EUR/USD: Trading the U.S. Advanced 4Q GDP Report

Trading the News: U.S. Gross Domestic Product (Annualized)

What’s Expected
Time of release:        01/29/2009 13:30 GMT, 08:30 EST
Primary Pair Impact :    EURUSD
Expected:         4.6%
Previous:         2.2%

Impact the U.S. GDP has had on EURUSD over the last 2 quarters

3Q 2009 U.S. Gross Domestic Product

The advanced GDP reading showed the U.S. economy accelerated in the third quarter for the first time in more than a year on the back of the stimulus-driven gains in consumer spending and home building, with the reading climbing an annualized 3.5% subsequent to shedding 0.7% the quarter prior, with economists’ expectations of 3.2%, figures from the Commerce Department showed in Washington. Taking a closer look at the breakdown of the report, household purchases climbed 3.4%, marking the highest level in more than two years. The gain in consumer spending, which accounts for approximately 70% of the economy was largely affected by policy makers “cash-for-clunkers” plan, the report announced. The Federal Reserve held its benchmark interest rate at 0.25% yesterday and is expected to do so throughout the first half of the year in order to spur economic growth.

2Q 2009 U.S. Gross Domestic Product

The advanced GDP reading showed the U.S. economy contracted at an annual pace of 1.0% in the third-quarter amid expectations for a 1.5% drop in the growth rate, led by a 1.2% drop in personal consumption, while government spending increased 5.6% from the first three-months of the year to mark the biggest rise since 2003. A deeper look at the report showed private investments tumbled at an annual pace of 20.4% after falling 50.5% in the first quarter, while exports slumped 7.0% followed by a 15.1% drop in imports. Nevertheless, as the government takes unprecedented steps to stimulate the ailing economy, policy makers anticipate the nation to emerge from the recession later this year, and the Federal Reserve is likely to hold the benchmark interest rate at the record low throughout the second-half of the year in an effort to foster a sustainable recovery.

What To Look For Before The Release

Traders with access to market depth information via the FXCM Active Trader Platform may use it to gauge the potency of the economic data release as well as to shed some light on the market’s directional bias. Increasing volume ahead of the announcement will telegraph likely follow-through behind whatever move is to materialize, while an imbalance in available liquidity on the Bid versus the Offer side of the market will tell us the direction major institutions are likely favoring ahead of the announcement:

Bullish Scenario: If we see substantially deeper available liquidity on the Bid side of the market, this tells us that major price providers in the market are looking to buy the Euro against the US Dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bullish bias on EURUSD ahead of the data release.

Bearish Scenario: If we see substantially deeper available liquidity on the Offer side of the market, this tells us that major price providers in the market are looking to sell the Euro against the US Dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bearish bias on EURUSD ahead of the data release.

How To Trade This Event Risk

The U.S. dollar is likely to face increased volatility over the next 24 hours of trading as economists forecast GDP to expand at an annual pace of 4.6% in the fourth-quarter, which would be the fastest pace of growth since the first three-months of 2006, and conditions are likely to improve going forward as the expansion in monetary and fiscal policy continues to feed through the real economy. The world’s largest economy emerged from the recession in the third-quarter, with the growth rate increasing 2.2% amid an initial forecasts for a 2.8% rise, while personal consumption slipped to 2.8% from a 2.9% clip. At the same time, retail spending unexpectedly contracted 0.3% in December, while demands for durable goods fell short of expectations, and the ongoing weakness in private sector consumption could taper the rise in economic activity as it remains one of the leading drivers of growth. Nevertheless, the Fed’s Beige Book said economic activity improved in 10 of the 12 districts, with home sales increasing in most region, but went onto say that the labor market “remained soft,” which continued to put downward pressures on wage growth. In addition, the central bank noted that households remained “cautious, price sensitive, and focused on necessities, but sometimes willing to spend on discretionary purchases,” and stated demands for borrowing “continued to decline or remained weak” in most districts. Nevertheless, the Federal Open Market Committee held the benchmark interest rate at the record-low of 0.25% this month, and reiterated that borrowing costs will stay low for an “extended period” of time as the central bank aims to encourage a sustainable recovery. The Fed stated economic conditions continued to improve from its previous meeting in December and noted that the deterioration in the labor market appears to be “abating,” but expects to see a “moderate” recovery for a time. Moreover, the central bank saw business spending “picking up” even as they remained “reluctant” to increase their labor force, and expects “a gradual returned to higher levels of resource utilization” as firms continue to replenish their stockpiles of unsold goods. However, MPC member Thomas Hoenig dissented and said that keeping the interest rate at the record-low for an “extend period” period of time was “no longer warranted,” and the central bank may turn increasingly hawkish over the coming months as the recovery continues to gather momentum.

Expectations for a marked rise in GDP favors a bullish outlook for the greenback as the economy returns to growth, and price action following the release  could set the stage for a long dollar trade as policy makers aim to normalize policy this year. Therefore, if the growth rate expands at an annual pace of 4.6% or greater, we will need to see a red, five-minute candle following the data to confirm a sell entry on two-lots of EUR/USD. Once these conditions are met, we will place the initial stop at the nearby swing high or a reasonable distance taking volatility into account, and this risk will establish our first goal. Our second objective will be based on discretion, and we will move the stop on the second lot to cost once the first trade reaches its target in order to preserve our profits.

In contrast, tightening credit conditions paired with the deterioration in the labor market may taper the rise in economic activity, and a dismal GDP report is likely to drag on the exchange rate as investors weigh the prospects for a sustainable recovery. As a result, if the growth rate expands at an annual pace of 2.2% or less, we will favor a bearish outlook for the reserve currency, and will utilize the same strategy for a long euro-dollar trade as the short position laid out above, just in reverse.

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To discuss this report contact David Song, Currency Analyst: dsong@fxcm.com