Sive Morten
Special Consultant to the FPA
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- 19,276
Fundamentals
This week mostly we have only two major events. First is - J. Powell testimony in Congress/Senate and second - inflation data. Both events have some interesting moments. In recent few weeks this has become especially evident as authorities start preparing background for the rate cut. We could see it in some J. Powell phrases as well. Concerning inflation - we have very interesting divergence among common and core CPI data and surprising jump in PPI on Friday. This definitely means something.
Market overview
Investor morale in the euro zone broke an eight-month streak of improvements with a bigger-than-expected decline in July, a survey showed on Monday, describing the results as a "bitter setback". Sentix's index for the euro zone fell to -7.3 points for July from 0.3 in June, putting the barometer firmly back in the red. The survey said that investors were concerned about French elections, upcoming German state elections and uncertainty over the U.S. presidential election later this year. Germany's economy, Europe's largest, also saw a fall in morale in July, with the index on the current situation declining to -32.3 from -26.3 in June. The drop follows three consecutive months of gains. "The recent recovery of the European economy has come to an abrupt end," Sentix said.
The European Central Bank can continue to gradually reduce interest rates without jeopardizing a current fall in inflation, governing council member Fabio Panetta said on Tuesday.
On Tuesday Federal Reserve Chair Jerome Powell acknowledged progress in inflation and a cooling job market, but did not give a clear signal that the U.S. central bank is close to cutting interest rates. Powell said that inflation "remains above" the U.S. Federal Reserve's 2% target, but has been improving in recent months and "more good data would strengthen" the case for central bank interest rate cuts. In remarks to Congress, he also noted that the job market has cooled, adding that "we now face two-sided risks," and can no longer focus solely on inflation. But Powell stopped short of offering the dovish view of the economy that some market participants were looking for.
Fed Chairman Jerome Powell expressed concern that holding interest rates too high for too long could jeopardize economic growth, teasing that rate reductions could be on the horizon as long as inflation continues to show progress.
Sterling hit a four-week high after Bank of England Chief Economist Huw Pill said on Wednesday the central bank was moving closer to cutting interest rates but services price inflation and wage growth remained uncomfortably strong.
Thursday's lower-than-expected consumer price index (CPI) report, boosted bets that the Fed's rate cuts would start in September.
Rent and housing costs are keeping U.S. inflation higher than preferred but consumer price pressures will continue to come down over time, Treasury Secretary Janet Yellen said on Tuesday, as a top White House adviser cited what she called "tremendous progress" in bringing down inflation.
Meantime, JPM CEO J. Dimon goes against the major stream this week, and issued another warning about inflation despite recent signs of easing in price pressures.
CPI BREAKDOWN
As closer we're coming to election date as more question is raising about the Fed policy and particular data values - at what degree they are economical rather than political. In fact, J. Powell has got direct question on this subject in his recent Congress testimony. Many US politicians, especially of Republican camp fairly suggest that Fed policy could be used to support Biden's administration and create positive picture of economy conditions closer to election date. The question of statistic authorities independence is rather arguable as they where caught recently many times in data manipulation.
So, it has happened - June CPI has dropped for 0.1% per month, and is only +3.0% YoY. Formally this is the first drop in 4 years. Obviously its a great news for the country's political leadership, since it is possible to return to the topic of rate cuts. At the same time, as we've mentioned above this might be a political request. So, both monetary authorities and statistical agencies have to respond to it. So maybe they overdid it a bit, because deflation is a sign of an economic downturn.
There was deflation in the 30s of the last century. Yes, it cannot be in conditions of demand support, but there are problems with the latter. Demand support after the covid epidemic was carried out through the budget. For this purpose, the monetary authorities sharply increased the national debt, grabbing all the money markets of the world. But the money printed during the covid period had to run out sooner or later. According to a number of experts, in April-July of this year. That's what happened.:
As the Fed has been trying to maintain a more or less tight monetary policy in recent months by selling securities from its balance sheet, problems with aggregate demand have begun. This is clearly seen in the construction sector in the United States, in industry, and even in official labor statistics (despite its inadequacy). And if we also take into account the elections …
In general, once again, it is absolutely necessary to ease monetary policy and, apparently, the Fed is actively preparing for this situation. The head office gave a signal: stop sufferingwith bulls**t with unrealistic targets. We are now waiting for similar news from all the world's central banks on all TV's electronic devices, including irons and blood pressure monitors.
