Resilient US Growth and Cooling Inflation Support Dollar Strength
The US dollar is strengthening this week following robust economic reports from the US, which have dampened expectations regarding the extent of the Federal Reserve's (Fed) rate cuts.
According to the second estimate released by the US Bureau of Economic Analysis (BEA), the US economy grew at an annual rate of 3.0% in the second quarter of the year. This reflects a stronger growth than the previous month’s preliminary estimate of 2.8% and significantly surpasses the 1.4% growth in the first quarter.
The BEA reports that the upward revision is primarily due to adjustments in consumer spending. Personal consumption, the driving force of economic growth, was revised up from the initial estimate of 2.3% to 2.9%.
While personal spending showed an increase, the price index for personal consumption expenditures (PCE) rose by 2.5% in the second quarter, following a 0.1 percentage point downward revision. The price index, excluding food and energy prices, was also revised downward by 0.1 percentage points, increasing by 2.8%.
Additionally, monthly PCE price index data remained unchanged compared to June, despite expectations of a 0.1 percentage point increase. The headline PCE price index was expected to rise by 2.6%, but the actual data showed a 2.5% increase.
Similarly, core PCE price index did not meet the expected increase, showing a 2.6% rise against the anticipated 2.7%.
Both headline PCE and core PCE, which excludes food and energy prices, recorded a monthly increase of 0.2% in line with expectations. Goods prices fell by less than 0.1%, while service prices increased by 0.2%.
Consequently, the data released this week from the US revealed that the economy continues to thrive while the pressure on consumer prices has eased faster than expected.
Easing Labor Market Concerns: Are Fed Rate Cut Expectations Overblown?
The weekly Initial Jobless Claims report indicated that claims for unemployment benefits totalled 231K in the week ending August 23rd. This figure was slightly below the market expectation of 232K but aligned with the four-week moving average of 231.5K.
As inflationary pressures in the US ease, data suggesting that the cooling in the labor market may not be as deep as feared has led to a slight reduction in expectations for the extent of rate cuts. As US Treasury yields rise, the USD, which has increased by over 1% since the beginning of the week, has strengthened its gains.
On the other hand, market participants are forecasting a 31 basis point easing at the September meeting; a 25 basis point rate cut is fully priced in, while the probability of a half-point cut remains priced at around 30%. Additionally, nearly 210 basis points of rate cuts are being priced in over the course of the nine Fed meetings scheduled in the next 12 months.
Some economists emphasize that the US economy, as highlighted by the data, continues to perform relatively well compared to the rest of the world. In this context, they caution that expectations for Fed rate cuts may be overly aggressive.
Markets are almost certain that the Fed will begin its easing cycle at the September meeting. However, expectations for the extent of the cuts will likely be clarified by the payroll growth data set to be released at the end of next week.
Non-farm payroll growth is expected to increase in August compared to the previous month. Following the 114K growth reported in July, which caused market turbulence, a growth of 163K is anticipated. The unemployment rate is also expected to decrease slightly to 4.2%.
Therefore, unless the payroll growth figures suggest otherwise, the potential future losses of the USD, which is already in an oversold condition, are likely to be limited.