Sive Morten
Special Consultant to the FPA
- Messages
- 18,676
Fundamentals
As usual, in the beginning of the year we do not have a lot economical events and numbers. Yes, we've got few - NFP in the US, CPI in EU and some others here and there. But mostly all eyes were on Epstein documents publication, so, a kind of hype, you know... Yes, we also have mentioned the fact of release in our Telegram, but we're not interested with content of these documents. Our interest is purely practical - how it will impact on political balance, and what consequences might be to financial markets. Now the dust is not settled yet around, we do not see big reasons to comment it. We intend just briefly mention this topic tomorrow in gold report, as it is more political rather than economical.
Meantime, our suggestion seems to be correct - recent news stream confirms that recent dollar strength is due changing of market expectations on future Fed policy. If you remember, in the beginning of the week we were a bit surprised with fact of drastic shift in dollar without any news releases. This perfectly fits to our previous report content - "who said that ECB will be behind the Fed in rate cut?" Although it was basic market view just two weeks ago...
Market overview
Euro zone inflation jumped as expected last month, supporting the European Central Bank’s case to keep interest rates at record highs for some time, even as markets continued to bet on a rapid fall in borrowing costs. Inflation across the 20-nation bloc jumped to 2.9% in December from 2.4% in November, just shy of expectations for a 3.0% reading.
The data is in line with the ECB's prediction that inflation bottomed out in November and will now hover in the 2.5% to 3% range through the year, well above its 2% target, before falling to target in 2025. Still, recent disruption of shipping via the Suez Canal has pushed up transportation costs.
The inflation jump comes as investors and policymakers appear to be drawing different conclusions about price trends and their implication for interest rates. Investors are betting that the ECB will cut rates six times this year with the first move coming in March or April while policymakers argue that it might take until mid-2024 to gain the confidence that inflation is indeed under control.
Investors argue that the ECB is too optimistic on growth and also point to a sharp drop in producer prices -- down 8.8% in November -- as evidence of cooling price pressures.
Ahead of Friday's December employment report, Thursday's data diary throws up ADP's private sector jobs reading and Challenger's layoff numbers for the same month - as well as weekly jobless claims. But as many eyes may be on the New York Fed's global supply chain pressure index - with fears of an escalation of the Middle East conflict increasing jitters about shipping supply chains and oil prices.
Some analysts pointed to the steep drop in daily takeup of the Fed's "reverse repo" money draining facility and said it would be "appropriate" to begin discussing the factor that may lead the central bank to slow the balance sheet runoff and halt QT. The effect of the Fed minutes combined with news that U.S. job openings fell to nearly a three-year low in November as the labor market gradually cools and an ISM manufacturing survey showing another month of contracting activity and falling input prices.
Investors ploughed $123.1 billion into cash in the seven days to Wednesday, marking the largest such inflow since March 2023 and a record for the first week of a year, Bank of America said in a report published on Friday.
The dollar was little changed on Friday after a rally in response to mixed data that suggested the world's largest economy showed pockets of weakness but remained resilient overall. The greenback earlier rallied after data showed the U.S. economy created 216,000 new jobs in December, exceeding the consensus forecast of 170,000. The unemployment rate was steady from November at 3.7%, compared with expectations of a rise to 3.8%, while average earnings rose 0.4% on a monthly basis, against forecasts of a 0.3% gain.
But that report was offset by data later in the session that indicated the U.S. services sector slumped last month. The Institute for Supply Management (ISM) said its non-manufacturing index fell to 50.6 last month, the lowest reading since May, from 52.7 in November. The services industry accounts for more than two-thirds of the economy. Economists polled by Reuters had forecast the index little changed at 52.6.
More importantly, the ISM's measure of services sector employment plunged to 43.3 last month, the lowest since July 2020 when the economy was reeling from the first wave of the pandemic. The index was at 50.7 in November.
Analysts said the jobs report suggested that the Federal Reserve would probably be in no rush to cut interest rates over the next few months. In the end, the futures market would likely come around closer to the Fed's forecast of about 75 bps of rate cuts in 2024, they noted.
Average hourly earnings rose 0.4% in December, matching the prior month's gain. That raised the year-on-year increase in wages to 4.1% from 4.0% in November.
Wage growth is well above its pre-pandemic average and the 3-3.5% range that most policymakers view as consistent with the Fed's 2% inflation target.