The Great Houses transnational investment banks also warm up this topic, releasing dovish forecasts. Citi says the Fed could cut rates by 200 bps for 8 straight meetings as the economy heads for a sharper contraction, appealing to new signs of a slowing economy and rising unemployment. Meantime, Morgan Stanley together with JPMorgan forecast collapse on US stock market due coming recession for 10-23%.
One-year inflation expectations fell for the second month in a row, falling to 3.02% in June from 3.17%:
So, when it's really necessary, the statistics meet you halfway. And this, by the way, is not the first time in the USA. Another thing is that the US economic system is so over-monetized that even a minimal issue will lead to a sharp increase in inflation. However, this is already the prospect of the next few months. By the way, data on prices in industry (PPI index) USA +2.6% per year, that is, for a maximum of 15 months...
But this is against the background of a constant industrial downturn. Although industrial prices are not consumer prices. In particular, deflation in the United States, which is clearly visible in 2023, is most likely due to an increase in imports and, thereby, increased competition among American manufacturers. Let's not forget about the expert estimates of inflation in the United States - more than 10%, and Larry Summers' about 8%. The picture in the American economy as a whole is more or less clear: an increase in imports against the background of rising domestic costs and a decline in demand and GDP. And as for the USA, it is almost all over the world.
Finally, just to close CPI topic, it is very interesting that the CPI as a consumer price index as a whole is moving into deflation (which would be expected given the rate increase and the economic slowdown), while the core index continues to grow. Obviously, this means an imbalance in consumption across groups of goods and services or, speaking simply, a decrease in consumption of everything less necessary, which is why, while supply remains the same, prices fall. In general, it is classic pre-recession/pre-crisis phenomena.
RECESSION BREATH
The global economic downturn continues, and it is becoming more and more difficult to hide it. The monetary authorities of all countries are in a difficult state, Powell admitted that he had not seen Biden for two years and was making decisions on his own. However, this is more about politics than economics. The question arises, what are the obvious signs of this decline that are not related to GDP data? For example - Copper consumption in China, or, say price on used cars falls for ~9% annually, reaching the new record or, say, Hot-Rolled coil steel that dropped three times and stands near the lows:
At the same time, the prices of container shipments from China are tending to the highs of the Covid era:
Together with the industrial downturn in the United States and an increase in imports, this means a reduction in the total volume of transportation (logistics companies are trying to maintain revenues amid falling volumes). Which also indicates a general decline. Well, the election results in many countries of the world, where almost everywhere the current authorities are actively losing, show that the standard of living of the population is falling. Whatever the official figures show.
Budget conditions are also too far from the healthy ones. In June, the United States spent a record $140 billion on interest on debt. This is 30% of all tax revenues.
The United States spends much more than it generates tax revenues. ️And the scale of spending on interest on debt is simply terrifying.
The average debt service rate rose to 3.28%, but growth slowed due to low borrowing in the second quarter. For market debt , the average interest rate increased to 3.34%. In the third quarter, the plan is to borrow $847 billion from the market so far, compared with less than $100 billion in the second quarter - this will create a large debt supply overhang. Although part (in the amount of $290 billion) are bills, the money for which, apparently, will come from reducing the Fed's reverse repo ($390 billion remains). In general, the supply pressure on the government debt curve will increase in the third quarter, but there may be more dollar liquidity due to the utilization of reverse repo by money market funds.
Let's go further. Corporate bankruptcies in the United States in June reached their highest monthly level since the beginning of 2020. 75 new corporate bankruptcy filings in June – a growth rate equal to the Covid shock of 2020. The accumulated number of bankruptcies since the beginning of the year is 346, a record for the last 13 years. High interest rates, supply chain problems and slowing consumer spending continue to weigh on business.
In Germany, things are even worse : 162 companies with a turnover of more than 10 million euros have encountered financial difficulties this year (+41% y/y). Of the 279 bankruptcies in 2023, only 35% of companies were able to be “saved” through the sale or restructuring of debts.
Bloomberg surprise index of the US Economy conditions stands at the lowest levels since 2015. Negativity in the construction sector is growing. The number of new homes for sale in the southern US has nearly doubled in just four years and is now higher than in 2006 (the year before the mortgage crisis began). At the same time, a record number of layoffs of construction workers was recorded in June (almost 5 thousand), at the levels of the crises of 2007 and 2020.
Allocation of American households and asset managers to stocks at historical highs. Retail traders now account for a record 18.8% of total options activity. Net long equity futures positions among asset managers and leveraged funds reached their highest level in a decade.
