The unexpectedly large US trade deficit may be down to special factors, but US Q1 growth likely stalled. Fed reaction awaited

By Raiko Shareef

The USD was knocked back rather sharply overnight, as investors mulled whether the FOMC would hike rates in light of a now-likely economic contraction in Q1.

AUD outperformed, on encouraging language from the RBA.

NZD gained, despite another fall in dairy prices.

The US printed a hefty trade deficit in March, larger than expected thanks to a huge spike in imports.

That can largely be laid at the feet of West Coast ports clearing the backlog of work, which piled up during a workers’ strike earlier in the year.

This deficit is larger than the BEA accounted for in its first estimate of Q1 GDP last week (+0.2%), and will likely result in that being revised down into negative territory.

Investors have now long given up on Q1 as a dud quarter, afflicted by transitory factors such as poor weather and the West Coast port strikes. Arguably, the market should be looking to April’s data, like the strong ISM services result last night, to see whether a Q2 rebound emerges, keeping the Fed on track to raise rates by September.

The strong selling of USD across the board probably has root in three factors.

First, investors will wonder whether the prospect of a negative Q1 GDP print may give Fed officials reason to push back rate hikes (unlikely, in our view, as central bankers are forward looking).

Second, after a couple of good sessions, USD bulls may be nervous about placing so much hope on Friday’s payrolls report.

Third, the continued contraction of US Treasury yield spreads over German peers helps to buoy EUR.

The AUD sits atop the G10 leaderboard, benefitting from some relatively optimistic language from the RBA yesterday, and despite a 25bp rate cut (see Interest Rates for details). AUD/USD is up 1.4% for the day at 0.7940.

NZD/USD initially traded heavily, despite a rising AUD, thanks to downward momentum in NZD/AUD, which pushed from 0.9610 to trade below 0.9500 overnight.

NZD largely shrugged off another weak dairy auction, overwhelmed by the broader USD sell-off.

We still think the near-term inclination for NZD/USD is to trade within a 0.75 – 0.78 range, before dropping to 0.74 by end-June. Of course, a very strong April jobs report could well change that.

Today, local investors will be focused on the NZ Q1 employment report, with the unemployment rate picked to fall.

Later, highlights include the ADP employment report in the US, and Fed Chair Yellen’s appearance as a panel discussant.

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