Sive Morten
Special Consultant to the FPA
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Fundamentals
Well, obviously the week between Xmas and NY never has been rich for economical events. Everybody tries to take a rest and prepare for starting of the next one. For now the major topic for all markets - when the Fed supposedly will start cutting rates and from what factor does it depend on... We have some thoughts on this subject. Also, as usual, briefly will take a look some events of this week...
Market overview
The dollar index fell on Tuesday and the euro hit a more than four-month high as investors waited on fresh clues to when the Federal Reserve is likely to begin cutting interest rates as inflation falls closer to the U.S. central bank’s 2% annual target. The greenback is on track to post its worst performance since 2020 against a basket of currencies as anticipation of Fed rate cuts dents the appeal of the U.S. currency relative to peers.
Many analysts expect the U.S. economy to markedly slow in 2024, but the Fed is also expected to act to ensure that the gap between the fed funds rate and realized inflation doesn’t widen too far. If inflation falls much faster than the Fed’s benchmark rate it can tighten monetary conditions more than Fed policymakers intend and increase the risk of a hard economic landing.
Data on Friday showed U.S. prices fell in November for the first in more than 3-1/2 years, pushing the annual increase in inflation further below 3%. Annual home prices in October rose again, pointing toward continued recovery of the housing market, data on Tuesday showed. Separately a Mastercard report showed U.S. retail sales rose 3.1% between Nov. 1 and Dec. 24 as shoppers looked for last-minute Christmas deals amid big promotions.
U.S. data on Thursday showed that the number of Americans filing initial claims for unemployment benefits rose last week, indicating the labor market continues to cool in the year's fourth quarter.
The yen has steadied near a recent five-month peak on the view that the Bank of Japan (BOJ) could soon mark an end to its ultra-easy policy. For most of 2022 and 2023, the policy has kept the Japanese currency under pressure as other major central banks embarked on aggressive rate-hike cycles. BOJ Governor Kazuo Ueda said on Monday the likelihood of achieving the central bank's inflation target was "gradually rising" and it would consider changing policy if prospects of sustainably achieving the 2% target increase "sufficiently".
Net shorts in the yen against the U.S. dollar fell to 64,902 contracts in the latest week ending Dec. 19, compared with 81,131 the previous week, according to data from the Commodity Futures Trading Commission.
The Federal Reserve's dovish December pivot has boosted the case for the weakening dollar to keep falling into 2024, though strength in the U.S. economy could limit the greenback’s decline. Policymakers now project 75 basis points of cuts next year. Still, betting on a weaker dollar has been a perilous undertaking in recent years, and some investors are wary of jumping the gun. A U.S. economy that continues to outperform its peers could be one factor presenting an obstacle for bearish investors.
An early December Reuters poll of 71 FX strategists showed expectations for the dollar to fall against G10 currencies in 2024, with the greater part of its decline coming in the second half of the year.
So far, it's been an uneven picture. In the eurozone, a downturn in business activity deepened in December, according to closely watched surveys that show the bloc’s economy is almost certainly in recession. Still, the European Central Bank has pushed back against rate cut expectations as it remains focused on fighting inflation. The euro is up more than 3% against the dollar this year.
The International Monetary Fund in October forecast the U.S. economy would grow by 1.5% in 2024, compared to 1.2% for the eurozone and 4.2% for China.
Of course, the dollar's trajectory could depend on how much Fed easing and falling inflation is already reflected in its price. Futures tied to the Fed's policy rate show investors factoring in more than 150 basis points in cuts next year, about twice as much as Fed policymakers have penciled in.
Questions for 2024 will be when the Fed begins cuts, and whether the first rate reduction is made to avoid over-tightening as inflation drops, or due to slowing U.S. economic growth. With markets already pricing in aggressive cuts, debate is also focused on how much further the dollar is likely to fall.
