Make America Great Again, or Make America Groan Again?

The United States surprised many on Friday by announcing a strong 3.2% GDP growth for the first quarter of 2019. This figure smashed the forecast 2.1% - 2.5% expected growth rate for that period, but many analysts are worried the economy is starting to overheat.

The US economy's gains coincide with the Dollar's stellar performance, and the Dollar Index being at a 22-month high. This is weighing on currencies including the Pound, and gold is presently £991.21 per ounce while the Sterling exchange rate is at $1.2922.

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Friday's GDP Data:

The figures released by the US Bureau of Economic Analysis put America's GDP at 3.2% for the first quarter of 2019 (January to March). This is significantly above the forecast of 2.1% - 2.5%, leading to concerns that the American economy may be overheating.

The BEA also revealed that consumer spending was up by 1.2%, business investment up by 2.7%, residential construction was down 2.8%, and inventory stockpiling had been worth $128.4 billion. The agency did admit that the stockpiling was due to a warning from President Trump over tariffs, which never materialised.

On the face of it, the data from January to March is promising for the American economy. It is evidently growing, and on top of this the unemployment rate is currently at a low 3.8%. The problem is that these figures are boosted by the stockpiling - which removed would put the GDP rate at 2.55% for Q1 - and they also don't point out the fact that these rising spending and investment figures are also a growth reduction; still gains, just less of them.

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The Dollar impact:

The US Dollar is strong at present. This is very odd, because the US stock markets are in Risk-On mode. This means there is appetite for taking risks with investments. Typically this is matched by a weak US Dollar. because people tend to sell Dollars/Dollar assets when looking to capitalise elsewhere.

A strong USD also goes in hand with tighter monetary policy, i.e. interest rate rises. The rate rises last year certainly helped the Dollar, but the Fed aborted future rises in January, citing the US/China trade war and other global uncertainties and turning dovish.

The problem is competition. The US Dollar reigns supreme because, despite its flaws, the weaknesses in other countries are more impactful; China is losing the trade war, the UK has Brexit, and Australia's housing bubble just popped - to name but a few.

USD is the world's primary reserve currency. This is hurting countries that have Dollar-denominated debts (like Argentina and Turkey) because when the greenback is high, as it is now, then there's less money to spend after debt repayment.

The knock-on effects are that a lack of spending hurts US exports and dents profits, hurts the S&P500 because of the amount of foreign investment involved (potentially causing a market slump) and could trigger debt crises on the basis of defaulting on repayments.

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Is the US economy overheating?

The Central Bank of Ireland defines economic overheating as “when the economy reaches the limits of its capacity to meet all of the demand from individuals, firms and government.” In the case of the United States, it looks as if it is beginning to overheat as it nears full employment. Unemployment is at 3.8% - not quite a record low but not far off. Inflation is around 1.6% at present, defying economists at the Fed repeatedly, but the expectation is a lurch for inflation back up to 2% and higher once employment is maximised.

If the US economy continues to outperform forecasts then it could experience a downturn. Supply would not meet demand, therefore prices rise. Increased prices leads to a spiral of increased wages, which happens when a country nears full employment as, with little competition, the cost of losing an employee is usually greater than the cost to retain.

The cost increase for goods also hits exports, with foreign buyers not willing to pay high prices. Factor in the US Dollar’s strength at the moment and this could be a big hit to US exports. This is what the Yield curve inversions were hinting at – the US economy is riding a high, but the potential fall could be a big hit to the country’s competitiveness. In short, if the Dollar continues to be strong and the US economy does overheat, there will be a big slump in response; lost trade, wage reductions, job losses, and cuts to public services.