EUR/USD: Trading the 2Q Preliminary U.S. GDP Report

Trading the News: U.S. Preliminary 2Q GDP

Why Is This Event Important:

With the rebound in economic activity tapering off, the Federal Reserve is likely to maintain the expansion in monetary policy throughout the second-half of the year, and Chairman Ben Bernanke may hold a dovish outlook going into 2011 as he aims to mitigate the downside risks for growth and inflation.

What’s Expected:

Time of release:08/27/2010 12:30 GMT, 8:30 EST

Primary Pair Impact :EURUSD

Expected: 1.4%

Previous: 2.4%

Will This Be Market Moving (Scenarios):

The preliminary GDP report is expected to show the U.S. economy expanding at an annualized pace of 1.4% in the second-quarter amid an initial forecast for a 2.4% rise in the growth rate, while personal consumption is projected to increase 1.6% from the first three-months of the year, and the mixed batch of data could weigh on market sentiment as the outlook for global growth remains clouded with uncertainties. As risk trends continue to drive price action in the currency market, a flight to safety could lead to U.S. dollar strengthen as it benefits from safe-haven flows, but fears of a protracted recovery could spark a bearish reaction in the greenback as growth prospects deteriorate.

The Upside

As businesses increase their rate of production and continue to replenish their inventory of unsold goods, the rise in global trade could lead to an enhanced growth report, which would spur an improved outlook for the world’s largest economy. Accordingly, policy makers may look to raise their assessment for future growth, which could lead the Fed to normalize monetary policy further in 2011 as the recovery gathers pace.

The Downside

However, the ongoing weakness in the labor market paired with tightening credit conditions will continue to have a negative impact on the economy, and private sector spending may continue to suffer over the medium-term as households and businesses maintain a cautious outlook for future growth. As a result, an unexpected drop in personal consumption could weigh on the U.S. dollar as it accounts for more than two-thirds of the economy, and the data could lead the Fed to expand monetary policy further over the coming months in an effort to encourage a sustainable recovery.

How To Trade This Event Risk

Expectations for a downward revision in the U.S. growth rate clearly favors a bearish outlook for the greenback, but an enhanced release could set the stage for a long dollar trade as the economic outlook improves. Therefore, if GDP expands at an annualized pace of 2.4% or higher in the second quarter, we will need a red, five-minute candle subsequent to the data to establish a sell entry on two-lots of EUR/USD. Once these conditions are fulfilled, we will set the initial stop at the nearby swing high or a reasonable distance after taking market volatility into account, and this risk will generate our first objective. The second target will be based on discretion, and we will move the stop on the second lot to breakeven once the first trade reaches its mark in an effort to lock-in our profits.

On the other hand, the slack within the private sector paired with the weakness in the labor market could lead to a downward revision in GDP as households and businesses continue to face tightening credit conditions, and the data could fuel a selloff in the greenback as the outlook for future growth deteriorates. As a result, if the economy expands 2.4% or less, we will favor a bearish outlook for the reserve currency, and will implement the same strategy for a long euro-dollar trade as the short position mentioned above, just in reverse.

Potential Price Targets For The Release

Impact that U.S. Preliminary GDP reading has had on USD during the last quarter

1Q 2010 U.S. Preliminary GDP

The preliminary GDP reading showed economic activity in the U.S. expanded at an annualized pace of 3.0% in the first quarter amid an initial forecast for a 3.4% rise in the growth rate, while personal consumption increased 3.5% during the first three-months of the year versus projections for a 3.8% advance. A deeper look at the report showed gross private investments increased 14.7% after surging 46.1% during the last three-months of 2009, while exports increased 7.2%, and the rebound in economic activity may gather pace in the second half of the year as businesses raise their rate of production. However, as households continue to face tightening credit conditions paired with subdued demands for employment, the Fed is likely to support the economy over the coming months and maintain its pledge to hold borrowing close to zero for an “extended” period of time in an effort to encourage 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 EUR 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 EUR 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.

Questions? Comments? Join us in the DailyFX Forum

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