Euro Stayed In Range After A Week Of IMF Reports And Spain's Downgrade

Equities did pull back last week on growth worry as IMF lowered global GDP forecasts. That helped the greenback and yen recovered but there was no sustainable buying. European majors somewhat shrugged off IMF's comments and Spain's downgrade and reclaimed much ground against other major currencies towards the end of the week. EUR/USD and EUR/JPY were kept in recent range and the sideway trading could extend initially this week. Nonetheless, we'd anticipate recent rally in the two pairs to resume soon, possibly in the latter part of this week.

IMF lowered estimates of global GDP to 3.3% for this year and 3.6% for 2013. That compared to prior projection of 3.5% in 2012 and 3.9% in 2013, made in July. IMF said that global recovery "has suffered new setbacks, and uncertainty weighs heavily on the outlook," "downside risks have increased and are considerable." And, "the answer depends on whether European and US policy makers can deal pro actively with their major short-term economic challenges."

Asian growth is projected to "pick up very gradually" and the region will remain the leader in growth. It expects Asia to expand "over two percentage points faster than the world average next year". However, it also warned that "sustained high rates of growth over the medium-term cannot be taken for granted." And it expressed concern that "magnitude of the recent slowdown in some large Asian economies has raised concerns that it might not be just cyclical." And, considering that "inflation expectations have remained well anchored," IMF urged that "should activity fail to pick up as projected, further easing may be warranted."

Growth in Asia is estimated to be at 5.4% this year, around 0.6% lower than April's forecast. And, there is one-in-seven odds that Asian growth will fall below 4% in 2013. Growth projection for China was also lowered to 7.8% in 2012 and 8.2% in 2013.

The World Bank lowered its growth forecast for East Asia and Pacific and noted that "China's slowdown this year has been significant, and some fear it could still accelerate." Also, it warned that "economic projections for EAP (East Asia and Pacific) are surrounded by considerable uncertainties, and a variety of risks continue to loom over the global and regional economy." Risk from euro was stemmed by recent policy moves but there are still main risk of "financial market disruptions" and US "fiscal cliff."

According to the report, "as external demand has further moderated and inflationary pressures recede, there is some space for accommodative policies in most countries, and in case of a major external slowdown, sufficient fiscal space for stimulus" while fiscal stimulus would "be more effective in keeping up demand, as policy rates are already low and liquidity relatively abundant in most East Asia-Pacific countries."

Growth projection on China was revised to 7.7% this year and 8.1% in 2013, down from 8.2% and 8.6% respectively. East Asian (excluding Japan and India) growth projection was lowered to 7.2% this year and 7.6% in 2013, down from 7.6% and 8.0% respectively. The 7.2% figure was the slowest pace since 2001 and was much weaker than 8.3% in 2011.

In another report, IMF stated in its Fiscal Monitor report that fiscal shortfalls in advanced economies would fall to an average of 5.9% of GDP in 2012 and 4.9% in 2013, from 6.6% last year. While the figures were revised modestly higher from July's estimates of 5.8% and 4.7% respectively, the trend of narrowing deficits is positive news for the market.

According to the world lender, "most countries have made significant headway in rolling back fiscal deficits and "the improvement in fiscal balances is most pronounced in advanced economies, where the fiscal shock was larger, followed by emerging market economies and to a lesser extent by low-income countries. In the IMF's latest Global Financial Stability Report, the world lender signaled concerns over the situation in eurozone and anticipated as much as USD 4.5 trillion is needed through 2013 so as to achieve the fiscal target. It stated that "intensification of the crisis has manifested itself in capital outflows from the periphery to the core at a pace typically associated with currency crises or sudden stops."

Meanwhile, the ESM and OMT "must be regarded by markets as real, not ‘virtual' and should be coupled with credible conditionality." According to the IMF, "restoring confidence among private investors is paramount for the stabilization of the euro area."

S&P downgraded the Spain's sovereign credit rating to BBB-, from BBB+, placing it much closer to junk level. In addition, the long term rating was also assigned a negative outlook. The rating agency noted that the outlook "reflects our view of the significant risks to Spain's economic growth and budgetary performance, and the lack of a clear direction in eurozone policy." And, the "deepening economic recession is limiting the Spanish government's policy options." It also noted that "the capacity of Spain's political institutions (both domestic and multilateral) to deal with the severe challenges posed by the current economic and financial crisis is declining."

IMF Managing Director Lagarde warned that heavily "frontloading" Greece with austerities could undermine the country's reform and recovery and "it's sometimes better to have a bit more time." She emphasized that it's what IMF had advocated for Portugal and Spain and is why they're advocating for Greece. Lagarde also pledged to "make sure that Greece is back on its feet, that it can one day return to markets, that it doesn't have the need for constant support." At this point, "the real issue is finding a durable solution for Greece." The comments are seen as a nod to Greece's plea of a two year extensions on its fiscal adjustment program.

In ECB's monthly bulletin,, the central bank reiterated that it's ready to buy bonds with its OMT program "once all the prerequisites are in place." And, ECB will also consider to buy bonds on the secondary markets “to the extent that they are warranted from a monetary policy perspective as long as program conditionality is fully respected." The central bank said that the announcement of OMT itself helped reduced "concerns about the materialization of destructive scenarios."

And it urged governments to "continue to implement the necessary steps to reduce both fiscal and structural imbalances and proceed with financial sector restructuring measures.” Regarding the economy, ECB said it will remain weak in the near-term and recover only gradually thereafter.

The latest Beige Book survey by the Fed showed that the US economy "expanded modestly." compared with the reference "expanded gradually" used in the August report. While most districts showed modest growth, the New York District had "a leveling off" in economic activity and Kansas City showed "some slowing in the pace of growth." Overall, improvement was seen in the housing market and the automobile sector.

Consumption was "generally flat to up slightly" while the manufacturing sector was "somewhat improved." The report appeared to be inline with Fed Chairman Ben Bernanke's earlier comments that the pace of economic growth is insufficient to bring the employment conditions back to normal.

After China's PMI data showed the second consecutive month of contraction in the manufacturing sector, the PBOC injected RMB 265B into the money market today through reverse repo. The size is the second largest as the central bank strikes to ease monetary conditions and boost economic growth.

In an article written for China Finance magazine, PBOC Governor Zhou Xiaochuan stated that "the external environment for our country's economic growth is very grim" and the impact from the international finance crisis is unabated and strengthening, and downward pressure on the domestic economy remains relatively big." Therefore, the central bank pledged to make stimulus to the economy "more preemptive, targeted and effective," while "keeping the continuity and stability in monetary policy."