GDP Annualized (2Q A) (08:30 ET; 12:30 GMT)
Expected: 3.2%
Previous: 0.7%

Personal Consumption (2Q A) (08:30 ET; 12:30 GMT)
Expected: 1.6%
Previous: 4.2%

How Will The Markets React?

Economic expansion in the US is expected to have re-accelerated in the second quarter at an annualized rate of 3.2 percent – a substantial jump from the tepid 0.7 percent growth experienced in the first quarter. The gain is likely to be led by the manufacturing sector, as a weaker US dollar has made American products more attractive. Furthermore, strong economic growth in Europe and Asia is also likely to have helped boost demand, as exports surged to a record of $132 billion in May, subsequently helping to pick up the slack in domestic purchases. In fact, consumer spending - which accounts for about 70 percent of the economy - is estimated to have slowed substantially to a 1.6 percent annualized pace in the second quarter from 4.2 percent in the first quarter, as the combination of surging gasoline prices and a vast weakening of the housing sector takes its toll. The rebound in the headline GDP reading will be very encouraging to the Federal Reserve, which estimates that the economy will grow by 2.25 percent - 2.5 percent in the fourth quarter of 2007 from a year before, though this represents a downgrade from February, when the bank’s range was 2.5 percent - 3 percent. A positive result will likely be reflected most clearly in the forex markets, as recent US dollar gains against the Euro and British pound will only be exacerbated. Bond and equity markets, on the other hand, will probably focus on the GDP price index. The figure is predicted to slow to 3.4 percent from 4.2 percent, signaling that inflation pressures are easing and indicating that the Fed will not have to raise interest rates in the near-term.

Bonds – US 10-Year Treasury Note Futures

Recent strong price action in 10-year Treasury note futures pushed through the upper end of the range pattern that had held for several weeks. The breakout targeted the 61.8% Fib at 106-21, and today's strength sliced right through that level. A close above there, which is looking very likely today, would imply that the contract is on a path to reach the previous highs in the 108-16 area. The release of US GDP may help the bid tone of Treasuries, as the price index is anticipated to show that inflation eased in the second quarter. With price pressures easing and economic expansion still unstable given the dismal state of the housing sector, markets are now starting to count on a January rate cut by the Fed.

FX – EUR/USD

A 14-month ascending trendline blocked gains beyond the July 24th high of 1.3852 for EUR/USD, while a short-term supporting trendline has recently prevented losses below 1.3700. Looking top-heavy and overbought, the odds are working in favor of a sharp drop towards 1.3300, but are the markets ready to buy up US dollars en masse? Friday’s release of second quarter US GDP could provide the impetus for a surge in the greenback, as the figure is anticipated to rebound an annualized 3.2 percent after slowing to a tepid 0.7 percent in the first quarter. On the other hand, an extremely disappointing figure could lead EUR/USD to test the all-time highs once again as traders consider the possibility of a Fed rate cut within the next year. Nevertheless, any gains for the pair may be short-lived as a turn for EUR/USD could be imminent.

Equities – S&P 500 Index

US stocks plunged as higher financing costs threatened to spur debt defaults and slow takeovers. The S&P 500 Index dropped 2.3 percent to 1482.66 while the Dow Jones Industrial Average tumbled 2.3 percent to 13,473.57 - marking the steepest declines for both indexes since a rout on February 27, when a sell-off in China spread globally and wiped out $3.3 trillion from markets worldwide. Exxon shares slid $4.56 to $88.23 after the company said that production decreased. Meanwhile, financial shares suffered with Citigroup down $1.40 to $47.81 while Bank of America slipped 70 cents to $47.23.

While the dominant theme for equity traders will likely remain earnings, the status of credit markets, and the potential for tighter liquidity, the release of US GDP for the second quarter adds additional event risk. A large improvement in GDP for the second quarter could help the S&P 500 stage a recovery after Thursday’s massive losses, especially if the price index eases back in line with expectations and boosts the chances of a rate cut by the Federal Reserve within the next year. However, if GDP disappoints, negative sentiment on the US economy could take a toll on equities for yet another day and push the S&P 500 down to the 1,450 level.

Terri Belkas is a Currency Strategist at FXCM.