Sive Morten
Special Consultant to the FPA
- Messages
- 19,257
Fundamentals
So there are two major events happened - Fed meeting and NFP report. Both topics have a lot of layers. Something stands on the surface, something is hidden. The one thing is becoming clear, guys. Even this week, when we've got absolutely stunning data of high importance it still was overshadowed by politics. I suggest that in August, or even in longer term, nobody will care about economy at all. Because now all cards are opened. What else the Fed could do? Rate cut is unavoidable and now it becomes not important what CPI we will get and what next NFP or GDP reports will be. Actually we were preparing to this moment and told every week that it should happen in the perspective of the year, starting from the moment when we've caught the first signs of problems in the US economy in 2022. Now political stakes stand so high, that nobody cares about economy, when Iran rockets soon will fly to Israel.
FED & NFP
So, Fed meeting and NFP this week. Concerning the first one, I wouldn't say that it has brought something special. Even based on markets reaction it was clear that investors were prepared and majority of information is priced-in already. There are only a few new points that J. Powell added:
This is all that we could say about Powell's speech. Now to turn smoothly to NFP data, here are two phrases from his speech concerning job market:
Speaking about NFP and recent collapse on stock market... Those who read us constantly should remember our long stories about the US job market and how it ismanipulated, falsificated sorry, adjusted by statistic authorities. Recent report was very week. But, not only NFP data is important. Let's take a bit broader view on this subject. Here is some charts for beginning:
There are a few charts of a special interest. First is "Weekly Hours" this indicator unfairly has low popularity, while it is the best predictor of coming changes in economy and job market in particular. It is very conservative and very rare change. But particularly this features make it unique. Take a look that average work week is dropping since 2021. This can't happen if your economy is raising, especially at 3%+ GDP level. Second is - ISM job components as in manufacturing as in service sectors point on contraction and stand below 50 level.
Another indirect confirmation of recession is a drop of average hourly earnings, which indicates slow down in production sector and disinflation in PPI. We've talked about as well previously. Finally - take a look at other broad based indicators - U6 unemployment, youth unemployment and continuing claims. All stand at 3 year peaks, while weekly claims are under way to this level. Finally, popular Sahm indicator that tracks recessions has reached 0.5 level that is threshold one.
Finally, the Fed's interest rates indicator shows 70% of recession.
What does all these stuff mean? For the market, the report is, of course, devastating - employment is growing slowly, unemployment has jumped, wages have stopped growing. Against this background, they already want to lower the rate by 50 bp in September with a probability of 67% right now ... stocks and the dollar are flying down, bonds are up.
Since we see constant and stable long-lasting tendency in major indicators, it is almost no chance to suggest the outbreak. This in turn means, that hardly the Fed will get the relief from job market, if even statistics authorities will try to "adjust" it again. If we recall that even by official calculations of Atlanta Fed, the official data is overweight for ~800-1000K of employees (in reality the difference is larger), then hardly we will see the Fed step out from its dovish plan. Now chances that it will become even more dovish seem better.
2 cents on JPY
Once we've said that Japan could become the source of world crisis, its starting point, and it still could happen. Recent 12%+ collapse of Nikkei index is a result of BoJ rate policy and following JPY rally. What's the problem? The risk of hedge funds collapsing short bets on the yen accurately materialized. They have to sharply reduce the share of borrowed funds [loans in yen], used to buy hype stocks with leverage. This is clearly demonstrated by the exchange rate of the Japanese currency and the Nasdaq 100. In the two weeks to July 23, leveraged investors liquidated 56,639 net short positions in the Japanese currency, the largest capitulation since early 2011.
Week for the main bubble of global markets - Nasdaq/AI/chips - after all closed in deep negative territory, almost -12% from the ATH. There was also a large-scale risk-off into government bonds: in just a few weeks, the yield on 2-year treasuries fell by more than 100 bp with now participation from the Fed. So recent moves on US bonds is a result of geopolitics (long-term bonds) and Japanese investors.
Perhaps we have not yet reached global margin-call in Western markets , but the path to it is now visible. Not occasionally Buffett was selling BofA shares at high pace: Berkshire sold Bank of America shares for the 12th day in a row. Since mid-July, the fund has received $3.8 billion in revenue.
