U.S. economic growth is treated negatively by traders

Philadelphia, Pennsylvania – (StockNewsDesk) – 09/26/2014 — The latest GDP release from the Commerce Department showed that quarterly growth came in at the fastest pace since the fourth quarter of 2011, at an annualized pace of 4.6%.

Impact on Stock Markets and Fed Policy

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This release caused futures to spike higher to a pre-market gain of almost 6 points on the S&P 500 ES Futures, a gain of 0.3%. However, these gains were quickly lost with futures going red, as traders expected the strong growth numbers may reaffirm market expectations of a rate hike in mid 2015, or even pull it in closer.

It is ironic, in some ways, that this positive economic news is treated as a negative by traders because of its effect on Fed policy. The Federal Reserve has already begun to tighten policy in some ways, as it winds down its QE program, and has begun discussions of a timetable for rate hikes, although it hedges by saying that future decisions will be data dependent.

Overall, QE has been a smashing success for inflation asset prices, as the stock market has climbed from a low of 666 in March 2009 to its recent peak of 2010 in mid September. Since then, stocks have modestly weakened. One concern going forward is the concern with how the market will react to a world in which the Fed is not actively injecting liquidity into financial markets.

GDP release, US Second QuarterGrowth Revised Upwards

Forward-Looking Indicators

US stocks, specifically the large cap indices such as the Dow Jones Industrial Average and the S&P 500, have been strong. Other more sensitive growth indices have been weak such as the small caps index, cyclic stocks index, and commodities and commodity stocks. When traders anticipate economic weakness, these are the stocks with the most concentrated selling pressure.

This has set up an interesting conflict between economic data, which continues to broadcast signals that the US economy continues to heal, and these real time economic signals hint at trouble ahead. One notable concern is Europe, which seems to be again on the verge of deflation, with a little political consensus needed to make the necessary decisions on the economy.

Boost for Dollar

Despite the mixed growth signals with backwards looking data and forward-looking indicators in conflict, one clear-cut winner continues to be the US dollar. Part of the weakness in commodities can be explained by the strength in the US dollar. The US economy continues to be the best performer relative to other major economies, and interest rate increases are on the horizon.

In contrast, Europe and Japan are continuing to increase stimulus efforts. Therefore, there is a greater demand for US dollars, especially relative to these currencies.

The dollar has been one of the strongest performing assets in 2014, as it tries to break out of its three-year base. This looks to be a lasting trend, as the Fed and the US economies are now ahead of the curve in dealing with rate increases, with economic growth picking up. Of course, there is always the possibility that weakness abroad begins to damage the US recovery.

Around 50% of multinational corporations’ revenue, such as those in the Dow Jones or S&P 500, comes from abroad. Therefore, the dollar’s strength typically tends to be bearish for those companies due to the foreign exchange effects. In contrast, small cap companies typically thrive when the dollar is strong. It will be interesting to see how these crosscurrents affect one another, going forward.

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