Financial markets initially reduced the probabilities of a March rate cut to around 53% but later boosted them to about 65% as traders digested the mixed employment report. Attention now shifts to December's consumer inflation report, scheduled to be published next Thursday.
So, the U.S. dollar's recent slide appears to be short-lived as some speculators have already reduced bets for aggressive Federal Reserve interest rate cuts this year, according to a Reuters poll of strategists who still say it will be weaker in a year. Market expectations that the Fed will start easing policy as early as March were tempered when minutes from December's policy meeting showed most policymakers agreed borrowing costs need to remain high for some time, suggesting a March cut is less likely.
Making clear the dollar has not yet been decisively knocked off its perch, a majority of analysts, 36 of 59, said the greater risk to their three-month forecast was the dollar trades stronger against major currencies than they currently predict. The remaining 23 said the risk was it could trade weaker. However, most said the dollar will slip against major currencies in 12 months as the Fed's latest dot plot predictions show three interest rate cuts by year-end.
The euro , which rose over 3% last year, its first yearly gain since 2020, was expected to capitalise on narrowing interest rate differentials and rise over 2% to trade around $1.12 in 12 months. It was trading at $1.09 on Thursday.
Among other major currencies, the Japanese yen , which has dropped about 30% in the past three years, was forecast to gain 6.6% to change hands at around 135/dollar in a year.
Sterling , which had a strong showing last year, gaining over 5.0%, was predicted to rise over 1.5% to $1.29 by year end. The Aussie and New Zealand dollars were expected to strengthen around 4% and 2.2%, respectively.
That said, Thierry Albert Wizman, global FX and rates strategist at Macquarie in New York, does not believe dollar gains since the beginning of the year could be sustained despite a pushback in rate cut expectations.
So let's try to figure all this stuff out
First is, as the Fed minutes have become the first data, released on Wed. If you take a look at the text of the message, you'll see that the sentiment of the dovish Fed is completely vapored out - much tougher than the market expected. A rate reduction is predicted later, there is no word about curtailing QT.
Additionally economists start writing (mostly in twitter), that this is an ancient practice to issue bonds - why not to finance US Treasury directly, without placing bonds on markets? We think this is next step in QE technology. This time money will be send not to the households in a way of different social programs, but directly to Ministry of Finance that will distribute them according to their needs. In fact this topic is already under discussion, and they intend actively to do it in 2024. The logic is simple - let's buy high yield paying by low yield. Or direct financing of problem banks etc. Consequently - they will scare everybody on stock market, barb hamsters down to skin so that no one will interfere. And then the “right” people will pick up everything that is valuable for cheap.
Second - corporate income (and maybe other) taxes should raise. But this will just accelerate recession. Because:
Next question is employment. Here we think that two moments are worthy of our attention. First is, despite that we've got NFP upside surprise again - all previous numbers were revised down in recent few months. Second, JOLT report shows constant downside trend - number of vacations is contracting. This is new signs of recession. In fact, job openings fell to a 32-month low. If monetary and fiscal policy is left unchanged, the situation should only get worse over the next few months, and by the 2nd quarter, unemployment should begin to rise.
Finally, let's take a look at United States Average Weekly Hours. This is great indicator and we monitor it over time. It is rather conservative and very rare change, that's why it is few who pay attention to it and it is not manipulated by different statistical tricks:
As you can see from the chart, this is not the first time this low has been reached (and with some acceleration towards the end of the year), so it is quite possible that next year this level will finally be broken down. And given that this indicator is very conservative, it can be stated that it clearly demonstrates the poor state of the real sector of the economy. This explains sharp reaction on recent PMI numbers.
It should be noted that support for demand from the budget has little effect on employment: American citizens prefer to buy cheaper Chinese goods. Actually, this is the main problem of the US economy, as we have repeatedly written about. So the only question is when the US will run out of free money to support demand. At this point, you will have to stop the tight monetary policy and start issuing money.
According to a number of experts, as we've mentioned last week, this should happen in March-April. We will assume that, most likely, by mid-spring, the leadership of the US Federal Reserve System will have to significantly change its monetary policy. But it is very possible that political reasons will force the Fed to do so sooner.
