US GDP Preview: Win-win for the dollar? Economy's flirt with recession to boost the buck

• Economists expect the US to report a meager 0.4% annualized growth rate in Q2.
• A negative print would put the world's largest economy in a technical recession. 
• The greenback is set to benefit from a return to growth or from fears.

Has America ducked a recession? That is what economists expect from the first release of the second quarter Gross Domestic Product (GDP) – a paltry 0.4% annualized growth rate. Un-annualized that is only 0.1%.

After shrinking by 1.6% annualized in the first three quarters of the year, a small miss would mean two consecutive quarters of contraction – one of the definitions of recession. I believe that the GDP outcome will have little impact on the dollar reaction – and that its chances are low.

Low chances for a recession

It is essential to note that only the National Bureau of Economic Research (NBER) officially defines recessions. Their broad criteria are

a significant decline in economic activity that is spread across the economy and lasts more than a few months

The NBER is unlikely to determine a recession while US job growth is at around a monthly pace of 400,000, and while retail sales look robust. An unemployment rate of 3.6% and ongoing shopping sprees are inconsistent with a recession. 

Moreover, that 1.6% squeeze in the first quarter was a result of an unusually high trade deficit and inventory reduction – one-off quirks. When inventories are depleted in one quarter, they tend to replenished later on. If such a fill-up happened already in Q2, growth could be higher 

Another reason to expect a stronger growth figure is the fact that economists missed estimates in the past two quarters – and that three consecutive disappointments last occurred in 2013. 

Source: FXStreet

Why a win-win is likely for the dollar

In case growth exceeds expectations, there would be no headlines screaming recession, which would be positive for the US dollar. It would show that additional rate hikes would be needed to tame inflation. 

Such a reaction would be boosted if the GDP Price Index – sometimes called "deflator" remains at elevated levels. The figure represents the inflationary impact on growth, and stood at 8.3% in the first quarter – a rapid pace of price rises. The economic calendar points to an 8% increase now, which would still be high. 

Source: FXStreet

In case my upbeat expansion expectations for a return to growth fail to materialize, headlines would scream recession. While pundits would be discussing the technicalities, markets would clearly see a deteriorating economic environment as a prelude to a drop in inflation. 

Two quarters of negative growth would also imply employment is set to fall – and that is also critical for the Fed. The central bank has two mandates: price stability and full employment. If labor markets cool, Fed Chair Jerome Powell and his colleagues would need to take jobs into consideration when discussing how to fight inflation. That would mean lower rate hikes. 

Will the dollar fall in case of negative numbers? Not so fast. The dollar reflects fear and not only the Fed's interest rates. If headlines indeed scream "US recession," other parts of the world are unlikely to thrive. "When America sneezes, the globe catches a cold" – goes the adage. 

One currency pair that is likely to feel the difference between expansion and contraction outcomes is USD/JPY. A better than expected GDP figure will likely send the currency pair higher, while a weak outcome would push 10-year yields lower, dragging USD/JPY down. 

When it comes to EUR/USD, GBP/USD, and commodity currencies, the dollar is more likely than not to come out on top – whether headlines scream recession or not. 

Final thoughts

The first release of GDP has a greater impact than consequent ones, when a technical recession is in play, the stakes are even higher. Nevertheless, the greenback has room to rise. 

Last note: I have written this preview before the Fed decision, which is set to have a substantial impact on the dollar and markets. If needed, an update will be provided.