Gold, by the way, played its role as an early signal of flight from risk. Now, it is possible that the paper price of the metal in dollars will experience volatility due to the closure of margin positions. But this is subject for Gold report tomorrow.
And now,suddenly, Yellen/the US Treasury is not even objects to Japan interventions. The problem turns out to be common:
The major hit was on Japanese banks. Only a month has passed:
Japan has a net investment position of 3.5 trillion. dollars. Of these, if I remember correctly, about 2 trillion. dollars of foreign debt investments. A significant part of these 2 trillion. dollars may well return to Japan if the rate rises, YCC will gradually weaken. They can return along the way by collapsing debt markets around the world and creating a terrible situation with liquidity in the global banking system. The main thing is that the Central Bank of Japan does not buy back dollars. Raising the rate, will only worsen the recession and cause an increase in the number of defaults by companies within the country. And collapse could start from banking sector.
Japanese banks have very low Return on Capital and Capital per se, somewhere around 3.5% and 4% of assets correspondingly. For example this is Japanese Post Bank, Mizuho and many others. They indicate that this bank simply lacks stability. It is enough to write off 4% of assets and the capital will become zero. Moreover, it is enough to create a reserve of 0.15% of assets to reduce profits to zero. in the Japanese banking system, which is deeply integrated into the global financial system, everything is very “subtle” and how the situation could unfold if a crisis scenario is realized is a big mystery.
Other issues to consider
Since we're focused mostly on EUR/USD let's have a look what is going on in EU. European inflation is in no hurry to resume its decline; consumer prices in July rose by 0.4% m/m, seasonally adjusted, and annual price growth even accelerated slightly to 2.6%. Core inflation remained at 2.9% y/y for the third month in a row. Energy prices are rising by 1.3%, and food products by 2.3% . The disinflationary effect on the energy side is ending, which pushes overall price indices up a little. New M. East tensions and scandal around oil delivery to Hungary and Slovakia from Russia makes situation even more tricky.
But the stable driver of price growth is still the same - this is the services sector , where inflation amounted to 0.4% m/m, seasonally adjusted, and 4% y/y, and has remained elevated for a long period of time. Moreover, the three- and six-month impulse of growth in prices for services remains around 5% (SAAR), i.e. over the past six months, services have risen in price at a rate 2.5 times higher than the ECB’s target. So ECB is coming to our scenario that chances on September rate cut are melting.
Another interesting stuff is about US GDP. The figure turned out to be much steeper than the consensus of +2%, but so far this is more of an estimate and not actual data. If you take a closer look at the structure of GDP growth for the quarter, the negative thing will be the jump in inventories. Moreover, a large share of GDP growth is consumption. spending is likely to be significantly revised downwards given the fresh negative quarterly reports from corporates and the latest data on the deterioration of households savings.
New orders for durable goods fell to $264.54 billion in June. This is the minimum since November 2021 -6.6% m/m with expectations of +0.3%. At the same time data shows drop in cargo tonnage in June and the production of transport equipment. Besides next time, GDP will compare to low base numbers of the last year that will return it to "correct" level and will show the "real face".
CONCLUSION
The Fed is once again plunging the US into recession at the peak of monetary policy tightening [possibly intentionally]. The bad news is now really bad: the “soft landing” narrative is going on a well-deserved vacation, and the “recessionary trade” is reinforced by the July US jobs report. Additionally to week NFP numbers, mentioned above, it makes sense to tell that annual job growth rate was only 1.6% while total employment in May and June was revised to -29K jobs. Speaking of data quality - for the last six months, data for 5 months were revised downward. We already have discovered and explained this trick earlier.
On July 2, Powell said the labor market was strong. This Wednesday, suddenly, at a press conference, I remembered the second side of the Central Bank’s mandate - maintaining the employment of American citizens. After the release of the employment report, the treasury market sharply changed its shoes and began to anticipate rate cut of almost -50 bp. in September with 70% probability.
What does it mean?
Reducing the rate by a minimum of 25 bp will not help anymore. Cut strongly - for example, by 50 bp. or more, as markets expect, means confirming Fed and JPow professional incompetence following the results of the July meeting. Besides, as we've said, it might be treated as a panic on the markets - aggravate the panic in the entire system confirmation of the recession by the regulator. It is all the more dangerous to make any unscheduled decision to soften the monetary policy before September. We've said - July is the best month for rate cut. And this chance has been lost.
