Dollar Soars as Q4 GDP Blows Away Expectations

Inventories accounted for close to 60 percent of the rise in GDP indicating that growth was primarily fueled by inventory build-up ahead of the school year and the holiday shopping season. Stronger consumer spending in the last 3 months of the year also contributed positively to GDP. Growth in Q4 was the fastest since the third quarter of 2003 - more than 6 years ago. The critical question going forward is whether this momentum can be sustained.

Although we were skeptical about whether GDP could live up to expectations, we also pointed out that after the recession in the 1980s, GDP grew at very healthy rates. Between the first quarter of 1983 and the second quarter of 1984, GDP grew at an average rate of 7.68 percent. This is not to say the U.S. economy will replicate this pace of growth in the quarters ahead, but we have previously seen the rubber-band effect after deep recessions.

The latest GDP numbers reinforces the credibility of Fed Chairman Ben Bernanke who has just secured his second term as the head of the U.S. central bank. With the holiday shopping season behind us and chilly temperatures across the nation, it will be interesting to see consumer spending and inventory buildup will continue to support the U.S. economy.

Meanwhile, for the foreign exchange market, the critical question is whether the strong U.S. report will finally cause the dollar to trade off of its economic outlook and not risk appetite. We have long stressed that USD/JPY tends to be the best currency to use to trade U.S. data because it has the most logical reaction to the report. For example, this morning's solid GDP number was unambiguously positive for USD/JPY. The other major currencies like the EUR/USD  and the AUD/USD are struggling with the dueling forces risk appetite and the outlook for the U.S. economy. For the time being, it appears the strong U.S. report is more positive for risk as the EUR/USD recaptures its initial losses.