Next question is inflation. We disagree with UBS analyst who said that Red Sea navigation problems makes no impact on market just because this is only 0.3% of global trade. We want to show you few charts. The global logistics market is aware of the situation in which it finds itself. Due to the blockade of the Red Sea by the Yemeni Houthis, the price of shipping a 40-foot container from Shanghai to Rotterdam has tripled, although the journey has only increased by 40%.
However, the record 15 thousand dollars for delivery of a box, 2021 prices, is still far away. Then the reason for the rise in transportation costs was a lack of infrastructure - containers accumulated in gigantic quantities in US ports: there were simply no container boxes on the world market. They rushed to America as a result of the distribution of helicopter money from Uncle Sam to the population for a speedy exit of the country’s economy from the Covid recession.
Now the situation is repeating itself: due to the lengthening of the delivery period, there is already a shortage of container ships on the market, and soon there will be a shortage of boxes. Transportation prices will continue to rise. Russian North Sea Route becomes the shortest way from Europe to Asia now, and transit there supposedly will increase exponentially already in the summer-autumn navigation of 2024.
Container shipping giant Maersk will begin redirecting all ships that were supposed to pass through the Red Sea and the Gulf of Aden to the south around Africa's Cape of Good Hope, the company press release. A new push for inflation and a problem that cannot be solved for the Americans even in two key world straits. A good gift for the elections. Nothing to say. Dry numbers point that problem is serious - since December, the cost of shipping goods from Asia to Northern Europe has increased by 173% (+$4000 per container). Just in 10 days before January 2, the number of transits through the Suez Canal decreased by 28% y/y 3.1% of world trade, but not 0.3%.
If you think that this hardly makes impact on major goods stream from China - you're wrong:
Another indirect sign of problems, we've briefly mentioned it in Telegram - signs of "shrinkflation". This topic is not new. But in recent time, the problems of previously highly profitable franchise start getting big problems, drop in defaults across the Globe.
[MEDIA]
It means that real inflation levels are undervalued and intentionally downplayed. It is usually done not by manipulating of inflation only but by all other statistics - here to put slightly better growth, here slightly lower inflation etc. to disguise the reality...
As usual, in the beginning of the year we do not have a lot economical events and numbers. Yes, we've got few - NFP in the US, CPI in EU and some others here and there. But mostly all eyes were on Epstein documents publication, so, a kind of hype, you know... Yes, we also have mentioned the fact of release in our Telegram, but we're not interested with content of these documents. Our interest is purely practical - how it will impact on political balance, and what consequences might be to financial markets. Now the dust is not settled yet around, we do not see big reasons to comment it. We intend just briefly mention this topic tomorrow in gold report, as it is more political rather than economical.
Meantime, our suggestion seems to be correct - recent news stream confirms that recent dollar strength is due changing of market expectations on future Fed policy. If you remember, in the beginning of the week we were a bit surprised with fact of drastic shift in dollar without any news releases. This perfectly fits to our previous report content - "who said that ECB will be behind the Fed in rate cut?" Although it was basic market view just two weeks ago...
Market overview
Euro zone inflation jumped as expected last month, supporting the European Central Bank’s case to keep interest rates at record highs for some time, even as markets continued to bet on a rapid fall in borrowing costs. Inflation across the 20-nation bloc jumped to 2.9% in December from 2.4% in November, just shy of expectations for a 3.0% reading.
The data is in line with the ECB's prediction that inflation bottomed out in November and will now hover in the 2.5% to 3% range through the year, well above its 2% target, before falling to target in 2025. Still, recent disruption of shipping via the Suez Canal has pushed up transportation costs.
The inflation jump comes as investors and policymakers appear to be drawing different conclusions about price trends and their implication for interest rates. Investors are betting that the ECB will cut rates six times this year with the first move coming in March or April while policymakers argue that it might take until mid-2024 to gain the confidence that inflation is indeed under control.
Investors argue that the ECB is too optimistic on growth and also point to a sharp drop in producer prices -- down 8.8% in November -- as evidence of cooling price pressures.
Nordea economists Anders Svendsen and Tuuli Koivu think the ECB is wrong again and they see inflation below 1.5% by the end of the summer, well below the ECB's own projections.
Ahead of Friday's December employment report, Thursday's data diary throws up ADP's private sector jobs reading and Challenger's layoff numbers for the same month - as well as weekly jobless claims. But as many eyes may be on the New York Fed's global supply chain pressure index - with fears of an escalation of the Middle East conflict increasing jitters about shipping supply chains and oil prices.
