On momentum, risks and clarity
- IMF became the latest entity to factor out any US fiscal stimulus
- Wider Eurozone PMI data stuttered to its lowest level in 6 months
- Activity has been very light this week ahead of Wednesday's FOMC
- After Alphabet's earnings, the focus is now on the rest of the FAANG stocks
By Neil Staines
“There is now no question mark over the world economy’s gain in momentum” — IMF
Yesterday the International Monetary Fund offered its latest growth forecast revisions. At the global level, the IMF left its forecasts unchanged for 2017 and 2018 (growth of 3.5% and 3.6%), stating that the global recovery is on a “firmer footing”.
But while the forecasts were unchanged at the global level, they contained modest upgrades for emerging market Asia (including China) and Europe, and downward revisions to the US and UK forecasts.
The IMF also became the latest entity to factor out any US fiscal stimulus for this year following the Fed and who (some time after) in turn followed the financial markets. This re-evaluation of the prospects of US fiscal stimulus alongside the narrowing interest-rate differentials, has undermined the USD in foreign exchange markets of late. As we discussed last week while the Eurozone maintains its faster recovery momentum, EURUSD risks remain to the topside.
"Ceteris paribus" (other things being equal) is a favourite term among economists to isolate the assumptions and inferences of one economic action or system from the influence or impact of those not studied or anticipated. At this stage of the global economic recovery, the macroeconomic backdrop is more supportive for EUR appreciation against the USD than it has been for some time, in our view — ceteris paribus.
“Living at risk is jumping off a cliff and building your wings on the way down” — Ray Bradbury
The IMF said that “several risks threaten the recovery, especially in the medium term” and, even as the German Ifo business confidence index plumbs new highs this morning, the wider Eurozone PMI data yesterday stuttered to its lowest level in six months. The Eurozone recovery has been remarkable as it essentially has been a creditless recovery. However, that is not to say that there are no risks to the recovery in the medium term from still heavily indebted banks and governments.
From our perspective, the biggest risk to current trends and to wider financial market sentiment is the performance of the equity markets, in particular in the US. Earnings season is reaching full flow as we approach the Fed meeting. So far, the proportion of companies reporting better-than-expected results remains high. However, after Alphabet beat earnings estimates (despite the huge EU antitrust fine), a warning about falling advertising revenue undermined the share price following the release. The focus on the rest of the FAANG (Facebook, Apple, Amazon, Netflix and Alphabet’s Google) stocks, over coming days, will be high.
Activity this week has been very light, as market participants await the comment and analysis from the July Federal Open Market Committee meeting on Wednesday. Expectations of the FOMC are minimal, with the recent theme of disappointing inflation seen generating a Fed pause in September — filled by the gradual start to balance-sheet normalisation. Indeed, markets are yet to be convinced that the Fed will resume its interest-rate normalisation in December with the overnight index swaps (OIS) curve implying only around a 45% chance of a 25 basis points rate rise.
Against this backdrop and the current overvaluation of US equities, the risks to the downside for US stocks are rising, a prospect that is increasingly sensitive to a more-hawkish-than-expected Fed and one where the impact would be exacerbated by the extreme levels of positioning in US bond markets (that could see a knee-jerk sharp curve steepening).
“More clarity on government policy is highly desirable” — Stanley Fischer
Earlier this month Fed vice chairman Stanley Fischer called on policymakers to do more to boost business investment, spur innovation and train and educate workers to jump-start a “dismal” record of productivity. Fiscal policy uncertainty may be hampering this investment. In the US, expectation of policy action has been completely unwound, and so the risks are now tilted to the topside for the USD. In this respect, in our view, the UK (GBP) and the US (USD) are in the same boat.
The growing consensus in the UK government towards a transition period for implementation after Brexit discussions has been seen as positive for GBP over recent sessions. From our view, the greater the “clarity on government policy”, the better the performance of GBP is likely to be. We will update our assessment after the Fed on Wednesday, however, in the near term we continue to expect the global monetary policy repricing (narrowed interest-rate differentials) and fluctuating USD risk premium to favour the EUR over the USD. GBP, however, may be surprisingly resilient.
In short, our expectations remain relatively low for this week, though the risk of corrections in the financial markets is rising.
— Edited by Clemens Bomsdorf
Neil Staines is head of trading at The ECU Group