Dollar Shrugs off Strong GDP but Next Week is Key

The US dollar traded higher against most of the major currencies this week thanks to a combination of stronger US data and rising stock values.

The US dollar traded higher against most of the major currencies this week thanks to a combination of stronger US data and rising stock values. Investors are attracted to the record breaking moves in US equities and their confidence is encouraged by better data and low interest rates. According to Friday's GDP report, the US economy grew 3.2% in the first quarter, which was significantly better than the market's 2.3% forecast. While trade and inventory take most of the credit, consumer spending also picked up in March. With that in mind, the greenback shrugged off the report as investors worry that softer price growth will prevent Federal Reserve's optimism.

Wednesday's FOMC meeting is one of the most important event risks next week. Everyone is wondering whether the Fed will recognize the improvements in data as a sign that the prior slowdown is temporary or overlooked them in favor of low inflation and sluggish global growth. Based on Friday's price action, investors think it will be the latter. When the Fed met last March, the dollar crashed after the dot plot forecast revealed that the majority of US policymakers no longer believe that a rate hike is necessary this year. At the time, Fed Chair Powell said the economy was in a good place but trade talks, Brexit, European tariffs, twin deficits and weaker global growth posed serious risk. Until some of these uncertainties are lifted he felt that "it's a great time for the Fed to be patient, to watch and wait."

Since then, job growth, retail sales, manufacturing activity and inflation ticked higher. The Fed will be relieved to see these improvements but the dollar will only rise if they indicate that the market's expectations for a rate cut are misplaced. Fed fund futures are pricing in a 67% chance of easing this year - but no Fed Presidents have talked about rate cuts while many insist that if data improves, another hike may be warranted this year. So if Powell downplays the possibility of easing, the dollar will extend its rise, otherwise investors will move onto non-farm payrolls. With jobless claims hitting 50-year lows this month, steady job growth is expected because the labor market is strong. The upcoming 10-day holiday in Japan lowers liquidity, which means it could expand USD/JPY volatility.

Meanwhile the best performing currency on Friday was the New Zealand dollar. We are beginning to see signs of a potential bottom in the New Zealand dollar thanks to the stronger than expected trade balance. New Zealand's trade surplus grew to 922M in March, which was 7 times greater than expected. Exports hit record highs on solid dairy demand from China. If this demand keeps up the RBNZ won't need to consider easing.

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