Finally, global sea logistics is broken due weather conditions, which also promises nothing good in perspective of 2-3 months. The US SPR sell-off helps a lot to keep CPI at low levels. Its impact stands for ~ 3.8% In June. If we add this component back, we get quite different numbers, closer to expert opinions. Because the only deflationary component will be used cars.
CONCLUSION:
When CPI numbers just has been released, GS called this situation as "pivotal". Indeed. But by our opinion, it has this quality not because of the 1st slowdown in 4 years but because of tricky situation for the Fed. No doubts that the Fed is under political pressure. For our long-term plan only two things are important - Fed's dovish surprise and no action from ECB in September. Now imagine in what conditions the Fed stands. They clearly know what's going on and the what the real inflation is. But right now they have a unique chance to cut the rate, using nominal downtick in CPI. As we've shown above, first steps in this direction are done, message is sent.
Personally, I see it reasonable to cut the rate right in July. But, keeping realistic view, since we have just two weeks to the Fed's meeting, I recognize that chances are melting. But maybe we get sharp dovish statement from J. Powell. Although this will be not as radical but still strong message.
At the same time, I do not exclude this chance totally. Because the Fed clearly knows about coming inflationary factors as from international logistics as from other components. and they can't be sure that they still will have this chance in September. Because in nearest two months situation could change drastically, and Powell will have only Wyoming meeting in late August to warn the markets on coming Fed's step. Besides, if situation will change - it will trigger negative effect among investors, raising talks about recession if they will start cutting rate with raising CPI. And you could imagine what will happen if stock market collapses right at the eve of Election day. While now it is very suitable moment to do this.
Big hurt might come from geopolitics. Those who read our Gold market reports know that we expect big activity on battlefield in late summer and structural shifts in power balance closer to the autumn. This could impact on the sentiment of foreign investors, and hence on US debt yield/demand.
Finally, September rate cut might be too late to bring effect right to elections. And now, while it is vacation time, you could cut and then watch for two months what will happen, then correct the policy in September... Thus, by all means July is very good moment for this decision.
Taking it all together, if EU will escape to become a side of conflict in Ukraine at least until September, EUR should keep going higher. We suggest no rate cut by ECB in September (as we've explained in previous reports) and dovish steps from the Fed. But EUR appreciation might be different depending on what these steps will be - either just rhetoric or rate cut in July.
This week mostly we have only two major events. First is - J. Powell testimony in Congress/Senate and second - inflation data. Both events have some interesting moments. In recent few weeks this has become especially evident as authorities start preparing background for the rate cut. We could see it in some J. Powell phrases as well. Concerning inflation - we have very interesting divergence among common and core CPI data and surprising jump in PPI on Friday. This definitely means something.
Market overview
Investor morale in the euro zone broke an eight-month streak of improvements with a bigger-than-expected decline in July, a survey showed on Monday, describing the results as a "bitter setback". Sentix's index for the euro zone fell to -7.3 points for July from 0.3 in June, putting the barometer firmly back in the red. The survey said that investors were concerned about French elections, upcoming German state elections and uncertainty over the U.S. presidential election later this year. Germany's economy, Europe's largest, also saw a fall in morale in July, with the index on the current situation declining to -32.3 from -26.3 in June. The drop follows three consecutive months of gains. "The recent recovery of the European economy has come to an abrupt end," Sentix said.
The European Central Bank can continue to gradually reduce interest rates without jeopardizing a current fall in inflation, governing council member Fabio Panetta said on Tuesday.
On Tuesday Federal Reserve Chair Jerome Powell acknowledged progress in inflation and a cooling job market, but did not give a clear signal that the U.S. central bank is close to cutting interest rates. Powell said that inflation "remains above" the U.S. Federal Reserve's 2% target, but has been improving in recent months and "more good data would strengthen" the case for central bank interest rate cuts. In remarks to Congress, he also noted that the job market has cooled, adding that "we now face two-sided risks," and can no longer focus solely on inflation. But Powell stopped short of offering the dovish view of the economy that some market participants were looking for.
Fed Chairman Jerome Powell expressed concern that holding interest rates too high for too long could jeopardize economic growth, teasing that rate reductions could be on the horizon as long as inflation continues to show progress.
Sterling hit a four-week high after Bank of England Chief Economist Huw Pill said on Wednesday the central bank was moving closer to cutting interest rates but services price inflation and wage growth remained uncomfortably strong.
Thursday's lower-than-expected consumer price index (CPI) report, boosted bets that the Fed's rate cuts would start in September.