Some believe that this will be a deflationary crisis. But we're convinced that the opposite will happen. The story of Ray Dalio, who was a young trader in 1971 is a great illustration. On August 15, 1971, he was a clerk on the floor of the New York Stock Exchange when President Richard Nixon announced that U.S. currency would no longer be redeemable for gold, ending the Bretton Woods system.
That is, at the moment when it became clear that the dollar had lost its value, everyone began to exchange the dollar for various assets. Moreover, note that there was no financial crisis, like in 2008. Commercial mortgage (CRE) is not such a global collateral, therefore, by and large, the only thing that can happen is a deep crisis in regional banks in the United States, which hold plenty of these commercial mortgages. But this problem will either be flooded with money, or a great banking merger under the shadow of JPMorgan. That is why the scenario should be inflationary with a rise in the price of real assets and, in particular, raw materials and gold.
At first stage of panic everybody will run into so-called "safe haven" US Treasury bonds. Because Universities and books teach that this is risk free asset. But this will last only until the moment when the case of Ray Dalio, mentioned above will come. It will interesting to watch what will happen to those investors.
So, the 1st part of our summer plan is done. As we've said, in a case of July cut, there should be a strong USD drop, otherwise, it should be small USD drop. Not occasionally we have two monthly bullish grabbers. Now, when everything is clear with the Fed, that they will cut rate in September for 0.5% we're going to the 2nd stage - ECB. By all means now we still keep our suggestion that ECB will not cut rate in September. Inflation is spinning up and even the Fed example will not be motivating enough to do this. By all means EUR should feel well in nearest 1-2 months, if of course we avoid any force major factor.
So there are two major events happened - Fed meeting and NFP report. Both topics have a lot of layers. Something stands on the surface, something is hidden. The one thing is becoming clear, guys. Even this week, when we've got absolutely stunning data of high importance it still was overshadowed by politics. I suggest that in August, or even in longer term, nobody will care about economy at all. Because now all cards are opened. What else the Fed could do? Rate cut is unavoidable and now it becomes not important what CPI we will get and what next NFP or GDP reports will be. Actually we were preparing to this moment and told every week that it should happen in the perspective of the year, starting from the moment when we've caught the first signs of problems in the US economy in 2022. Now political stakes stand so high, that nobody cares about economy, when Iran rockets soon will fly to Israel.
FED & NFP
So, Fed meeting and NFP this week. Concerning the first one, I wouldn't say that it has brought something special. Even based on markets reaction it was clear that investors were prepared and majority of information is priced-in already. There are only a few new points that J. Powell added:
- A rate cut too late may unduly weaken the economy;
- A rate cut may be discussed at a meeting in September, BUT there was a real discussion about the rate cut (in July).
- We are not thinking about reducing the rate by 50 bps right now.
- There is a widespread opinion among Fed chairmen that we are close to easing the policy;
- It's time to adjust the interest rate
- The Fed does NOT need to be 100% focused on inflation
- ️In the basic scenario, one would think that from this point on, the rate would begin to decrease
- "All Fed chairmen supported today's interest rate decision."
This is all that we could say about Powell's speech. Now to turn smoothly to NFP data, here are two phrases from his speech concerning job market:
- I do not consider the labor market to be a likely source of inflationary pressure. Therefore, I do not want to see excessive cooling
- If the Fed sees something similar to a significant downturn in the labor market, we will react.
Speaking about NFP and recent collapse on stock market... Those who read us constantly should remember our long stories about the US job market and how it is
There are a few charts of a special interest. First is "Weekly Hours" this indicator unfairly has low popularity, while it is the best predictor of coming changes in economy and job market in particular. It is very conservative and very rare change. But particularly this features make it unique. Take a look that average work week is dropping since 2021. This can't happen if your economy is raising, especially at 3%+ GDP level. Second is - ISM job components as in manufacturing as in service sectors point on contraction and stand below 50 level.
Another indirect confirmation of recession is a drop of average hourly earnings, which indicates slow down in production sector and disinflation in PPI. We've talked about as well previously. Finally - take a look at other broad based indicators - U6 unemployment, youth unemployment and continuing claims. All stand at 3 year peaks, while weekly claims are under way to this level. Finally, popular Sahm indicator that tracks recessions has reached 0.5 level that is threshold one.
