Sive Morten
Special Consultant to the FPA
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Fundamentals
This week we have double ambush, guys - retail sales data and inflation. As it often happens in recent months, they are not that they seem to be. There, if you dig components a bit, are a lot of surprises. Also situation is gradually changing in EU as you will see. Particularly speaking - industrial sector. It is falling too fast and that could even overshadow high wage inflation, which is our cornerstone to suggest no rate cut in September from ECB. Discussion of general things, US budget and other stuff we leave for Gold report tomorrow.
Market overview
The dollar fell against the yen on Friday, and was softer against other peers as traders took profits and investors sifted through economic data to gauge the Federal Reserve's appetite for interest-rate cuts. Disappointing U.S. housing numbers also kept pressure on the greenback, helping it shed some of the lift it got a day earlier from data showing inflation trending down and consumer resilience. U.S. single-family homebuilding fell in July as higher mortgage rates and house prices kept prospective buyers on the sidelines, suggesting the market remained depressed at the start of the third quarter.
Data on Thursday showed the number of Americans filing new applications for unemployment benefits dropped to a one month-low last week while U.S. retail sales increased by the most in 1-1/2 years in July, dashing expectations that the Fed could cut interest rates by 50 basis points (bps) next month. Odds for such a move is now 25.5%, according to the CME Group's FedWatch Tool. Traders are now looking to Fed Chairman Jerome Powell's upcoming Jackson Hole speech, but Weller does not expect any pre-commitment to either a 25 bps or 50 bps cut next month.
Retail sales increased 1.0% last month, well above market forecasts for a 0.3% gain, the Commerce Department's Census Bureau said on Thursday, suggesting that consumers have maintained spending by bargain hunting. Some investors said the robust data did not alter bets that the Federal Reserve could begin lowering rates in September, but dimmed the chance that the central bank will start easing policy with a hefty 50 basis-point rate cut.
Nordea chief market analyst Jan von Gerich said the speed of the Wall Street bounce-back was a reason to be wary of further volatility ahead. "The tentative rebound in risk appetite has happened surprisingly fast, so I would be cautious," he said.
On Monday, the New York Federal Reserve's latest household survey showed that the median 3-year inflation outlook has fallen to the lowest point in the 11-year history of the series. It is now just 2.3%. To be sure, inflation forecasts over other time horizons were nearer to 3%, but the whole survey is basically eliciting the same responses that it was in the years before the pandemic. This may suggest that the "old normal" has returned to some degree.
Financial markets have virtually pulled the plug on above-target inflation expectations as well. Breakeven" inflation assumptions embedded in Treasury-protected securities subsided to within a whisker of the Fed's 2.0% target last week on both 5- and 10-year trajectories. That was the lowest in more than three years. While
Bank of America's latest global fund manager survey showed a rapid reduction in managers identifying higher inflation as the biggest risk to portfolios. While as many one-in-three said it was the biggest "tail risk" in July, only one-in-eight thought so this month.
University of California, Berkeley professor Brad DeLong recently puzzled over why the market's implied inflation picture changed so suddenly.
It looks increasingly wide of the mark to argue that the episode has firmly entrenched expectations of higher inflation. If expectations have been firmly "re-anchored", a large part of the central banks' recent battle has been won and the only risk is that they now leave it too late to ease credit again.But even accepting market twists and turns, there is clearly little in public or corporate surveys to suggest high future inflation is seen a major problem.
Two more Federal Reserve officials on Thursday gravitated toward an interest rate cut next month as solid economic data prompted financial markets to further scale back bets the U.S. central bank would kick off its monetary easing cycle with a bigger-than-usual reduction in borrowing costs. St. Louis Fed President Alberto Musalem and Atlanta Fed President Raphael Bostic had previously been more wary than many of their colleagues about lowering borrowing costs too soon.
In an interview published in the Financial Times on Thursday, Bostic also said he is open to a rate cut at the September meeting, a change from his previous expectation for this year of a single quarter-percentage-point reduction in borrowing costs in the fourth quarter.
If the U.S. Federal Reserve does not start cutting interest rates relatively soon, U.S. consumers could become dispirited, Bank of America CEO Brian Moynihan said on Sunday.
