How to Trade the US Gross Domestic Product (GDP) Report

04/29/2009 12:01 am EST

Focus: FOREX

The advanced GDP reading for the US is likely to reinforce a dour outlook for the world's largest economy as economists forecast the annual rate of growth to contract 4.7% in the first quarter, and economic activity is likely to remain subdued throughout the year as businesses continue to scale back on production and employment in an effort to reduce costs.

Trading the News: US Gross Domestic Product (Annualized)

What's Expected:
Time of release: 4/29/2009 12:30 GMT, 08:30 EST
Primary Pair Impact: EUR/USD
Expected: -4.7%
Previous: -6.3%

Impact the US GDP Has Had on EUR/USD the Last Two Quarters

4Q 2008 US Gross Domestic Product
The advance GDP reading for the US showed that the world's largest economy contracted at an annual pace of 3.8% in the fourth quarter to mark the biggest drop since 1982, and conditions are likely to get worse as the region faces its worst economic downturn in over a quarter century. A deeper look at the report showed personal consumption, which is one of the biggest drivers of growth, slipped 3.8% during the three months to December, while business investments plunged 19.1% from the third quarter to post the biggest drop since 1975, and the data foreshadows a deepening recession in the US as private-sector spending falters. As a result, the Federal Reserve is widely expected to hold the overnight lending rate at the record-low of 0.25% for some time, and announced that the central bank will utilize policy tools beyond the interest rate in an effort to stem the downside risks for growth and inflation.

3Q 2008 US Gross Domestic Product
Economic activity in the third quarter fell less than expected as the advanced GDP reading showed that the economy contracted 0.3% amid expectations for a 0.5% decline. The breakdown of the report showed that personal consumption slipped 3.1% from the previous quarter, which foreshadows a dour outlook for growth as private spending accounts for nearly two-thirds of the economy. As growth prospects deteriorate at a rapid pace, the US economy may face its longest recession in over a quarter century, and may lead the FOMC to ease policy further in an effort to avoid a deep and severe downturn in the economy. Despite the enhanced reading for growth, the outlook remains bleak as credit conditions remain far from normal, and consumers are likely to curb spending in the months ahead as they continue to face falling home prices paired with financial uncertainties.

What to Look for Before the Release

MoneyShow.com readers 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 that 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 the major institutions and will favor a bullish bias on EUR/USD 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 the major institutions and will favor a bearish bias on EUR/USD ahead of the data release.

NEXT: How to Trade This Event Risk |pagebreak|

How to Trade This Event Risk

The advanced GDP reading for the US is likely to reinforce a dour outlook for the world's largest economy as economists forecast the annual rate of growth to contract 4.7% in the first quarter, and economic activity is likely to remain subdued throughout the year as businesses continue to scale back on production and employment in an effort to reduce costs.

Manufacturing and service-based activity fell throughout the first quarter, while industrial outputs slid for the fifth consecutive month in March, and as the capacity utilization rate remains at a record-low of 69.3%, the slump in production is likely to drag on the economy throughout the first half of the year. Moreover, stockpiles held by businesses dropped for the sixth month in February, while wholesale inventories plunged 1.5% during the same period to mark the biggest drop since record keeping began in 1992, and the data foreshadows a deepening downturn in the region as private-sector demands falter.

Retail spending unexpectedly fell 1.1% in March, which was followed by a 0.8% drop in durable goods orders, while consumer credit fell $7.5 billion in February to an annual pace of $2.56 trillion, and conditions are likely to get worse as households face a weakening labor market paired with tightening credit conditions. A report by the labor department showed that non-farm payrolls slipped another 663K in March, which pushed the annual rate of unemployment to a 25-year high of 8.5%, up from 8.1% in February, while continuing claims for jobless benefits reached a fresh record high in the week ending April 4, and the outlook for growth and inflation remains bleak as the International Monetary Fund (IMF) forecasts the growth rate to contract 2.8% this year.

At the same time, Fed vice chairman Donald Kohn reinforced the improved outlook held by chairman Ben Bernanke, stating that he expects economic conditions "To stabilize later this year" as policymakers continue to take unprecedented steps to shore up the ailing economy, but went on to say that "A wide range of uncertainty surrounds that outlook" as financial conditions remain far from normal. As the central bank holds the overnight lending rate at a record low and expands its balance sheet at a rapid pace to soften the landing of the economy, the extraordinary efforts should help to stem the downside risks for growth and inflation, however, as the downturn in the world economy intensifies, the downturn in global trade may continue to weigh on the economy going forward. Meanwhile, as investors continue to weigh the viability of the financial institutions in the US, a dismal GDP reading could weigh on the exchange rate as growth prospects deteriorate, but nevertheless, as risk trends continue to dictate price action in the foreign exchange market, a drop in risk sentiment could boost the appeal of the US dollar as the reserve currency continues to benefit from safe-haven flows.

Expectations for a 4.7% drop in 1Q GDP favors a bearish forecast for the greenback, but nevertheless, an enhanced growth report could set the stage for a bullish dollar trade as the Federal Reserve expects economic activity to improve later this year. Therefore, if the annualized growth rate falls less than 4.0% in the first quarter, we will look for a red, five-minute candle following the release to confirm a sell entry on two lots of EUR/USD, and once these conditions are met, we will set our initial stop at the nearby swing high (or reasonable distance taking volatility into account), and this risk will establish our first target. Our second target will be purely based on discretion, and we will move the stop on the second lot to break even once the first trade reaches its target in an effort to preserve our profits.

On the other hand, as firms reduce outputs and cut stockpiles at a record pace, economic activity is likely to weaken further, and price action following a dismal first quarter growth reading may call for a short dollar trade as the region faces a deepening recession. As a result, an in-line print or a drop of more than 4.7% in GDP would lead us to sell the greenback, and we will follow the same strategy for a long EUR/USD trade as the short position revealed above, just in reverse.

By David Song, Currency Analyst, DailyFX.com

 

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