And while the University of Michigan's survey showed U.S. consumer sentiment fell in July, investors focused on the fact that it showed improving expectations for inflation for the next year and beyond.
Rent and housing costs are keeping U.S. inflation higher than preferred but consumer price pressures will continue to come down over time, Treasury Secretary Janet Yellen said on Tuesday, as a top White House adviser cited what she called "tremendous progress" in bringing down inflation.
Meantime, JPM CEO J. Dimon goes against the major stream this week, and issued another warning about inflation despite recent signs of easing in price pressures.
Dimon joined many economists in sounding the alarm on burgeoning U.S. debt and deficits. The federal government has so far spent $855 billion more than it has collected in the 2024 fiscal year. For fiscal 2023, the government’s deficit spending came in at $1.7 trillion.
CPI BREAKDOWN
As closer we're coming to election date as more question is raising about the Fed policy and particular data values - at what degree they are economical rather than political. In fact, J. Powell has got direct question on this subject in his recent Congress testimony. Many US politicians, especially of Republican camp fairly suggest that Fed policy could be used to support Biden's administration and create positive picture of economy conditions closer to election date. The question of statistic authorities independence is rather arguable as they where caught recently many times in data manipulation.
So, it has happened - June CPI has dropped for 0.1% per month, and is only +3.0% YoY. Formally this is the first drop in 4 years. Obviously its a great news for the country's political leadership, since it is possible to return to the topic of rate cuts. At the same time, as we've mentioned above this might be a political request. So, both monetary authorities and statistical agencies have to respond to it. So maybe they overdid it a bit, because deflation is a sign of an economic downturn.
There was deflation in the 30s of the last century. Yes, it cannot be in conditions of demand support, but there are problems with the latter. Demand support after the covid epidemic was carried out through the budget. For this purpose, the monetary authorities sharply increased the national debt, grabbing all the money markets of the world. But the money printed during the covid period had to run out sooner or later. According to a number of experts, in April-July of this year. That's what happened.:
As the Fed has been trying to maintain a more or less tight monetary policy in recent months by selling securities from its balance sheet, problems with aggregate demand have begun. This is clearly seen in the construction sector in the United States, in industry, and even in official labor statistics (despite its inadequacy). And if we also take into account the elections …
In general, once again, it is absolutely necessary to ease monetary policy and, apparently, the Fed is actively preparing for this situation. The head office gave a signal: stop suffering
The
One-year inflation expectations fell for the second month in a row, falling to 3.02% in June from 3.17%:
So, when it's really necessary, the statistics meet you halfway. And this, by the way, is not the first time in the USA. Another thing is that the US economic system is so over-monetized that even a minimal issue will lead to a sharp increase in inflation. However, this is already the prospect of the next few months. By the way, data on prices in industry (PPI index) USA +2.6% per year, that is, for a maximum of 15 months...
But this is against the background of a constant industrial downturn. Although industrial prices are not consumer prices. In particular, deflation in the United States, which is clearly visible in 2023, is most likely due to an increase in imports and, thereby, increased competition among American manufacturers. Let's not forget about the expert estimates of inflation in the United States - more than 10%, and Larry Summers' about 8%. The picture in the American economy as a whole is more or less clear: an increase in imports against the background of rising domestic costs and a decline in demand and GDP. And as for the USA, it is almost all over the world.
Finally, just to close CPI topic, it is very interesting that the CPI as a consumer price index as a whole is moving into deflation (which would be expected given the rate increase and the economic slowdown), while the core index continues to grow. Obviously, this means an imbalance in consumption across groups of goods and services or, speaking simply, a decrease in consumption of everything less necessary, which is why, while supply remains the same, prices fall. In general, it is classic pre-recession/pre-crisis phenomena.
RECESSION BREATH
The global economic downturn continues, and it is becoming more and more difficult to hide it. The monetary authorities of all countries are in a difficult state, Powell admitted that he had not seen Biden for two years and was making decisions on his own. However, this is more about politics than economics. The question arises, what are the obvious signs of this decline that are not related to GDP data? For example - Copper consumption in China, or, say price on used cars falls for ~9% annually, reaching the new record or, say, Hot-Rolled coil steel that dropped three times and stands near the lows:
At the same time, the prices of container shipments from China are tending to the highs of the Covid era:
Together with the industrial downturn in the United States and an increase in imports, this means a reduction in the total volume of transportation (logistics companies are trying to maintain revenues amid falling volumes). Which also indicates a general decline. Well, the election results in many countries of the world, where almost everywhere the current authorities are actively losing, show that the standard of living of the population is falling. Whatever the official figures show.