The European Central Bank will cut its deposit rate twice more this year, in September and December, according to an over-80% majority of economists polled by Reuters, fewer reductions than markets currently expect. By contrast, interest rate futures are pricing a total of four cuts by end-year. An unexpected rise in euro zone inflation in July, near record-low unemployment and still-steady economic activity in the common currency bloc give ECB policymakers cause to be cautious.
Still five respondents expected just one more reduction this year while eight predicted three.
PPI, CPI and Retail Sales scrutiny
Since PPI numbers have been released first and shown surprising decreasing, let's get started with them. And first surprise appears not in common PPI index but with its wider brother that includes all Producers' supply chains - PPI All commodities:
Wow. Growth for the month by 1.5% ... And this is in a situation of a sharp drop in industrial production, by 0.64% for the month of July! At the same time, the June data was revised down by 0.43%, which means a decrease of 1% for the month! This already exceeds the pace of the crisis of 1930-32!
If we look at the annual figures, the decrease was 0.2 (July to July). In such a situation, prices should fall, but they are rising. This means that inflation trends are very strong and, most likely, there is a serious price increase. We already knew this, the prices in the United States are rising quite quickly, but this week it became clear from official data.
In general, since January 2020, the US dollar has lost 25% of its purchasing power. In fact, many basic necessities for members of the "middle" class are now becoming luxury items. This consumer class although slowly but stubbornly is disappearing.
Now concerning CPI. At first glance everything is just great - according to expectations or slightly lower. Cumulative index numbers tells almost nothing about real situation, but detailed look opens a lot of interesting stuff. Annual inflation according to July data:
So YoY core inflation is 3.2%, however, at the previous value (June to June) it was 3.3%. But the most important thing is something else. A drop in consumer inflation can mean a serious stagnation in demand, and then this is not a positive, but a negative sign. And this is we also could see from Retail Sales. Another interesting inflationary observation is amount of houses in the US with the price 1Mln+.
8.5% of U.S. homes are now worth more than $1 million, the highest ever. Five years ago, less than 4% of homes were worth more than $1 million, and ten years ago, less than 2%. So we see the doubling of this number every 5 years, which means 20% per year. Yes, of course, it could be just built higher amount of more expensive houses, but we suggest that there we have inflationary component either.
Next one is indirect indicator that rare considered, but it is very representative as it is involved in all spheres of manufacturing process. This is insurance. The US financial sector continues to parasitize the real sector, exacerbating inflationary pressures. Insurance coverage for all types of businesses has increased by about 12% since the beginning of 2022, which is almost 3 times higher than the pre-pandemic rate. Commercial rates for all types of business insurance increased sharply in IIQ 24 — in some regions, increasing by about 10%.
Meantime, american retail recorded growth of 1% m/m in July, but here once again we couldn't avoid "the magic" - the data for June was revised to -0.2% m/m, resulting in an annual sales growth of only 2.7% y/y, which is close to inflation.
Revisions now it is a "special feature" of statistics authorities in the US guys. Not only for Retail Sales but GDP, NFP etc. As I said in video if works like follows. Human being mind is aimed always at new information that is shown positive. While investors pay less attention to old data and revisions, but now this is the vital factor. People are in habit with long lasting tradition of previous 1-2 decades, when revisions were fair and not very significant. And statisticians use it at 100%. Now our approach to data has to be changed. We have to treat new data as "preliminary" numbers and make conclusion about them only on the next month. Now if you take a look at revisions, the picture will be quite different. I wonder what the revision will be for July data in September?
Although nominal sales are growing, the major conclusion that we could make is Americans are not ready to cut costs, which have grown significantly in 2020-2021, but they have no sources to increase them either.
How Grandma Europe feels..
I would say - not very well. Liquidity in the system is dropping.
Production sector stands in awful situation, no matter who and what tells about this. Industrial production in the eurozone is -3.9% per year, the 6th negative in a row and the 13th in the last 14 months.