Policymakers at the ECB and the BoE did not signal any imminent rate cuts at their policy meetings this month, but traders are pricing in 162 bps of cuts by the ECB next year, with the probability of two cuts by April. The BoE is also expected to cut rates by 148 bps in 2024.
The Fed is expected to cut its key rate to around 3.75% by the end of 2024, it will only fall to around 3% by the end of 2026, then rise back to around 3.5% thereafter, money market pricing suggests
Such expectations are consistent with a scenario where the so-called 'neutral' interest rate, which neither stimulates nor slows economic growth, has risen since before the COVID-19 pandemic, economists say. Higher inflation risks on the back of geopolitical tensions and reshoring, looser fiscal policy and potential improvements in productivity from the likes of AI are among factors that may be lifting the neutral rate, often dubbed 'R-star'.
In the euro area, ECB policymakers point to a neutral rate of around 1.5%-2%. Next week will be in focus - NFP report, EU inflation.
In general the structural crisis brings no surprises. It goes very slow, so that we even could not sign big problems month by month but it is constant. It does not stop at all, the crisis continues and continues. And this process, which began in the United States in the early fall of 2021, will continue around the world for quite a long time.
At the same time we see non proportional shifts in different sectors - oil has dropped, while uranian ore, gold have raised strongly, as well as cocoa and steel. While demand to Lithium has collapsed as massive turn to electric vehicles and supposed turn to green energy is under question.
In general, this is a typical picture of a structural crisis, when the old models of certain markets are destroyed and their trends end. During the crisis, it is quite difficult to create a new industrial infrastructure for battery recycling. So, with some probability, you will have to return to internal combustion engines. And such stories arise in almost all industries, the new industrial resolution is faced with objective demand constraints. And if we also take into account the need to practically restore the entire basic infrastructure of the world economy, the issue becomes even more acute. Here are just few new numbers of last week, but they still show the same picture.
WHEN THE FED WILL START CUTTING RATES?
So, above we've shown you average market expectations of the Fed policy. In general, market expects ~1.6% rate cut in 2024, but terms are differ starting from March and up to June. What also seems interesting - take a look at average expectations of rate cut from the ECB and BoE, they are mostly the same, around 1.5%. From this point of view, US Dollar should not loose positions as rate cut will be equal.
Another moment that is worthy of our attention - some analysts talk about the same thing as we did last week (and week before). Who said that EU will show better economy statistics than the US? With the current pace of drop in recession and fast deflation - EU could come to the necessity of rate cut even earlier than the US. We also think so. Germany's industrial base is being devastated. A study of industrial plants on their production plans paints a grim picture. According to MUFG, one third of companies are considering moving abroad - and the picture is similar across the European region.
32% of industrial companies are considering the possibility of moving capacity abroad. Of these, 16% have already implemented these measures, 10.5% are in the process of implementation and 5.2% are in the planning process. More than half of companies view the energy transition as “negative” or “very negative” for their own business, the highest proportion since the survey began in the first quarter of 2021. The eurozone faces weak growth next year, economists say.
And the major hazard comes from high rates (!!!) and geopolitical issues. Indeed, just two moments to mention - first is fuel delivery now is possible only by sea (afer explosion of North Stream), which is becoming expensive, and already shows deficit of diesel fuel in EU. Second is confiscation of Russian reserves that 95% deposited in EU. US takes no risk as they hold just around 5%, but try to force EU to confiscate them. If this will happen - EUR start loosing its international status as reserve currency very fast.
So, from this point of view we do not see big risk for USD from EUR rivals. It could take place on short term, say, until the end of Spring 2024, but then situation will start to change. We see big risk from another side, and it is US domestic one.
First is, inflation. This practice is not only American, it is widespread, along with “individually observed inflation” - if you do not believe the statistical services, then this is your personal problem. But check for McDonalds "Shrinkflation" or WalMart prices and you will see the truth.
