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  •  An economic miracle?
  •  No justification for more QE in the US
  •  Some advice Mitt Romney should give London
  •  Digesting Draghi - day 2
  •  Market moves

After focusing mostly on Europe and in particular Mario Draghi, the markets have had to adapt to a better than expected Q2 GDP report from the US. It showed that the US economy expanded by 1.5% in Q2 on an annualised basis. Although that is below the 1.9% rate in Q1 it was above the consensus 1.4%. The markets reacted in typical fashion: buying the dollar and selling Treasuries, causing yields to rise and dragging USDJPY higher with it. But will the GDP report alter the course of the FOMC meeting that concludes next Wednesday?

An economic miracle?

There had been some expectation in the market that the Fed would do more QE on the back of intensifying risks emanating from the currency bloc; however growth at this rate suggests that the US economy is far from recessionary territory. The Fed's mandate is to provide full employment and keep the inflation rate under control. It has managed to keep core inflation (stripping out food and energy) a fairly stable 2.2% in June, and this pair has been trading in a fairly narrow range for some time, which suggests the Fed is doing its job when it comes to inflation. However, unemployment has been more stubborn and remains at an elevated 8.2%, and job growth is fairly anaemic. There is some good news; initial jobless claims have been trending lower in recent weeks, although that could be due to the usual disruption during the summer months caused by factory shutdowns etc.

No justification for more QE

On balance the economic data does not suggest another round of QE is necessary from the Fed. Although the employment picture is weak, Fed officials may want to wait to see if the economy picks up in the second half of the year, since the growth outlook is neither too good for jubilation nor too bad for more stimulus, in our view. For example, personal consumption declined from 2.4% in Q1 to 1.5% in Q2, which is fairly muted but not a bad reading. Services and private sector investment rose at a faster rate in Q2 than Q1, and investment in residential and non-residential building also registered healthy gains for the third straight quarter. This is important since housing has been a major drag on the US economy in the last four years. Also, growth in the US is not reliant on the public sector: government spending slipped to 1.4% in Q2 after a 3% decline in Q1.

Some advice Mitt Romney should give London

It is interesting that the US economy is so resilient in the face of deep recessions across the Atlantic, and that growth is managing to do well even while government spending is falling. Dare I say it, but Republican Presidential candidate Mitt Romney should stop telling London how to "do" the Olympics and offer some useful advice: by telling us the trick of how to have steady growth while reducing government spending.

Digesting Draghi - day 2

Europe is not far from the markets' minds either, as investors digest Draghi's comments for the second day. After yesterday's stunning rally the markets have woken up today in a slightly less jubilant mood. Stocks are still rallying, but Spanish bond yields rose to 6.95% today after comments from the Bundesbank suggested that Germany will not support bond purchases or give the rescue funds banking licences to print money and act as sovereign lenders of last resort. This knocked the wind out of the bond markets and also the euro, which tumbled to a low of 1.2240. However, they have since picked up as we get close to the end of the European week, and EURUSD is once again testing the 1.2330 level - a key resistance zone for this pair - after the leaders of Germany and France stood together and offered to do everything possible to save the currency union.

Market moves:

There have been some nasty earnings reports from the US with Anglo American disappointing along with online retailer Amazon. That comes hot on the heels of Facebook's earnings disappointment, which led to further declines for the beleaguered social "notworking" site (a line I admit to stealing from the Lex column at the FT). This hasn't disrupted the rally in S&P's today, which have followed European equities higher. However, the S&P may struggle to gain traction above 1,380 - a key resistance zone - as investors worry about the future outlook for profits.

The weekly closes in EURUSD, gold and in GBPJPY are on my radar this afternoon. If EURUSD can close above 1.2330 then we may see back towards 1.25, I think a break above $1,635 in gold would suggest the markets are fully expecting QE and if GBPJPY can close above 123.30 - the base of the Ichimoku cloud - then it suggests that risk really is back on. All of these signals could be opportunities to sell later next week especially if central banks don't deliver what the markets' want.

In an environment of loose monetary policy and expectation that the politicians and the ECB can reduce the credit risk for Spain and Italy this is good news for commodity currencies. AUDJPY is re-testing its 100-day moving average resistance at 81.85. Above here opens the way for a move above its recent range and towards 84.00 in the medium-term. The daily RSI is also supportive of further upward momentum as you can see in the chart below.

AUDJPY: Daily chart



Best Regards,

Kathleen Brooks| Research Director UK EMEA |

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