economic impact from the current tariffs in place is negligible, something which has been well reported so, barring a further and more significant escalation, the current trade dispute is unlikely to affect the US economy much.
What Does This Mean for The Fed?
In light of the Fed’s recent rate hike in June, there is next to no chance of them raising rates again this time around. However, what the market is expecting is much more hawkish and confident statement from the Fed. Fed chair Powell’s recent testimony before the Senate shows that the Fed remains totally comfortable with ongoing “gradual” policy increases. Strong GDP growth and rising inflation raise the risk of a more aggressive rate path than currently projected and the Fed’s statement this week should likely reflect this.
For now, USD Index remains pinned just below the 95.10 resistance level. If we see some pullback from here, traders should watch the 91.00 level which could prove to be the right shoulder of a large head and shoulder pattern, suggesting a much bigger USD rally in play. Alternatively, if we see a break of the current resistance level, focus will shift to a run up toward the next resistance level at 97.66.