KUWAIT, Sept 24 (KUNA) -- Monetary policy trajectory and global politics were the main theme and market movers last week. On the monetary front, the Federal Reserve backed its previous testimony that one more rate hike was on the table for the current fiscal year with the Bank's surprisingly optimistic tone regarding the US economy, according to a report released by the National Bank of Kuwait on Sunday.
Moreover, the FED concluded that the balance sheet reduction will commence in October as markets expected. After the Federal Reserve's announcement, the two year US Treasury yield soared to the highest level since the global financial crisis at 1.4151%, while interest rate prospects for December moved in the same direction to around 60%.
The FED's tone symbolizes that the US economy is on its way back to a normal state of economic activity without the support of monetary assistance. Looking at the Treasury yield curve, short term interest rates are rising faster than longer term rates, which flattened the curve, while world stock markets fell on Thursday as investors adjusted towards indications from the Federal Reserve that it may raise interest rates for a third time this year.
North Korea's threats at the end of the week have managed to temporarily divert markets attention from last week's monetary policy decisions that have dominated the markets focus and changed the path of financial assets. North Korean officials mentioned it may initiate trials on a hydrogen bomb over the Pacific Ocean after President Donald Trump swore to destroy the isolated country.
Tensions have been increasing for the past weeks between the two nations, causing higher volatility in markets. On the currency front, the US dollar was trading mixed at the start of the week against its G-10 peers in anticipation of FOMC's monetary trajectory.
The mixed momentum from the greenback disappeared on Wednesday after the Fed made formal announcement that it would begin tapering its balance sheet in October and the FED was more optimistic than markets predicted.
The DXY gained strong ground against a basket of currencies, soaring 1.25%. The gains in the index were short lived as it fell back to the levels at the start of the week. The DXY began the week at 91.868 and closed on Friday at 92.259. The common currency had a strong footing at the start of the week, supported by positive euro area economic figures. However, that all changed after the FED's monetary statement, the single currency depreciated from the 1.20 level to 1.1860.
The FED's optimism was not enough to keep the euro subdued as the US dollar weakened with additional encouraging data from euro-zone. The EURUSD opened on Monday at 1.1942 and ended its weekly session at 1.1952. The Sterling pound was in consolidation mode the entire week, trying to find its direction. The GBPUSD opened on Monday at 1.3581, rose to a high of 1.3656 and fell to a low of 1.3448 after Moody's downgraded the UK's sovereign rating. The reasons for the demotion were pressures on the country's economic strength and the higher debt levels since the vote to leave the EU. The pair was down by 0.66% at the end of the week.
The Japanese yen was under pressure on Monday as investor's risk appetite resumed and the safe haven currency continued to weaken ahead of the FOMC's meeting. On Thursday, the yen was floored to the lowest level since July 17 at 112.71 after the FED's meeting was concluded.
The USDJPY is the most US interest rate sensitive currency pair right now, with US yields creeping up, the pair is likely to follow the US yields north.
In the commodities space, the yellow metal was at three weeks low on Monday as investor's risk appetites resumed. On Wednesday, the price of gold declined to the lowest level since August 25, pressured by higher US yields, which cause the opportunity cost of carrying gold to increase. The precious metal lost 1.55% of its value last week.
After its two-day policy meeting, the Federal Open Market Committee unanimously voted to maintain the federal funds rate between 1.00-1.25% and initiate the process of unwinding its balance sheet by October as anticipated by markets.
The biggest surprise was the amendments to the economic forecasts, which now expect stronger growth this year, unemployment rate to descend further in the next two years and a longer timeline to attain the inflation objective.
In comparison to the FED's previous projections, US GDP is expected to come at 2.4% for 2017 versus an earlier estimate of 2.2% and 2018 growth prospects remained unchanged at 2.1%. The latest inflation readings have continued to run below the Fed's 2% target.
The Fed's preferred measure of price growth, the core PCE index, fell to 1.4% year to year in July, marking the smallest increase since December 2015. Moreover, the bank cut its inflation forecast from 1.7% to 1.5% for this year, while no changes were made for the unemployment rate for 2017. The Unemployment rate is expected to drop further to 4.1% in 2018 and 2019.
The Fed has left its median projection for the Fed funds rate unchanged for 2017 and 2018.
This indicates there is still support for one more hike this year and three more to come in 2018 despite the frequency of downside inflation figures the past six months.
Markets currently expect a 60% chance of an increase in the FED's overnight rate for December and around 70% of FED officials support a rate hike in December. Although, there is plenty of figures on the way before the FED meets in December, which could cause members in the committee to revise their opinions, and the decision to retain a December hike may be a close call for some members.
Second, the dot plots for 2019 and beyond were lowered, reflective of a dovish shift in sentiment in the long run. In conclusion, the committees tone was optimistic, blamed low inflation on transitory factors and should pick up as the labor market strengthens. The pace of monetary tightening foreseen by the Fed continues to be more rapid than priced into the market. However, the Fed has been a lot more hawkish than the market for a long time. This theme therefore remains unchanged. The monthly survey produced by the Federal Reserve Bank of Philadelphia on manufacturing conditions improved to a three months high in September.
The index was elevated by 5 points to 23.8, while economists forecasted a level of 17.2. The unexpected rise in the index is largely reflected by accelerations in the pace of growth in new orders and shipments. The new orders index jumped 9.1 points and the shipments index surged up 8.4 points. The survey reinforces that continuous growth persists in the region's manufacturing sector and firms expect an acceleration of production growth for the next six months.
On the inflation spectrum, America's import prices registered the largest increase in seven months, a rise of 0.6% for August, largely reflecting a spike in fuel prices, which soared 4.2% last month. This brings the annual rate from 1.2% seen in July to 2.1% in August.
The annual increase in import prices has slowed sharply since posting 4.7% in February, which was the biggest advance in five years. Import prices excluding petroleum are also on the rise due to the dollar's weakness against the currencies of the United States main trading partners since the beginning of the year.
Eurozone inflation figures came in as markets expected with annual headline inflation rising to a 4 months high at 1.5% in August from 1.3% recorded in July. The rise was mostly attributed to services, food and energy base effects, with the energy component rising from 2.2% to 4.0% year on year. In August last year, the rate was 0.2%, the Eurostat said. The core annual rate remained steady at 1.2%. The lowest inflation rates were seen in Ireland, Cyprus, Greece and Romania for the month, while the highest were in Lithuania, Estonia and Latvia.
Future inflation expectations have fallen in recent months due to a stronger currency causing imported goods to cheapen, which is counter to what the ECB has been trying to achieve. In September, the ECB elevated its growth forecasts for the Eurozone economy over the coming years but cut back its inflation forecasts, stating the strength of the common currency as a factor in the decision.
Overall, inflationary pressures have been gaining strong momentum in comparison to last year and demand in the 19 countries sharing the single currency remains firm as the PMI figures suggest. (end) mfs.rk