Finally, the Fed's interest rates indicator shows 70% of recession.
What does all these stuff mean? For the market, the report is, of course, devastating - employment is growing slowly, unemployment has jumped, wages have stopped growing. Against this background, they already want to lower the rate by 50 bp in September with a probability of 67% right now ... stocks and the dollar are flying down, bonds are up.
Since we see constant and stable long-lasting tendency in major indicators, it is almost no chance to suggest the outbreak. This in turn means, that hardly the Fed will get the relief from job market, if even statistics authorities will try to "adjust" it again. If we recall that even by official calculations of Atlanta Fed, the official data is overweight for ~800-1000K of employees (in reality the difference is larger), then hardly we will see the Fed step out from its dovish plan. Now chances that it will become even more dovish seem better.
2 cents on JPY
Once we've said that Japan could become the source of world crisis, its starting point, and it still could happen. Recent 12%+ collapse of Nikkei index is a result of BoJ rate policy and following JPY rally. What's the problem? The risk of hedge funds collapsing short bets on the yen accurately materialized. They have to sharply reduce the share of borrowed funds [loans in yen], used to buy hype stocks with leverage. This is clearly demonstrated by the exchange rate of the Japanese currency and the Nasdaq 100. In the two weeks to July 23, leveraged investors liquidated 56,639 net short positions in the Japanese currency, the largest capitulation since early 2011.
Week for the main bubble of global markets - Nasdaq/AI/chips - after all closed in deep negative territory, almost -12% from the ATH. There was also a large-scale risk-off into government bonds: in just a few weeks, the yield on 2-year treasuries fell by more than 100 bp with now participation from the Fed. So recent moves on US bonds is a result of geopolitics (long-term bonds) and Japanese investors.
Perhaps we have not yet reached global margin-call in Western markets , but the path to it is now visible. Not occasionally Buffett was selling BofA shares at high pace: Berkshire sold Bank of America shares for the 12th day in a row. Since mid-July, the fund has received $3.8 billion in revenue.
Gold, by the way, played its role as an early signal of flight from risk. Now, it is possible that the paper price of the metal in dollars will experience volatility due to the closure of margin positions. But this is subject for Gold report tomorrow.
And now,suddenly, Yellen/the US Treasury is not even objects to Japan interventions. The problem turns out to be common:
The major hit was on Japanese banks. Only a month has passed:
These are realized losses from the sale of Western debts. The Japanese bank's unrealized losses from investments in US and European government bonds [totaling $67 billion] jumped to 1.86 trillion yen or $12.3 billion! Norinchukin's total investment portfolio is $365 billion; various things can be sold to cover losses. In July, Moody's put bank under review with a view to downgrading its rating.
Japan has a net investment position of 3.5 trillion. dollars. Of these, if I remember correctly, about 2 trillion. dollars of foreign debt investments. A significant part of these 2 trillion. dollars may well return to Japan if the rate rises, YCC will gradually weaken. They can return along the way by collapsing debt markets around the world and creating a terrible situation with liquidity in the global banking system. The main thing is that the Central Bank of Japan does not buy back dollars. Raising the rate, will only worsen the recession and cause an increase in the number of defaults by companies within the country. And collapse could start from banking sector.
Japanese banks have very low Return on Capital and Capital per se, somewhere around 3.5% and 4% of assets correspondingly. For example this is Japanese Post Bank, Mizuho and many others. They indicate that this bank simply lacks stability. It is enough to write off 4% of assets and the capital will become zero. Moreover, it is enough to create a reserve of 0.15% of assets to reduce profits to zero. in the Japanese banking system, which is deeply integrated into the global financial system, everything is very “subtle” and how the situation could unfold if a crisis scenario is realized is a big mystery.
Other issues to consider
Since we're focused mostly on EUR/USD let's have a look what is going on in EU. European inflation is in no hurry to resume its decline; consumer prices in July rose by 0.4% m/m, seasonally adjusted, and annual price growth even accelerated slightly to 2.6%. Core inflation remained at 2.9% y/y for the third month in a row. Energy prices are rising by 1.3%, and food products by 2.3% . The disinflationary effect on the energy side is ending, which pushes overall price indices up a little. New M. East tensions and scandal around oil delivery to Hungary and Slovakia from Russia makes situation even more tricky.
