Sive Morten
Special Consultant to the FPA
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- 18,673
Fundamentals
This week was relatively quiet, and some action has come not from PCE numbers as everybody expected. We would point two major issues of this week. First is just miserable Durable Goods orders, collapsed for ~6%, second - poor PMI numbers on Friday that (together with Fed members comments) have triggered massive dollar sell-off and rally on FX and Gold market. Sentiment is changing again. As we've warned - the Fed&Co will keep nightmaring markets until they totally loose the mind and any sense of direction and reality. Markets already do not know where to run - yesterday was strong CPI, now is poor PCE, yesterday was strong GDP now is poor PMI etc. This ping-pong tells us two things. First is, it indirectly confirms our view that there are no real growth in the US economy. Otherwise, data would be relatively stable. Which, in turn, also confirms it's manipulation. Second - it makes market nervous and emotionally react on any change in the wind. This is the shaking boat action. In fact, now we have only two major components to watch for - dynamic of inflationary sentiment and economy conditions. Yes, they are related to each other, but still, are different. In this report we take a look at inflation. Economy conditions we will consider tomorrow in Gold report. It is too large information just for single research. But, taking them together - you'll see why we do not expect any rate cut, not only until the summer but maybe through the 2024.
Market overview
The dollar fell against the euro on Friday on weaker than expected U.S. economic data. U.S. manufacturing slumped further in February, with a measure of factory employment dropping to a seven-month low amid declining new orders. Construction spending, which had been expected to increase, also fell in January. Economists at Goldman Sachs cut their gross domestic product (GDP) estimate for the first quarter by 0.2 percentage points to 2.2% after the data.
Treasury yields fell sharply on Friday after weak U.S. economic data and comments from Federal Reserve officials bolstered expectations for interest rate cuts later this year. The Institute for Supply Management (ISM) said its manufacturing PMI fell to 47.8 last month from 49.1 in January, the 16th straight month that the PMI remained below 50. The University of Michigan surveys of consumers showed all three measures for sentiment, current conditions and consumer expectations falling more than expected.
The dollar has been largely range-bound with traders focusing closely on economic data for any new clues on when the U.S. Federal Reserve is likely to begin cutting interest rates. arc Chandler, chief market strategist at Bannockburn Global Forex in New York, noted that -
On Thursday, the U.S. personal consumption expenditures (PCE) report was in line with expectations and showed annual inflation growth the smallest in three years.
Investors appeared to shrug off a note of caution from Richmond Federal Reserve President Thomas Barkin, who said U.S. price pressures still exist and it is too soon to predict when the Fed will cut rates
The next major U.S. economic release will be February’s employment report due next Friday. Economists polled by Reuters expect the U.S. economy created 188,000 new jobs, after a blowout 353,000 jobs in January.
Data on Friday showed that euro zone inflation dipped last month but underlying price growth remained stubbornly high, adding to the case for the European Central Bank to hold interest rates at record highs a bit longer before starting to ease policy towards mid-year.
The European Central Bank will first cut interest rates in June, according to a near two-thirds majority of economists in a Reuters poll, though they were split on the chances of the cut coming earlier or later than they expected. Inflation, which the ECB targets at 2.0%, moderated to 2.8% in January from a peak of 10.6% in October 2022 and is expected to drop further. Most members of the Governing Council, including President Christine Lagarde, are aligned with the view that more data, especially on the labour market, will be required before cutting the deposit rate from a record high 4.00%.
Still, economists said it would not be the start of a substantial easing cycle - "There is always a risk that as soon as the economy recovers just a tiny bit, inflation will come back so that argues against aggressive rate cuts," added ING's Brzeski. An early cut by the ECB could mean a weaker euro and risks of additional imported inflation as a similar Reuters poll found the U.S. Federal Reserve is also expected to reduce rates in June, with a significant risk of a later move.
But unlike in the euro zone, growth in the world's No. 1 economy remains resilient and U.S. recession fears are fast fading.
