23 to 29 July: All that glitters is not gold

The US economy expanded by 4.1% in seasonally adjusted annualised terms in 2018 Q2. All core components exhibited expansion, as real consumer spending rose 4%, government spending increased 2.1%, non-residential investments were up 7.3%, exports edged up 9.3%, while imports were flat. Net trade contributed 1.1ppt to headline growth. In contrast, residential investment was the only component that contracted in Q2, by 1.1%. Moreover, seasonally adjusted annualised growth in 2018 Q1 was revised up 0.2ppt to 2.2%.

The headline GDP growth rate and its components reflect the inherent strength of the US economy. However, the pace is unsustainable, in our view. The positive impact of government spending will fade in 2019, as fiscal stimulus runs out. Furthermore, exports are unlikely to continue to rise at this pace. We believe that exports dynamics were exceptionally strong in Q2, because many of the exporters unloaded their inventories before tariffs took effect. GDP growth should be solid in the coming quarters, but without any tailwinds like additional fiscal stimulus or a weaker dollar, growth is unlikely to significantly exceed 3% in the coming quarters.

Indeed, after the release of the US GDP data, global FX market movements reflected widespread doubts about the sustainability of such strong growth going forward. Emerging market currencies in general rallied against the USD, as market players took the view that economic activity will be solid, but not strong enough to trigger a more aggressive response from the Fed. Futures markets strengthened only modestly, now implying a 66% chance that the Fed funds rate will be between 2.00-2.25% at the end of this year and only a 5% chance of 3 more hikes

This week, there are a number of important central bank meetings. On Tuesday, the BOJ will deliver an update, with speculation rife that there will be a change in policy following the biggest jump in yields in 2 years last week (forcing the central bank to intervene). This will be followed by the Fed on Wednesday (no change expected) and the BOE on Thursday (a 2nd rate hike of the cycle expected for the UK).

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