Budget conditions are also too far from the healthy ones. In June, the United States spent a record $140 billion on interest on debt. This is 30% of all tax revenues.
The United States spends much more than it generates tax revenues. ️And the scale of spending on interest on debt is simply terrifying.
The average debt service rate rose to 3.28%, but growth slowed due to low borrowing in the second quarter. For market debt , the average interest rate increased to 3.34%. In the third quarter, the plan is to borrow $847 billion from the market so far, compared with less than $100 billion in the second quarter - this will create a large debt supply overhang. Although part (in the amount of $290 billion) are bills, the money for which, apparently, will come from reducing the Fed's reverse repo ($390 billion remains). In general, the supply pressure on the government debt curve will increase in the third quarter, but there may be more dollar liquidity due to the utilization of reverse repo by money market funds.
Let's go further. Corporate bankruptcies in the United States in June reached their highest monthly level since the beginning of 2020. 75 new corporate bankruptcy filings in June – a growth rate equal to the Covid shock of 2020. The accumulated number of bankruptcies since the beginning of the year is 346, a record for the last 13 years. High interest rates, supply chain problems and slowing consumer spending continue to weigh on business.
In Germany, things are even worse : 162 companies with a turnover of more than 10 million euros have encountered financial difficulties this year (+41% y/y). Of the 279 bankruptcies in 2023, only 35% of companies were able to be “saved” through the sale or restructuring of debts.
Bloomberg surprise index of the US Economy conditions stands at the lowest levels since 2015. Negativity in the construction sector is growing. The number of new homes for sale in the southern US has nearly doubled in just four years and is now higher than in 2006 (the year before the mortgage crisis began). At the same time, a record number of layoffs of construction workers was recorded in June (almost 5 thousand), at the levels of the crises of 2007 and 2020.
Allocation of American households and asset managers to stocks at historical highs. Retail traders now account for a record 18.8% of total options activity. Net long equity futures positions among asset managers and leveraged funds reached their highest level in a decade.
Finally, global sea logistics is broken due weather conditions, which also promises nothing good in perspective of 2-3 months. The US SPR sell-off helps a lot to keep CPI at low levels. Its impact stands for ~ 3.8% In June. If we add this component back, we get quite different numbers, closer to expert opinions. Because the only deflationary component will be used cars.
CONCLUSION:
When CPI numbers just has been released, GS called this situation as "pivotal". Indeed. But by our opinion, it has this quality not because of the 1st slowdown in 4 years but because of tricky situation for the Fed. No doubts that the Fed is under political pressure. For our long-term plan only two things are important - Fed's dovish surprise and no action from ECB in September. Now imagine in what conditions the Fed stands. They clearly know what's going on and the what the real inflation is. But right now they have a unique chance to cut the rate, using nominal downtick in CPI. As we've shown above, first steps in this direction are done, message is sent.
Personally, I see it reasonable to cut the rate right in July. But, keeping realistic view, since we have just two weeks to the Fed's meeting, I recognize that chances are melting. But maybe we get sharp dovish statement from J. Powell. Although this will be not as radical but still strong message.
At the same time, I do not exclude this chance totally. Because the Fed clearly knows about coming inflationary factors as from international logistics as from other components. and they can't be sure that they still will have this chance in September. Because in nearest two months situation could change drastically, and Powell will have only Wyoming meeting in late August to warn the markets on coming Fed's step. Besides, if situation will change - it will trigger negative effect among investors, raising talks about recession if they will start cutting rate with raising CPI. And you could imagine what will happen if stock market collapses right at the eve of Election day. While now it is very suitable moment to do this.
Big hurt might come from geopolitics. Those who read our Gold market reports know that we expect big activity on battlefield in late summer and structural shifts in power balance closer to the autumn. This could impact on the sentiment of foreign investors, and hence on US debt yield/demand.
Finally, September rate cut might be too late to bring effect right to elections. And now, while it is vacation time, you could cut and then watch for two months what will happen, then correct the policy in September... Thus, by all means July is very good moment for this decision.
Taking it all together, if EU will escape to become a side of conflict in Ukraine at least until September, EUR should keep going higher. We suggest no rate cut by ECB in September (as we've explained in previous reports) and dovish steps from the Fed. But EUR appreciation might be different depending on what these steps will be - either just rhetoric or rate cut in July.
