Dollar trounced on GDP, view of easy Fed

Traders work on the floor of the New York Stock Exchange.
Brendan McDermid | Reuters
Traders work on the floor of the New York Stock Exchange.

The dollar nosedived, stocks floundered and bonds sold off Wednesday as traders awaited the Fed's take on the surprise weakness in first-quarter growth.

The dollar index tumbled more than 1 percent after the government said first-quarter growth was just 0.2 percent, fanning expectations for a dovish Fed, when it releases its post-meeting statement at 2 p.m. EDT. GDP was expected to grow at 1 percent, and economists still expect a bounce back in the second and third quarter.

The Dow seesawed in negative territory, while European stocks were whipped as the euro rallied hard, breaking out to a new recent high of 1.11. Traders said higher U.S. bond yields were not reflecting the GDP number as much as the fact that European yields moved higher, and the German bund yield rose dramatically. It gained 10 basis points to about 0.26 percent. The U.S. 10-year bond was at 2.05 percent.

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"It just furthers the narrative that the first quarter was weak, and the jury is still out whether it was a one off or we just lost some momentum. I think it was weather-related, West Coast port related. I think we will bounce back in the second quarter, but the Fed is going to be skeptical of that," said Stephen Stanley, chief economist at Amherst Pierpont Securities.

Stanley expected flat growth and was the most negative on the Street in his first quarter GDP forecast, but he now expects growth of about 3 to 3.5 percent in the second and third quarters.

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Marc Chandler, chief currency strategist at Brown Brothers Harriman, said even though the dollar is getting crushed, the markets should still be guided by policy divergence. European easing for instance should weigh on the euro and support the dollar rally, as the Fed moves toward rate hikes.

"(The euro) is making new highs for this correction. I'm still reluctant to say that the dollar bull market has ended," Chandler said. "I think this is still corrective in nature and I think a lot of it will hinge on the Federal Reserve today, but more importantly next week's jobs data."

The Fed has made it clear it is data dependent and will decide on rate hikes as it sees more figures. Expectations for the first hike are as early as September but definitely by December. Weak March jobs data had made some traders expect the first hike later rather than sooner, and now each jobs report is an important key to Fed hiking.

Chandler said he thinks the next target for the euro could be 112.5 "I won't be too concerned until we get to 112.5. I think it's important that it's macro economics that shape the dollar, not the dollar shaping macro economics."

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First quarter GDP grew just 0.2 percent, well below the 1 percent expected by economists. Treasury yields, however, continued to hold gains despite the fact that weak data is usually a bullish sign, meaning yields move lower. Stocks were already negative and futures gave up more gains in a somewhat delayed reaction to the 8:30 a.m. EDT report on GDP. Stocks continued to be slightly weaker on the day.

"The Fed's been arguing the headwinds in the economy are transitory and there's nothing in the data to suggest it's not transitory. The rise in commodities prices reinforces it," Chandler said.

Chandler also pointed to the bond market, where the 2-year yield remained flat, even though the long end rose. The short end is more predictive of Fed hiking.

"To me, the most important thing here is the sharp backup of U.S. interest rates and (the dollar) is not giving the support because you have a huge selloff in European bonds, which is even bigger," he said.

Peter Boockvar, chief market strategist at Lindsey Group, said several factors were driving European rates. For one, European money supply overnight grew at its fastest pace in six years, showing the result of European Central Bank quantitative easing. He said there was also positive private sector loan growth for the first time in three years in March. "It shows there's maybe some traction in bank lending," he said.

Boockvar said U.S. 10-year yield, at 2 percent for the first time in six weeks, is rising for a myriad of reasons, including signs of firmer inflation. He said another reason for higher yields in general is that foreigners have been net sellers of U.S. bonds, and the Fed is no longer a buyer.

"This is an interesting moment here," said Boockvar. "I think the Fed would be irresponsible if they lean in one direction because there's so much data between now and the June meeting," he said.