Some analysts pointed to the steep drop in daily takeup of the Fed's "reverse repo" money draining facility and said it would be "appropriate" to begin discussing the factor that may lead the central bank to slow the balance sheet runoff and halt QT. The effect of the Fed minutes combined with news that U.S. job openings fell to nearly a three-year low in November as the labor market gradually cools and an ISM manufacturing survey showing another month of contracting activity and falling input prices.
Investors ploughed $123.1 billion into cash in the seven days to Wednesday, marking the largest such inflow since March 2023 and a record for the first week of a year, Bank of America said in a report published on Friday.
The dollar was little changed on Friday after a rally in response to mixed data that suggested the world's largest economy showed pockets of weakness but remained resilient overall. The greenback earlier rallied after data showed the U.S. economy created 216,000 new jobs in December, exceeding the consensus forecast of 170,000. The unemployment rate was steady from November at 3.7%, compared with expectations of a rise to 3.8%, while average earnings rose 0.4% on a monthly basis, against forecasts of a 0.3% gain.
But that report was offset by data later in the session that indicated the U.S. services sector slumped last month. The Institute for Supply Management (ISM) said its non-manufacturing index fell to 50.6 last month, the lowest reading since May, from 52.7 in November. The services industry accounts for more than two-thirds of the economy. Economists polled by Reuters had forecast the index little changed at 52.6.
More importantly, the ISM's measure of services sector employment plunged to 43.3 last month, the lowest since July 2020 when the economy was reeling from the first wave of the pandemic. The index was at 50.7 in November.
Analysts said the jobs report suggested that the Federal Reserve would probably be in no rush to cut interest rates over the next few months. In the end, the futures market would likely come around closer to the Fed's forecast of about 75 bps of rate cuts in 2024, they noted.
Average hourly earnings rose 0.4% in December, matching the prior month's gain. That raised the year-on-year increase in wages to 4.1% from 4.0% in November.
Wage growth is well above its pre-pandemic average and the 3-3.5% range that most policymakers view as consistent with the Fed's 2% inflation target.
Financial markets initially reduced the probabilities of a March rate cut to around 53% but later boosted them to about 65% as traders digested the mixed employment report. Attention now shifts to December's consumer inflation report, scheduled to be published next Thursday.
So, the U.S. dollar's recent slide appears to be short-lived as some speculators have already reduced bets for aggressive Federal Reserve interest rate cuts this year, according to a Reuters poll of strategists who still say it will be weaker in a year. Market expectations that the Fed will start easing policy as early as March were tempered when minutes from December's policy meeting showed most policymakers agreed borrowing costs need to remain high for some time, suggesting a March cut is less likely.
Making clear the dollar has not yet been decisively knocked off its perch, a majority of analysts, 36 of 59, said the greater risk to their three-month forecast was the dollar trades stronger against major currencies than they currently predict. The remaining 23 said the risk was it could trade weaker. However, most said the dollar will slip against major currencies in 12 months as the Fed's latest dot plot predictions show three interest rate cuts by year-end.
The euro , which rose over 3% last year, its first yearly gain since 2020, was expected to capitalise on narrowing interest rate differentials and rise over 2% to trade around $1.12 in 12 months. It was trading at $1.09 on Thursday.
Among other major currencies, the Japanese yen , which has dropped about 30% in the past three years, was forecast to gain 6.6% to change hands at around 135/dollar in a year.
Sterling , which had a strong showing last year, gaining over 5.0%, was predicted to rise over 1.5% to $1.29 by year end. The Aussie and New Zealand dollars were expected to strengthen around 4% and 2.2%, respectively.
That said, Thierry Albert Wizman, global FX and rates strategist at Macquarie in New York, does not believe dollar gains since the beginning of the year could be sustained despite a pushback in rate cut expectations.
So let's try to figure all this stuff out
First is, as the Fed minutes have become the first data, released on Wed. If you take a look at the text of the message, you'll see that the sentiment of the dovish Fed is completely vapored out - much tougher than the market expected. A rate reduction is predicted later, there is no word about curtailing QT.