How long can this “society of the spectacle” continue to function? Probably until the accumulated gap between official and “individually observed” inflation (say, from 2020) reaches a level of 50-60% percent. Relatively speaking, the official accumulated CPI from 2020 to 2025 will be 25% (now approximately 19%), and prices for essential goods will increase by 75%.
Revaluation of values, by the way, does not take much time. Massive epiphany should come exactly in a year, when the second inflationary wave accelerates. While the accumulated gap between official and real inflation is 20-30%, you can, if not ignore it, then at least doubt it and not express your guesses out loud.
Second is - free money in turnover. The Fed constantly is drying up liquidity. And stubbornly cuts its balance sheet, which is now at the level fo March 2021:
Meantime investors are running into the bond market. As we've explained - buyers are waiting for a deflationary impulse, nothing less. One cannot expect a deflationary impulse from productivity growth, so the only hope is for a recession and a financial crisis. Actually, not only we do speak about it. Here is, Rabobank, for example. But, why and when?
Not occasionally last month we very often were looking on Personal Savings. This is a key for estimation of the moment, when rate could be cut. The decrease in savings is due to a faster growth rate of expenses compared to income. Over the past 6 months, the savings rate has averaged 4.3%, over 12m— 4.5% compared to 7.4% in 2019. Interest expenses have a negative impact. So non-mortgage interest rates are 2.75%.
It is important to note that savings have a direct impact on the ability of the net allocation of financial assets, which can be channeled into monetary assets, stocks, bonds, insurance or pension reserves. The average annual savings rate is 900 billion, and now it is aiming for 800 billion. Households were the main providers of liquidity to the bond market, saving the treasuries market.
The liquidity gap is about 1.6-1.7 trillion per year (the rest is covered by pension, insurance, state funds and direct strategic allies of the United States). Obviously, with savings of 0.8 trillion a year, you can't really walk around, but you still need to keep the stock market bubble at its maximum for a century.
Net government support as a% of disposable income is approximately at the level of 2016-2019. Net government support is not stimulating, and with a budget deficit of 2 trillion per year, what does this mean? In case of a crisis, there is no resource to support the population anymore!"
Actually, this last statement is the most important one. We assert that the crisis will definitely continue. And this means that either there will be an easing of monetary policy (which has already been actually announced) with an almost inevitable money printing, or a direct deflationary drop in the standard of living of the population. Since it is almost impossible to imagine such a thing in an election year, this means that a few months before the election, the issue of the dollar will be resumed. The timing will be chosen so that the inevitable inflationary wave begins after the elections.
To this we can add another graph, the growth of interest expenses of American households.
What remains is the monetization of debt through QE and a reduction in the cost of servicing. That's the problem with that. By March 2024, the excess liquidity in the US banking system will be depleted, sooner or later it will be necessary to turn on the printing press, otherwise there will be no one to buy out 2 trillion deficits per year. Recall by the way that BFTP programme is also should be closed in March... It means that banks will have to return all money back and get on the balance their Treasury bonds with existed paper loss. Maybe they will extend the programme, but what if not?
As we have explained this already today, individual consumption is supported (i.e. financed) by the budget, against the background of restrictive monetary policy (the Fed is reducing its balance sheet, that is, reducing the amount of cash in the economy). The budget receives money by increasing the national debt, but the sources to service this debt inside the economy is running out - savings are tending to zero! So, it has to be served externally, by some external inflows in some way, which means QE. Otherwise economy, and banking sector first of all, will collapse.
By the end of spring 2024, they will have to start printing. There are still about six months left before the elections, which is a lot, but if we extend the situation until the beginning of summer, then we can count on the fact that inflation will not begin by the elections yet. Therefore, we can assume that in May-June, the Fed will begin to actively reduce the rate and adopt new emission programs.
Guys, I also thought initially to make a part on other US debt issues, but now I think it is enough for pre New Year report, so I do not want to overload you at the eve of the holidays. At least we've considered very important topic. So, take a rest and have a good New Year time with your close ones!