It is never happened before and here is again...
All this stuff about sounds very familiar, like we heard it sometime. Sentiment is changing (again!) - PMI collapsed, Fed will cut, strong buy now! Just few days ago everybody were selling due strong CPI numbers. What's going on? Guys, we should not listen this garbage, stay with the plan, this is the only chance to survive. If you start wheel and dart- you're doomed. We treat recent hype on Friday as a chance to shake the boat. Mostly it is aimed on households' investors on stock market. As usually happens - they start buying at the market spent already. Big guys push all hamsters in to shave them down to skin later. Stats of recent weeks shows that households strongly activating on stock market.
Speaking about ECB/Fed competition, who goes first - we keep our suggestion intact. ECB will cut first, and EUR will loose competition to USD. As we've mentioned, ECB constantly cut Money supply - The contraction of M1 accelerated to -8.6% y/y, the growth of M3 halved to 0.1% y/y. But demand for money is not raising as overall economy is slowing down. It means that inflation in EU has more chances to fall faster than in the US
Now let's take a look at the US. Market expectations now is gradual rate cut, starting in summer but not steady. We think that this is either intentional disinformation or misunderstanding. We do not agree with this statement and keep our own view that hardly the Fed will cut rate in 2024 at all. If even this happens, it will happen in IIIQ and we will not get 75 bp cut this year.
First is let's take a look at dynamic of the bond market. It is 43 weeks in a row in red. The dynamic of interest yield curve also doesn't suggest any rate cut at all, and I would say the opposite - yields are raising on long-term tail. Bond market seems to begin tired from endless US Treasury appetites. Although 7- year auction was in market, the 2-year auction looks weak - yield on them went up, which is not surprising, because the placement volume increased to $63 billion. This was the largest two-year auction in history. The demand-to-supply ratio fell to 2.492 from 2.571 last month, the lowest since March 2023. Recall that week ago it was awful 20-year auction - we talked about it last week.
Once US Treasury has stopped to cut money supply - prices across the board start moving higher. Oil prices began to rise. It all started after something went wrong in the Repo market again and the Fed put the brakes on reducing its balance sheet. Trafigura, by the way, also relates rising oil prices to returning demand. It looks like this is just the beginning - and the longer this monetary pro-inflation fest continues, the higher oil will rise. Because PSR strategic reserve will no longer be drained. Because its done - Biden Administration has purchased SPR oil in 12 of the last 14 weeks (+743K last week).
Now let's go further. NFIB's small business survey asked 10,000 firms whether they planned to increase selling prices over the next three months. The recent increase in the share of companies saying "yes" suggests that CPI inflation may increase in the coming months.
The Fed Reverse Repo is keep dropping and now stands around 500 Bln down from ~ $2.5 Trln, despite that RRPO rate stands around 5.3%. As WSJ writes, Last fall, a committee that advises the Treasury suggested that the Fed's pile of money-market fund cash could finance a flood of short-term bill issuance. It's an unusual market shift that has allowed U.S. authorities to keep long-term interest rates relatively low in recent months despite accelerating debt issuance.
The Treasury bill market has now reached nearly $6 trillion , up from less than $2 trillion at the end of 2017. Much of the reverse repo flow is also the result of record amounts of money that investors have poured into money market funds (assets now total more than $6 trillion). Many analysts and portfolio managers expect usage of the program to continue to decline, which they say will likely limit the functioning of an important shock absorber in the U.S. Treasury market ."
In fact, the bubble of super expectations of the Fed's "soon cut", mentioned above will be replaced by a bubble of "fear and horror" from rising long bond yields and falling short yields. Now everything speaks for it. The US Treasury's plans to place more long-term treasuries instead of short ones will create an overhang of supply in the market and push the price of bonds down, which means holes in banks' balance sheets will begin to expand.