The depressing industrial production data in Europe for June suggests that the morgue is still quiet. The energy crisis is behind us, ECB rates have gone down, and industry shows no signs of life. In June 2024, industrial production in the EU fell by 3.2% (y/y), in the euro area (the top industrial countries) – by 3.9% (y/y). Of the large industrial economies, Austria and Germany are in a severe crisis; Hungary and the Czech Republic are doing badly. Only three countries that are not overburdened with industry – Greece, Cyprus and Malta – are showing enviable growth.
In the engine room of European integration – Germany – the crisis has been going on for 5 years, since 2019. The period is already long enough to take anti-crisis measures and adapt to the new conditions. If this has not happened, then these decisions cannot be made, and they are not under the control of business and the German government. This means that the crisis will last until the external conditions for Germany change. Perhaps this will never happen. As indirect sign, we could mention that Germany intends to close Ukraine financing after November 2024. EU has no excessive money...
CONCLUSION:
Based on market overview we see that the market has moved from a state of hysteria to more reasonable expectations for the Fed rate, but what has been happening in the last couple of weeks is a very clear symptom, high leverage will still show itself. Carry is back... The belief that the economy cannot fall and all problems will always be bought out by the Fed and the budget is still in force. So, market mostly in a rosy glasses.
On Thursday, the markets were cheered up by strong retail figures. But, as usual, it was not without special magic: the previous month was revised downward. At the same time, two thirds of the increase [!!!] due to cars — is it a suspicious statistic? It's simple: dealers have sharply reduced car prices due to falling demand. In real terms, sales for key product groups have even fallen — the long-term negative trend is not changing. At the same time, the US industrial sector remains in nose dive, i.e. there are signals that the market is not paying attention to yet. In August, there was a decrease in industrial production again [operational data from the Federal Reserve Bank of New York].
The general inflationary picture of the United States is now a vivid illustration of stagflation. if we look at stable components, inflation returned to the 3-3.5% region. When you start looking at components, you understand that inflationary pressure is not dropping, I would say it is even growing. Currently market consensus is 0.5% rate cut in September, while JPM even expects 1% cut until the end of the year. This is where theoretically we could try to play, because at least official data tells that situation is not friendly for 0.5% rate cut (if it is friendly for any rate cut at all). But as we've explained in previous reports, the US has no choice. Thus, it might be just 25 points cut in September. And market now is overpricing it.
Kamala is already promising new "goodies" to voters, from $25,000 for the purchase of housing with the first mortgage, to regulating food prices. The budget is on an "unstable trajectory". It's very funny to look at the dynamics of changes in interest rate expectations in September. Together with the grocery prices control that she intends to proclaim, it is just great feed for inflation. By the way, this plan will cost $1.7 Trln - "Kamunism". Cheers.
The cut rate even for 25 points in a such of situation and data very fast will lead to the next spin of inflation in the US.
Speaking about EU, recent numbers show more aggressive drop in production sector that we thought, so it works in favor of September rate cut by ECB. We still hope that ECB fears are stronger and they will keep rate unchanged, but recent data decreases the probability of this event.
This time, the Fed meeting (17-18) will be after ECB (12 of Sep). It is naive to suggest that ECB will not yet know what the Fed will do, but, as indirect indicator we could suggest that if ECB will keep rate unchanged then it could mean that the Fed will cut the rate only for 25 points. This could be win/win situation for us. First is to ride on EUR and then reverse it in favor of USD. Nobody knows of course, but let's dream a bit.
At least, based on recent inflation statistics and fast fading of recent recession fears, the rate cut for 25 points seems like reasonable suggestion. In longer term perspective markets are totally wrong with their calm concerning inflation and recession. Consequences will be very heavy. And recent gold dynamic confirms it. As I said already a few months ago - I wouldn't consider any US assets for purchase and use current rally as the last great chance to out.
This week we have double ambush, guys - retail sales data and inflation. As it often happens in recent months, they are not that they seem to be. There, if you dig components a bit, are a lot of surprises. Also situation is gradually changing in EU as you will see. Particularly speaking - industrial sector. It is falling too fast and that could even overshadow high wage inflation, which is our cornerstone to suggest no rate cut in September from ECB. Discussion of general things, US budget and other stuff we leave for Gold report tomorrow.