Well, obviously the week between Xmas and NY never has been rich for economical events. Everybody tries to take a rest and prepare for starting of the next one. For now the major topic for all markets - when the Fed supposedly will start cutting rates and from what factor does it depend on... We have some thoughts on this subject. Also, as usual, briefly will take a look some events of this week...
Market overview
The dollar index fell on Tuesday and the euro hit a more than four-month high as investors waited on fresh clues to when the Federal Reserve is likely to begin cutting interest rates as inflation falls closer to the U.S. central bank’s 2% annual target. The greenback is on track to post its worst performance since 2020 against a basket of currencies as anticipation of Fed rate cuts dents the appeal of the U.S. currency relative to peers.
Many analysts expect the U.S. economy to markedly slow in 2024, but the Fed is also expected to act to ensure that the gap between the fed funds rate and realized inflation doesn’t widen too far. If inflation falls much faster than the Fed’s benchmark rate it can tighten monetary conditions more than Fed policymakers intend and increase the risk of a hard economic landing.
Data on Friday showed U.S. prices fell in November for the first in more than 3-1/2 years, pushing the annual increase in inflation further below 3%. Annual home prices in October rose again, pointing toward continued recovery of the housing market, data on Tuesday showed. Separately a Mastercard report showed U.S. retail sales rose 3.1% between Nov. 1 and Dec. 24 as shoppers looked for last-minute Christmas deals amid big promotions.
U.S. data on Thursday showed that the number of Americans filing initial claims for unemployment benefits rose last week, indicating the labor market continues to cool in the year's fourth quarter.
The yen has steadied near a recent five-month peak on the view that the Bank of Japan (BOJ) could soon mark an end to its ultra-easy policy. For most of 2022 and 2023, the policy has kept the Japanese currency under pressure as other major central banks embarked on aggressive rate-hike cycles. BOJ Governor Kazuo Ueda said on Monday the likelihood of achieving the central bank's inflation target was "gradually rising" and it would consider changing policy if prospects of sustainably achieving the 2% target increase "sufficiently".
Net shorts in the yen against the U.S. dollar fell to 64,902 contracts in the latest week ending Dec. 19, compared with 81,131 the previous week, according to data from the Commodity Futures Trading Commission.
The Federal Reserve's dovish December pivot has boosted the case for the weakening dollar to keep falling into 2024, though strength in the U.S. economy could limit the greenback’s decline. Policymakers now project 75 basis points of cuts next year. Still, betting on a weaker dollar has been a perilous undertaking in recent years, and some investors are wary of jumping the gun. A U.S. economy that continues to outperform its peers could be one factor presenting an obstacle for bearish investors.
An early December Reuters poll of 71 FX strategists showed expectations for the dollar to fall against G10 currencies in 2024, with the greater part of its decline coming in the second half of the year.
So far, it's been an uneven picture. In the eurozone, a downturn in business activity deepened in December, according to closely watched surveys that show the bloc’s economy is almost certainly in recession. Still, the European Central Bank has pushed back against rate cut expectations as it remains focused on fighting inflation. The euro is up more than 3% against the dollar this year.
The International Monetary Fund in October forecast the U.S. economy would grow by 1.5% in 2024, compared to 1.2% for the eurozone and 4.2% for China.
Of course, the dollar's trajectory could depend on how much Fed easing and falling inflation is already reflected in its price. Futures tied to the Fed's policy rate show investors factoring in more than 150 basis points in cuts next year, about twice as much as Fed policymakers have penciled in.
Questions for 2024 will be when the Fed begins cuts, and whether the first rate reduction is made to avoid over-tightening as inflation drops, or due to slowing U.S. economic growth. With markets already pricing in aggressive cuts, debate is also focused on how much further the dollar is likely to fall.