If we also take into account the fact that literally in 10 days BTFP will be canceled and some banks will have to repay the money borrowed from the Fed (those who took money a year ago), and in return get their long-term treasuries back, then this will also add to the reduction in liquidity, according to various estimates, from 80 to 100 billion dollars.
At the same time, money market funds will continue to seek refuge and will find it, again, in short treasuries and reverse repo. If the yield on it, of course, becomes more attractive compared to short-term treasuries. In general, we could see the yield curve inversion disappear, not because the Fed will lower rates, as it usually happens, but because yields on long treasuries will finally become higher than on short ones. But this is bad news.
Now let's take a look at some stats:
1) The basic indicators of trend inflation are growing;
3) Super-base inflation, the inflation rate preferred by Fed Chairman Powell, tends to rise - just take a look at "Services" component in recent PCE data;
4) After the Fed's reversal in December, the labor market remains tense, applications for unemployment benefits are very low, and wage inflation is steady between 4% and 5%.
5) Small business surveys show that more and more small businesses are planning to raise selling prices (shown above).
6) Surveys of production show a trend towards higher prices, another leading indicator of inflation.
7) Prices for ISM services also tend to increase.
8) Small business surveys show that more and more small businesses are planning to increase employee wages.
9) Asking rents are rising and more cities are seeing rents rise and home prices are rising.
Therefore, analysts believe that the Fed will spend most of 2024 fighting inflation. As a result, bond yields will remain high. Inflation is really accelerating. In fact, as we have seen, the situation on the labor market is far from being so clear-cut, and market expectations NEVER come true, no matter what they are. That is, any market forecasts speak only about internal sensations, and not about what reality will be like in the foreseeable future.
Thus, taking it all together, the most likely scenario that can be considered is stagflation rather than a soft landing. When inflation accelerates, the Fed may need to not only keep rates stable, but raise it following the rise in inflation to the next peak, which will most likely lead to an increase in holes in the balance sheets of banks, an increase in funding rates for corporations and individuals and, in ultimately, to a decline in consumption and a financial crisis against the backdrop of high inflation, which will have to be extinguished by easing financial conditions, the rigidity or softness of which depends not only on the rate.
This week was relatively quiet, and some action has come not from PCE numbers as everybody expected. We would point two major issues of this week. First is just miserable Durable Goods orders, collapsed for ~6%, second - poor PMI numbers on Friday that (together with Fed members comments) have triggered massive dollar sell-off and rally on FX and Gold market. Sentiment is changing again. As we've warned - the Fed&Co will keep nightmaring markets until they totally loose the mind and any sense of direction and reality. Markets already do not know where to run - yesterday was strong CPI, now is poor PCE, yesterday was strong GDP now is poor PMI etc. This ping-pong tells us two things. First is, it indirectly confirms our view that there are no real growth in the US economy. Otherwise, data would be relatively stable. Which, in turn, also confirms it's manipulation. Second - it makes market nervous and emotionally react on any change in the wind. This is the shaking boat action. In fact, now we have only two major components to watch for - dynamic of inflationary sentiment and economy conditions. Yes, they are related to each other, but still, are different. In this report we take a look at inflation. Economy conditions we will consider tomorrow in Gold report. It is too large information just for single research. But, taking them together - you'll see why we do not expect any rate cut, not only until the summer but maybe through the 2024.
Market overview
The dollar fell against the euro on Friday on weaker than expected U.S. economic data. U.S. manufacturing slumped further in February, with a measure of factory employment dropping to a seven-month low amid declining new orders. Construction spending, which had been expected to increase, also fell in January. Economists at Goldman Sachs cut their gross domestic product (GDP) estimate for the first quarter by 0.2 percentage points to 2.2% after the data.
Treasury yields fell sharply on Friday after weak U.S. economic data and comments from Federal Reserve officials bolstered expectations for interest rate cuts later this year. The Institute for Supply Management (ISM) said its manufacturing PMI fell to 47.8 last month from 49.1 in January, the 16th straight month that the PMI remained below 50. The University of Michigan surveys of consumers showed all three measures for sentiment, current conditions and consumer expectations falling more than expected.