Market overview
The dollar fell against the yen on Friday, and was softer against other peers as traders took profits and investors sifted through economic data to gauge the Federal Reserve's appetite for interest-rate cuts. Disappointing U.S. housing numbers also kept pressure on the greenback, helping it shed some of the lift it got a day earlier from data showing inflation trending down and consumer resilience. U.S. single-family homebuilding fell in July as higher mortgage rates and house prices kept prospective buyers on the sidelines, suggesting the market remained depressed at the start of the third quarter.
Data on Thursday showed the number of Americans filing new applications for unemployment benefits dropped to a one month-low last week while U.S. retail sales increased by the most in 1-1/2 years in July, dashing expectations that the Fed could cut interest rates by 50 basis points (bps) next month. Odds for such a move is now 25.5%, according to the CME Group's FedWatch Tool. Traders are now looking to Fed Chairman Jerome Powell's upcoming Jackson Hole speech, but Weller does not expect any pre-commitment to either a 25 bps or 50 bps cut next month.
Retail sales increased 1.0% last month, well above market forecasts for a 0.3% gain, the Commerce Department's Census Bureau said on Thursday, suggesting that consumers have maintained spending by bargain hunting. Some investors said the robust data did not alter bets that the Federal Reserve could begin lowering rates in September, but dimmed the chance that the central bank will start easing policy with a hefty 50 basis-point rate cut.
Nordea chief market analyst Jan von Gerich said the speed of the Wall Street bounce-back was a reason to be wary of further volatility ahead. "The tentative rebound in risk appetite has happened surprisingly fast, so I would be cautious," he said.
On Monday, the New York Federal Reserve's latest household survey showed that the median 3-year inflation outlook has fallen to the lowest point in the 11-year history of the series. It is now just 2.3%. To be sure, inflation forecasts over other time horizons were nearer to 3%, but the whole survey is basically eliciting the same responses that it was in the years before the pandemic. This may suggest that the "old normal" has returned to some degree.
Financial markets have virtually pulled the plug on above-target inflation expectations as well. Breakeven" inflation assumptions embedded in Treasury-protected securities subsided to within a whisker of the Fed's 2.0% target last week on both 5- and 10-year trajectories. That was the lowest in more than three years. While
Bank of America's latest global fund manager survey showed a rapid reduction in managers identifying higher inflation as the biggest risk to portfolios. While as many one-in-three said it was the biggest "tail risk" in July, only one-in-eight thought so this month.
University of California, Berkeley professor Brad DeLong recently puzzled over why the market's implied inflation picture changed so suddenly.
Going further, he suggests the Fed may actually face the risk of undershooting its inflation target for much of the next five years, if implied inflation rate in markets at around 2% is an average and over that time and with current rates still between 2.5% and 3.0%. July's NFIB survey showed high inflation remains the single most important problem among small firms, it also noted that the net number of them planning price rises has fallen to the lowest point since April 2023. The number of owners expecting to raise employee compensation is also at the lowest level in three years.
It looks increasingly wide of the mark to argue that the episode has firmly entrenched expectations of higher inflation. If expectations have been firmly "re-anchored", a large part of the central banks' recent battle has been won and the only risk is that they now leave it too late to ease credit again.But even accepting market twists and turns, there is clearly little in public or corporate surveys to suggest high future inflation is seen a major problem.
Two more Federal Reserve officials on Thursday gravitated toward an interest rate cut next month as solid economic data prompted financial markets to further scale back bets the U.S. central bank would kick off its monetary easing cycle with a bigger-than-usual reduction in borrowing costs. St. Louis Fed President Alberto Musalem and Atlanta Fed President Raphael Bostic had previously been more wary than many of their colleagues about lowering borrowing costs too soon.
In an interview published in the Financial Times on Thursday, Bostic also said he is open to a rate cut at the September meeting, a change from his previous expectation for this year of a single quarter-percentage-point reduction in borrowing costs in the fourth quarter.