Policymakers at the ECB and the BoE did not signal any imminent rate cuts at their policy meetings this month, but traders are pricing in 162 bps of cuts by the ECB next year, with the probability of two cuts by April. The BoE is also expected to cut rates by 148 bps in 2024.
The Fed is expected to cut its key rate to around 3.75% by the end of 2024, it will only fall to around 3% by the end of 2026, then rise back to around 3.5% thereafter, money market pricing suggests
Such expectations are consistent with a scenario where the so-called 'neutral' interest rate, which neither stimulates nor slows economic growth, has risen since before the COVID-19 pandemic, economists say. Higher inflation risks on the back of geopolitical tensions and reshoring, looser fiscal policy and potential improvements in productivity from the likes of AI are among factors that may be lifting the neutral rate, often dubbed 'R-star'.
In the euro area, ECB policymakers point to a neutral rate of around 1.5%-2%. Next week will be in focus - NFP report, EU inflation.
In general the structural crisis brings no surprises. It goes very slow, so that we even could not sign big problems month by month but it is constant. It does not stop at all, the crisis continues and continues. And this process, which began in the United States in the early fall of 2021, will continue around the world for quite a long time.
At the same time we see non proportional shifts in different sectors - oil has dropped, while uranian ore, gold have raised strongly, as well as cocoa and steel. While demand to Lithium has collapsed as massive turn to electric vehicles and supposed turn to green energy is under question.
In general, this is a typical picture of a structural crisis, when the old models of certain markets are destroyed and their trends end. During the crisis, it is quite difficult to create a new industrial infrastructure for battery recycling. So, with some probability, you will have to return to internal combustion engines. And such stories arise in almost all industries, the new industrial resolution is faced with objective demand constraints. And if we also take into account the need to practically restore the entire basic infrastructure of the world economy, the issue becomes even more acute. Here are just few new numbers of last week, but they still show the same picture.
WHEN THE FED WILL START CUTTING RATES?
So, above we've shown you average market expectations of the Fed policy. In general, market expects ~1.6% rate cut in 2024, but terms are differ starting from March and up to June. What also seems interesting - take a look at average expectations of rate cut from the ECB and BoE, they are mostly the same, around 1.5%. From this point of view, US Dollar should not loose positions as rate cut will be equal.
Another moment that is worthy of our attention - some analysts talk about the same thing as we did last week (and week before). Who said that EU will show better economy statistics than the US? With the current pace of drop in recession and fast deflation - EU could come to the necessity of rate cut even earlier than the US. We also think so. Germany's industrial base is being devastated. A study of industrial plants on their production plans paints a grim picture. According to MUFG, one third of companies are considering moving abroad - and the picture is similar across the European region.
32% of industrial companies are considering the possibility of moving capacity abroad. Of these, 16% have already implemented these measures, 10.5% are in the process of implementation and 5.2% are in the planning process. More than half of companies view the energy transition as “negative” or “very negative” for their own business, the highest proportion since the survey began in the first quarter of 2021. The eurozone faces weak growth next year, economists say.
And the major hazard comes from high rates (!!!) and geopolitical issues. Indeed, just two moments to mention - first is fuel delivery now is possible only by sea (afer explosion of North Stream), which is becoming expensive, and already shows deficit of diesel fuel in EU. Second is confiscation of Russian reserves that 95% deposited in EU. US takes no risk as they hold just around 5%, but try to force EU to confiscate them. If this will happen - EUR start loosing its international status as reserve currency very fast.
So, from this point of view we do not see big risk for USD from EUR rivals. It could take place on short term, say, until the end of Spring 2024, but then situation will start to change. We see big risk from another side, and it is US domestic one.
First is, inflation. This practice is not only American, it is widespread, along with “individually observed inflation” - if you do not believe the statistical services, then this is your personal problem. But check for McDonalds "Shrinkflation" or WalMart prices and you will see the truth.