But the stable driver of price growth is still the same - this is the services sector , where inflation amounted to 0.4% m/m, seasonally adjusted, and 4% y/y, and has remained elevated for a long period of time. Moreover, the three- and six-month impulse of growth in prices for services remains around 5% (SAAR), i.e. over the past six months, services have risen in price at a rate 2.5 times higher than the ECB’s target. So ECB is coming to our scenario that chances on September rate cut are melting.
Another interesting stuff is about US GDP. The figure turned out to be much steeper than the consensus of +2%, but so far this is more of an estimate and not actual data. If you take a closer look at the structure of GDP growth for the quarter, the negative thing will be the jump in inventories. Moreover, a large share of GDP growth is consumption. spending is likely to be significantly revised downwards given the fresh negative quarterly reports from corporates and the latest data on the deterioration of households savings.
New orders for durable goods fell to $264.54 billion in June. This is the minimum since November 2021 -6.6% m/m with expectations of +0.3%. At the same time data shows drop in cargo tonnage in June and the production of transport equipment. Besides next time, GDP will compare to low base numbers of the last year that will return it to "correct" level and will show the "real face".
CONCLUSION
The Fed is once again plunging the US into recession at the peak of monetary policy tightening [possibly intentionally]. The bad news is now really bad: the “soft landing” narrative is going on a well-deserved vacation, and the “recessionary trade” is reinforced by the July US jobs report. Additionally to week NFP numbers, mentioned above, it makes sense to tell that annual job growth rate was only 1.6% while total employment in May and June was revised to -29K jobs. Speaking of data quality - for the last six months, data for 5 months were revised downward. We already have discovered and explained this trick earlier.
On July 2, Powell said the labor market was strong. This Wednesday, suddenly, at a press conference, I remembered the second side of the Central Bank’s mandate - maintaining the employment of American citizens. After the release of the employment report, the treasury market sharply changed its shoes and began to anticipate rate cut of almost -50 bp. in September with 70% probability.
What does it mean?
Reducing the rate by a minimum of 25 bp will not help anymore. Cut strongly - for example, by 50 bp. or more, as markets expect, means confirming Fed and JPow professional incompetence following the results of the July meeting. Besides, as we've said, it might be treated as a panic on the markets - aggravate the panic in the entire system confirmation of the recession by the regulator. It is all the more dangerous to make any unscheduled decision to soften the monetary policy before September. We've said - July is the best month for rate cut. And this chance has been lost.
Some believe that this will be a deflationary crisis. But we're convinced that the opposite will happen. The story of Ray Dalio, who was a young trader in 1971 is a great illustration. On August 15, 1971, he was a clerk on the floor of the New York Stock Exchange when President Richard Nixon announced that U.S. currency would no longer be redeemable for gold, ending the Bretton Woods system.
That is, at the moment when it became clear that the dollar had lost its value, everyone began to exchange the dollar for various assets. Moreover, note that there was no financial crisis, like in 2008. Commercial mortgage (CRE) is not such a global collateral, therefore, by and large, the only thing that can happen is a deep crisis in regional banks in the United States, which hold plenty of these commercial mortgages. But this problem will either be flooded with money, or a great banking merger under the shadow of JPMorgan. That is why the scenario should be inflationary with a rise in the price of real assets and, in particular, raw materials and gold.
At first stage of panic everybody will run into so-called "safe haven" US Treasury bonds. Because Universities and books teach that this is risk free asset. But this will last only until the moment when the case of Ray Dalio, mentioned above will come. It will interesting to watch what will happen to those investors.
So, the 1st part of our summer plan is done. As we've said, in a case of July cut, there should be a strong USD drop, otherwise, it should be small USD drop. Not occasionally we have two monthly bullish grabbers. Now, when everything is clear with the Fed, that they will cut rate in September for 0.5% we're going to the 2nd stage - ECB. By all means now we still keep our suggestion that ECB will not cut rate in September. Inflation is spinning up and even the Fed example will not be motivating enough to do this. By all means EUR should feel well in nearest 1-2 months, if of course we avoid any force major factor.