If the U.S. Federal Reserve does not start cutting interest rates relatively soon, U.S. consumers could become dispirited, Bank of America CEO Brian Moynihan said on Sunday.
The European Central Bank will cut its deposit rate twice more this year, in September and December, according to an over-80% majority of economists polled by Reuters, fewer reductions than markets currently expect. By contrast, interest rate futures are pricing a total of four cuts by end-year. An unexpected rise in euro zone inflation in July, near record-low unemployment and still-steady economic activity in the common currency bloc give ECB policymakers cause to be cautious.
Still five respondents expected just one more reduction this year while eight predicted three.
PPI, CPI and Retail Sales scrutiny
Since PPI numbers have been released first and shown surprising decreasing, let's get started with them. And first surprise appears not in common PPI index but with its wider brother that includes all Producers' supply chains - PPI All commodities:
Wow. Growth for the month by 1.5% ... And this is in a situation of a sharp drop in industrial production, by 0.64% for the month of July! At the same time, the June data was revised down by 0.43%, which means a decrease of 1% for the month! This already exceeds the pace of the crisis of 1930-32!
If we look at the annual figures, the decrease was 0.2 (July to July). In such a situation, prices should fall, but they are rising. This means that inflation trends are very strong and, most likely, there is a serious price increase. We already knew this, the prices in the United States are rising quite quickly, but this week it became clear from official data.
In general, since January 2020, the US dollar has lost 25% of its purchasing power. In fact, many basic necessities for members of the "middle" class are now becoming luxury items. This consumer class although slowly but stubbornly is disappearing.
Now concerning CPI. At first glance everything is just great - according to expectations or slightly lower. Cumulative index numbers tells almost nothing about real situation, but detailed look opens a lot of interesting stuff. Annual inflation according to July data:
- Car insurance inflation: 18.6%
- Inflation in the transport sector: 8.8%
- Inflation in hospital services: 6.1%
- Inflation in the homeowner service sector: 5.3%
- Rent inflation: 5.1%
- Electricity price inflation: 4.9%
- Car repair price inflation: 4.6%
- Food price inflation away from home: 4.1%
So YoY core inflation is 3.2%, however, at the previous value (June to June) it was 3.3%. But the most important thing is something else. A drop in consumer inflation can mean a serious stagnation in demand, and then this is not a positive, but a negative sign. And this is we also could see from Retail Sales. Another interesting inflationary observation is amount of houses in the US with the price 1Mln+.
8.5% of U.S. homes are now worth more than $1 million, the highest ever. Five years ago, less than 4% of homes were worth more than $1 million, and ten years ago, less than 2%. So we see the doubling of this number every 5 years, which means 20% per year. Yes, of course, it could be just built higher amount of more expensive houses, but we suggest that there we have inflationary component either.
Next one is indirect indicator that rare considered, but it is very representative as it is involved in all spheres of manufacturing process. This is insurance. The US financial sector continues to parasitize the real sector, exacerbating inflationary pressures. Insurance coverage for all types of businesses has increased by about 12% since the beginning of 2022, which is almost 3 times higher than the pre-pandemic rate. Commercial rates for all types of business insurance increased sharply in IIQ 24 — in some regions, increasing by about 10%.
Meantime, american retail recorded growth of 1% m/m in July, but here once again we couldn't avoid "the magic" - the data for June was revised to -0.2% m/m, resulting in an annual sales growth of only 2.7% y/y, which is close to inflation.
Revisions now it is a "special feature" of statistics authorities in the US guys. Not only for Retail Sales but GDP, NFP etc. As I said in video if works like follows. Human being mind is aimed always at new information that is shown positive. While investors pay less attention to old data and revisions, but now this is the vital factor. People are in habit with long lasting tradition of previous 1-2 decades, when revisions were fair and not very significant. And statisticians use it at 100%. Now our approach to data has to be changed. We have to treat new data as "preliminary" numbers and make conclusion about them only on the next month. Now if you take a look at revisions, the picture will be quite different. I wonder what the revision will be for July data in September?
Although nominal sales are growing, the major conclusion that we could make is Americans are not ready to cut costs, which have grown significantly in 2020-2021, but they have no sources to increase them either.