Additionally economists start writing (mostly in twitter), that this is an ancient practice to issue bonds - why not to finance US Treasury directly, without placing bonds on markets? We think this is next step in QE technology. This time money will be send not to the households in a way of different social programs, but directly to Ministry of Finance that will distribute them according to their needs. In fact this topic is already under discussion, and they intend actively to do it in 2024. The logic is simple - let's buy high yield paying by low yield. Or direct financing of problem banks etc. Consequently - they will scare everybody on stock market, barb hamsters down to skin so that no one will interfere. And then the “right” people will pick up everything that is valuable for cheap.
Second - corporate income (and maybe other) taxes should raise. But this will just accelerate recession. Because:
- It will reduce the profitability of companies, and ability to cover of growing interest on debt by profits and, therefore, increase the number of defaults;
- Push down the stock market, which, in fact, are those very corporations;
- Suppress demand from corporates in the economy
- Will complicate the opportunity for competition for personnel with salaries.
Next question is employment. Here we think that two moments are worthy of our attention. First is, despite that we've got NFP upside surprise again - all previous numbers were revised down in recent few months. Second, JOLT report shows constant downside trend - number of vacations is contracting. This is new signs of recession. In fact, job openings fell to a 32-month low. If monetary and fiscal policy is left unchanged, the situation should only get worse over the next few months, and by the 2nd quarter, unemployment should begin to rise.
Finally, let's take a look at United States Average Weekly Hours. This is great indicator and we monitor it over time. It is rather conservative and very rare change, that's why it is few who pay attention to it and it is not manipulated by different statistical tricks:
As you can see from the chart, this is not the first time this low has been reached (and with some acceleration towards the end of the year), so it is quite possible that next year this level will finally be broken down. And given that this indicator is very conservative, it can be stated that it clearly demonstrates the poor state of the real sector of the economy. This explains sharp reaction on recent PMI numbers.
It should be noted that support for demand from the budget has little effect on employment: American citizens prefer to buy cheaper Chinese goods. Actually, this is the main problem of the US economy, as we have repeatedly written about. So the only question is when the US will run out of free money to support demand. At this point, you will have to stop the tight monetary policy and start issuing money.
According to a number of experts, as we've mentioned last week, this should happen in March-April. We will assume that, most likely, by mid-spring, the leadership of the US Federal Reserve System will have to significantly change its monetary policy. But it is very possible that political reasons will force the Fed to do so sooner.
Next question is inflation. We disagree with UBS analyst who said that Red Sea navigation problems makes no impact on market just because this is only 0.3% of global trade. We want to show you few charts. The global logistics market is aware of the situation in which it finds itself. Due to the blockade of the Red Sea by the Yemeni Houthis, the price of shipping a 40-foot container from Shanghai to Rotterdam has tripled, although the journey has only increased by 40%.
However, the record 15 thousand dollars for delivery of a box, 2021 prices, is still far away. Then the reason for the rise in transportation costs was a lack of infrastructure - containers accumulated in gigantic quantities in US ports: there were simply no container boxes on the world market. They rushed to America as a result of the distribution of helicopter money from Uncle Sam to the population for a speedy exit of the country’s economy from the Covid recession.
Now the situation is repeating itself: due to the lengthening of the delivery period, there is already a shortage of container ships on the market, and soon there will be a shortage of boxes. Transportation prices will continue to rise. Russian North Sea Route becomes the shortest way from Europe to Asia now, and transit there supposedly will increase exponentially already in the summer-autumn navigation of 2024.
Container shipping giant Maersk will begin redirecting all ships that were supposed to pass through the Red Sea and the Gulf of Aden to the south around Africa's Cape of Good Hope, the company press release. A new push for inflation and a problem that cannot be solved for the Americans even in two key world straits. A good gift for the elections. Nothing to say. Dry numbers point that problem is serious - since December, the cost of shipping goods from Asia to Northern Europe has increased by 173% (+$4000 per container). Just in 10 days before January 2, the number of transits through the Suez Canal decreased by 28% y/y 3.1% of world trade, but not 0.3%.
If you think that this hardly makes impact on major goods stream from China - you're wrong:
Another indirect sign of problems, we've briefly mentioned it in Telegram - signs of "shrinkflation". This topic is not new. But in recent time, the problems of previously highly profitable franchise start getting big problems, drop in defaults across the Globe.
[MEDIA]
It means that real inflation levels are undervalued and intentionally downplayed. It is usually done not by manipulating of inflation only but by all other statistics - here to put slightly better growth, here slightly lower inflation etc. to disguise the reality...
