Fallout from US GDP continues

The heady expectations for US 2Q GDP growth were dashed on Friday as inventories subtracted 1.2 percentage points from growth.

Federal Reserve
Source: Bloomberg

The Atlanta Fed’s GDPNow estimate dived well below the 2.5% last week based on its projection for inventories, and it turned out to be far worse than many had expected. There is no chance of a September rate hike now, and for it to occur in December the Fed will require steady job growth and a noted pick up in GDP in the second half of the year – developments that are far from certain.

US Wholesale inventories declined 0.1% year-on-year in June – the first year-on-year decline seen since the GFC.

The big miss in US 2Q GDP saw the DXY US dollar drop 1.25% on Friday. This provided welcome relief for emerging market currencies and commodity prices that had been under pressure from USD strength. The Bloomberg commodity index gained over 1%, and WTI oil broke its ten-day losing streak to close up 0.9%. This helped the S&P 500 energy sector see the second best performance on Friday after telecoms. In such an environment, gold and silver could be set for a bit of a run, and certainly the risk of US PMIs or non-farm payrolls disappointing this week offers further upside to them.

This also saw the Aussie dollar gain 1.3%, and it does look like it has an upside bias. If the RBA upsets rate cut expectations tomorrow, the Aussie could set course to retest US$0.78. And some of the upside momentum behind the currency could see it continue head that way in the near term even if the RBA does cut rates.

One major concern on the horizon for further commodity price and Aussie dollar gains is what is playing out in China’s heavily-indebted industrial province of Liaoning. The ongoing debate over how to deal with the defaulted bonds of Dongbei Special Steel Group is spilling over into a general concern about all bonds issued by Liaoning-based firms. Right Way Real Estate Development Co. was forced to issue bonds on Thursday at a 289 basis point premium to the national average on similar maturities. The risk for commodities and their related assets is that China dramatically toughens its stance on dealing with heavily indebted SOEs and eases the amount of credit being extended to the over-capacity industrial sector. This would be a good thing for China’s long term economic health, but the short term market reaction in the commodity space is unlikely to be pleasant. The thing to watch is whether these credit premiums start to be charged in the rest of China’s struggling industrial North-Eastern provinces.

The European bank stress test results were better than many had expected, but there was a lot of valid criticism that they failed to model any potential negative impacts from Brexit. Unsurprisingly, Italy’s Banca Monte dei Paschi di Siena flashed up serious capital concerns, but the other two worst performers were Ireland’s Allied Irish Bank (AIB) and the UK’s RBS. Although two out of the three still closed out Friday’s session higher.

Most Asian markets are looking to open higher after the S&P 500 made another new high on Friday and commodity prices bounced back. The major exception to this is Japan. The yen has continued to strengthen in the wake of the major BOJ disappointment on Friday, which was further compounded by the USD selloff in the wake of GDP. The Japanese yen strengthened more than 3% on Friday, and the Nikkei looks set to open down more than 1%.

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