How long can this “society of the spectacle” continue to function? Probably until the accumulated gap between official and “individually observed” inflation (say, from 2020) reaches a level of 50-60% percent. Relatively speaking, the official accumulated CPI from 2020 to 2025 will be 25% (now approximately 19%), and prices for essential goods will increase by 75%.
Revaluation of values, by the way, does not take much time. Massive epiphany should come exactly in a year, when the second inflationary wave accelerates. While the accumulated gap between official and real inflation is 20-30%, you can, if not ignore it, then at least doubt it and not express your guesses out loud.
Second is - free money in turnover. The Fed constantly is drying up liquidity. And stubbornly cuts its balance sheet, which is now at the level fo March 2021:
Meantime investors are running into the bond market. As we've explained - buyers are waiting for a deflationary impulse, nothing less. One cannot expect a deflationary impulse from productivity growth, so the only hope is for a recession and a financial crisis. Actually, not only we do speak about it. Here is, Rabobank, for example. But, why and when?
Not occasionally last month we very often were looking on Personal Savings. This is a key for estimation of the moment, when rate could be cut. The decrease in savings is due to a faster growth rate of expenses compared to income. Over the past 6 months, the savings rate has averaged 4.3%, over 12m— 4.5% compared to 7.4% in 2019. Interest expenses have a negative impact. So non-mortgage interest rates are 2.75%.
It is important to note that savings have a direct impact on the ability of the net allocation of financial assets, which can be channeled into monetary assets, stocks, bonds, insurance or pension reserves. The average annual savings rate is 900 billion, and now it is aiming for 800 billion. Households were the main providers of liquidity to the bond market, saving the treasuries market.
The liquidity gap is about 1.6-1.7 trillion per year (the rest is covered by pension, insurance, state funds and direct strategic allies of the United States). Obviously, with savings of 0.8 trillion a year, you can't really walk around, but you still need to keep the stock market bubble at its maximum for a century.
Net government support as a% of disposable income is approximately at the level of 2016-2019. Net government support is not stimulating, and with a budget deficit of 2 trillion per year, what does this mean? In case of a crisis, there is no resource to support the population anymore!"
Actually, this last statement is the most important one. We assert that the crisis will definitely continue. And this means that either there will be an easing of monetary policy (which has already been actually announced) with an almost inevitable money printing, or a direct deflationary drop in the standard of living of the population. Since it is almost impossible to imagine such a thing in an election year, this means that a few months before the election, the issue of the dollar will be resumed. The timing will be chosen so that the inevitable inflationary wave begins after the elections.
To this we can add another graph, the growth of interest expenses of American households.
What remains is the monetization of debt through QE and a reduction in the cost of servicing. That's the problem with that. By March 2024, the excess liquidity in the US banking system will be depleted, sooner or later it will be necessary to turn on the printing press, otherwise there will be no one to buy out 2 trillion deficits per year. Recall by the way that BFTP programme is also should be closed in March... It means that banks will have to return all money back and get on the balance their Treasury bonds with existed paper loss. Maybe they will extend the programme, but what if not?
As we have explained this already today, individual consumption is supported (i.e. financed) by the budget, against the background of restrictive monetary policy (the Fed is reducing its balance sheet, that is, reducing the amount of cash in the economy). The budget receives money by increasing the national debt, but the sources to service this debt inside the economy is running out - savings are tending to zero! So, it has to be served externally, by some external inflows in some way, which means QE. Otherwise economy, and banking sector first of all, will collapse.
By the end of spring 2024, they will have to start printing. There are still about six months left before the elections, which is a lot, but if we extend the situation until the beginning of summer, then we can count on the fact that inflation will not begin by the elections yet. Therefore, we can assume that in May-June, the Fed will begin to actively reduce the rate and adopt new emission programs.
Guys, I also thought initially to make a part on other US debt issues, but now I think it is enough for pre New Year report, so I do not want to overload you at the eve of the holidays. At least we've considered very important topic. So, take a rest and have a good New Year time with your close ones!