How Grandma Europe feels..
I would say - not very well. Liquidity in the system is dropping.
Production sector stands in awful situation, no matter who and what tells about this. Industrial production in the eurozone is -3.9% per year, the 6th negative in a row and the 13th in the last 14 months.
The depressing industrial production data in Europe for June suggests that the morgue is still quiet. The energy crisis is behind us, ECB rates have gone down, and industry shows no signs of life. In June 2024, industrial production in the EU fell by 3.2% (y/y), in the euro area (the top industrial countries) – by 3.9% (y/y). Of the large industrial economies, Austria and Germany are in a severe crisis; Hungary and the Czech Republic are doing badly. Only three countries that are not overburdened with industry – Greece, Cyprus and Malta – are showing enviable growth.
In the engine room of European integration – Germany – the crisis has been going on for 5 years, since 2019. The period is already long enough to take anti-crisis measures and adapt to the new conditions. If this has not happened, then these decisions cannot be made, and they are not under the control of business and the German government. This means that the crisis will last until the external conditions for Germany change. Perhaps this will never happen. As indirect sign, we could mention that Germany intends to close Ukraine financing after November 2024. EU has no excessive money...
CONCLUSION:
Based on market overview we see that the market has moved from a state of hysteria to more reasonable expectations for the Fed rate, but what has been happening in the last couple of weeks is a very clear symptom, high leverage will still show itself. Carry is back... The belief that the economy cannot fall and all problems will always be bought out by the Fed and the budget is still in force. So, market mostly in a rosy glasses.
On Thursday, the markets were cheered up by strong retail figures. But, as usual, it was not without special magic: the previous month was revised downward. At the same time, two thirds of the increase [!!!] due to cars — is it a suspicious statistic? It's simple: dealers have sharply reduced car prices due to falling demand. In real terms, sales for key product groups have even fallen — the long-term negative trend is not changing. At the same time, the US industrial sector remains in nose dive, i.e. there are signals that the market is not paying attention to yet. In August, there was a decrease in industrial production again [operational data from the Federal Reserve Bank of New York].
The general inflationary picture of the United States is now a vivid illustration of stagflation. if we look at stable components, inflation returned to the 3-3.5% region. When you start looking at components, you understand that inflationary pressure is not dropping, I would say it is even growing. Currently market consensus is 0.5% rate cut in September, while JPM even expects 1% cut until the end of the year. This is where theoretically we could try to play, because at least official data tells that situation is not friendly for 0.5% rate cut (if it is friendly for any rate cut at all). But as we've explained in previous reports, the US has no choice. Thus, it might be just 25 points cut in September. And market now is overpricing it.
Kamala is already promising new "goodies" to voters, from $25,000 for the purchase of housing with the first mortgage, to regulating food prices. The budget is on an "unstable trajectory". It's very funny to look at the dynamics of changes in interest rate expectations in September. Together with the grocery prices control that she intends to proclaim, it is just great feed for inflation. By the way, this plan will cost $1.7 Trln - "Kamunism". Cheers.
The cut rate even for 25 points in a such of situation and data very fast will lead to the next spin of inflation in the US.
Speaking about EU, recent numbers show more aggressive drop in production sector that we thought, so it works in favor of September rate cut by ECB. We still hope that ECB fears are stronger and they will keep rate unchanged, but recent data decreases the probability of this event.
This time, the Fed meeting (17-18) will be after ECB (12 of Sep). It is naive to suggest that ECB will not yet know what the Fed will do, but, as indirect indicator we could suggest that if ECB will keep rate unchanged then it could mean that the Fed will cut the rate only for 25 points. This could be win/win situation for us. First is to ride on EUR and then reverse it in favor of USD. Nobody knows of course, but let's dream a bit.
At least, based on recent inflation statistics and fast fading of recent recession fears, the rate cut for 25 points seems like reasonable suggestion. In longer term perspective markets are totally wrong with their calm concerning inflation and recession. Consequences will be very heavy. And recent gold dynamic confirms it. As I said already a few months ago - I wouldn't consider any US assets for purchase and use current rally as the last great chance to out.
