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IMF Downgrade of U.S. and U.K. Economies Puts Investors on Notice

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The International Monetary Fund (IMF) has slashed its growth outlook for the world’s No. 1 and No. 5 economies, citing political pressures and fiscal uncertainty in its evaluation of the next two years.

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U.S. Outlook Cut as Fiscal Stimulus Remains Elusive

After a dismal first half of 2017, the U.S. economy is projected to grow just 2.1% in 2017, the IMF said in its widely watched World Economic Outlook. That’s down from the April estimate of 2.3%. The forecast for 2018 was also reduced to 2.1% from 2.5%.

The Washington-based lending institution cited contradicting policies as one of the main reasons for the downgrade. It also looks like President Trump’s fiscal stimulus proposals won’t get off the ground anytime soon.

U.K. Faces Brexit Barrier

The United Kingdom’s path out of the European Union became murkier last month after Prime Minister Theresa May failed to build on her parliamentary majority in a snap election. The result knocked the Conservatives eight seats back of a majority, forcing the party to join forces with Northern Ireland’s Democratic Unionists.

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It’s precisely this uncertainty that triggered a downgrade of the U.K.’s economic fortunes. The economy is now seen growing just 1.7% this year compared to the April forecast of 2%. The Fund maintained its 2018 outlook of 1.5% growth.

Brexit remains a highly contentious subject for the U.K. – one that is unlikely to be resolved anytime soon.

Fund Managers Monitoring Financial Risks

Fund managers have been complaining for months now that U.S. stocks are the most overvalued in the world. According to a monthly survey from Bank of America Merrill Lynch, a net 80% of fund managers are underweight U.S. equities. That’s down only slightly from the 84% who indicated the same in June. This makes the IMF’s latest downgrade of the U.S. economy especially concerning.

At the same time, the Fund maintained a generally positive outlook on global growth. It also raised its forecasts for China, Japan and the Eurozone, reflecting a solid first half of the year.

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Economy

U.S. Nonfarm Payrolls Unexpectedly Decline in September

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The U.S. job machine slowed significantly in September, as Hurricanes Harvey and Irma ripped through the southern states, disrupting local economies in their wake.

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Overall nonfarm employment fell by 33,000 last month, following a revised gain of 169,000 in August, the Department of Labor reported from Washington. Analysts in a Bloomberg survey forecast an increase of 100,000.

The jobless rate declined to 4.2% even as workforce participation rose. That’s a level not seen since 2001.

Signs of wage inflation were present last month. Average hourly earnings rose at a faster 0.5% on month and 2.9% annually, official data showed.

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Earlier this week, payrolls processor ADP Inc. said U.S. private sector employers added 135,000 positions last month. Economists had projected 98,000.

Hurricane Harvey made landfall in Texas at the end of August, triggering the biggest weekly spike in jobless claims since 2012. A total of 298,000 Americans filed for state unemployment benefits in the week ended Sept. 2, a gain of 62,000 from the week before.

September was the first negative reading on payrolls in seven years. Hiring is expected to rebound in the fall as the states of Texas and Florida resume cleanup efforts in the wake of hurricane season.

Solid employment growth has been one of the few mainstays of the U.S. economic recovery, prompting the Federal Reserve to gradually normalize monetary policy. The Fed is widely expected to raise interest rates again before year’s end. The Fed’s “great unwind” of its balance sheet will begin this month at a rate of $10 billion.

The report had no immediate impact on the currency markets, with the U.S. dollar index (DXY) rising gradually shortly after the data were announced.

«Featured image from Shutterstock.»

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Economy

BOJ Rate Decision: Bank of Japan Keeps Policy on Hold After September Meeting

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The Bank of Japan (BOJ) has voted to keep its trend-setting interest rate at record lows, as policymakers continue to rely on record stimulus to keep the economy humming.

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BOJ Policy Decision

In an 8-1 vote, the BOJ kept its benchmark interest rate at -0.1%, where it has stood since January 2016. The decision was widely expected by economists, who say the BOJ is unlikely to budge on monetary policy anytime soon.

The BOJ also maintained its purchase of Japanese government bonds (JGBs) so that the 10-year JGB yield remains at zero percent. Meanwhile, annual bond purchases continue to be held at ¥80 trillion.

The BOJ shifted course on monetary policy last September when it made yield-curve targeting its central concern. Since then, it has been status quo.

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Economic Picture Brightens

Central bankers have been largely hands-off to let monetary policy do its job. Recent data suggest ultra-loose policies are finally having their desired effect. Japan is currently in the midst of its longest period of uninterrupted growth in more than a decade. Quarterly gross domestic product (GDP) expanded 0.6% between March and June, the fastest in more than two years.

In annualized terms, the economy expanded 4% in the second quarter, official data showed. That was much bigger than the 2.5% annualized gain forecast by economists.

Japan has now been on the right side of growth for six consecutive quarters and nine of the past 11.

Strong domestic demand and a synchronized global recovery lifting Japanese exports have been the main factors behind the growth.

Despite solid growth, inflation continues to lag the central bank target of 2%. Core inflation rose in July for the seventh straight month, but came in at just 0.5%. National CPI also expanded 0.5% annually in July for its seventh straight gain.

Inflation has been so disappointing that the BOJ recently postponed its inflation deadline for the sixth straight time. The move highlights the growing frustration with low inflation under the Abe regime.

Yen Losing Ground

Japan’s currency declined again on Thursday to trade at fresh two-month lows. The dollar-yen (USD/JPY) exchange rate reached a session high of 112.65 before paring gains. At the time of writing, the pair is up 0.2% at 112.51.

The yen has been in free-fall for the past two weeks as risk sentiment returned to the financial markets. The yen is a highly liquid reserve currency that usually receives strong bids during periods of instability. With investors pouring money into stocks, the yen has fallen by the wayside in recent weeks.

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Analysis

Breaking News: Dollar Soars as Fed Reveals Tapering Plan

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Highlights of the Fed Meeting

  • The Fed will start reducing its balance sheet next month
  • No interest rate change this time around, benchmark rate remains at 1.25%
  • December hike much more likely than previously
  • No change in outlook language

Overall our expectations of a slightly hawkish Fed were fulfilled, as the immediate start of the tapering is quicker than expected, and 11 was the number of Fed officials that see another rate hike in 2017, with only for expecting the rate to remain 1.25%. The market is pricing in a 50% chance for a hike and the ratio suggests that the majority of the Fed officials are leaning towards another tightening step. We expect the Fed to closely monitor the reaction of the market and intervene verbally should risk assets react in an “unwanted” way.

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EUR/USD, Hourly Chart

What’s Next for the Markets?

The Dollar is rallying heavily after the hawkish announcement and the with the significant devaluation of the currency in recent months, there is ample room for a bounce to form. The currency pair has a strong support zone near 1.17 that could serve as a primary target for the move.

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Stock markets are tumbling int he wake of the decision but given the recent strength in equities, in the face of the rising interest rate expectations, we don’t expect a serious move lower after the decision, despite the valuation concerns. Financial stocks should outperform, on the rising rate expectations, while tech issues and growth stocks should lag the broader indices. The major indices are around 0.5% lower since the decision, but even the short-term uptrends aren’t in danger for now.

S&P 500, Hourly Chart

Bitcoin got slightly lower following the announcement, but the decline is minuscule compared to the recent moves in the coin and it seems unlikely that it will have a meaningful effect on the cryptocurrency segment, despite the theoretically bearish implication. Gold will likely be pushed lower in its correction, but the long-term uptrend should remain intact.

Featured image from Shutterstock

 

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