The dollar has been largely range-bound with traders focusing closely on economic data for any new clues on when the U.S. Federal Reserve is likely to begin cutting interest rates. arc Chandler, chief market strategist at Bannockburn Global Forex in New York, noted that -
The dollar was also pulled down in line with shorter-dated Treasury yields on Friday after Fed Governor Chris Waller said he would like the U.S. central bank to address a reset of the balance sheet towards shorter-term Treasury bills that would better match the short-term policy rate that the Fed controls as its key monetary policy tool. Waller hopes for lower interest rates, saying decisions about the ultimate size of the Fed balance sheet have no bearing in its inflation fight rate policy.
On Thursday, the U.S. personal consumption expenditures (PCE) report was in line with expectations and showed annual inflation growth the smallest in three years.
Investors appeared to shrug off a note of caution from Richmond Federal Reserve President Thomas Barkin, who said U.S. price pressures still exist and it is too soon to predict when the Fed will cut rates
The next major U.S. economic release will be February’s employment report due next Friday. Economists polled by Reuters expect the U.S. economy created 188,000 new jobs, after a blowout 353,000 jobs in January.
Data on Friday showed that euro zone inflation dipped last month but underlying price growth remained stubbornly high, adding to the case for the European Central Bank to hold interest rates at record highs a bit longer before starting to ease policy towards mid-year.
Global factory surveys showed manufacturing output had continued to fall in both Europe and Asia.
The European Central Bank will first cut interest rates in June, according to a near two-thirds majority of economists in a Reuters poll, though they were split on the chances of the cut coming earlier or later than they expected. Inflation, which the ECB targets at 2.0%, moderated to 2.8% in January from a peak of 10.6% in October 2022 and is expected to drop further. Most members of the Governing Council, including President Christine Lagarde, are aligned with the view that more data, especially on the labour market, will be required before cutting the deposit rate from a record high 4.00%.
Still, economists said it would not be the start of a substantial easing cycle - "There is always a risk that as soon as the economy recovers just a tiny bit, inflation will come back so that argues against aggressive rate cuts," added ING's Brzeski. An early cut by the ECB could mean a weaker euro and risks of additional imported inflation as a similar Reuters poll found the U.S. Federal Reserve is also expected to reduce rates in June, with a significant risk of a later move.
But unlike in the euro zone, growth in the world's No. 1 economy remains resilient and U.S. recession fears are fast fading.
The ECB meets on Thursday and the focus is on whether policy makers will repeat that it's too early to discuss rate cuts or open the door to a move. Pricing also suggests the ECB could cut before the Fed does - not surprising perhaps given a relatively weak euro zone economy. The ECB typically moves after the Fed.
It is never happened before and here is again...
All this stuff about sounds very familiar, like we heard it sometime. Sentiment is changing (again!) - PMI collapsed, Fed will cut, strong buy now! Just few days ago everybody were selling due strong CPI numbers. What's going on? Guys, we should not listen this garbage, stay with the plan, this is the only chance to survive. If you start wheel and dart- you're doomed. We treat recent hype on Friday as a chance to shake the boat. Mostly it is aimed on households' investors on stock market. As usually happens - they start buying at the market spent already. Big guys push all hamsters in to shave them down to skin later. Stats of recent weeks shows that households strongly activating on stock market.
Speaking about ECB/Fed competition, who goes first - we keep our suggestion intact. ECB will cut first, and EUR will loose competition to USD. As we've mentioned, ECB constantly cut Money supply - The contraction of M1 accelerated to -8.6% y/y, the growth of M3 halved to 0.1% y/y. But demand for money is not raising as overall economy is slowing down. It means that inflation in EU has more chances to fall faster than in the US
Now let's take a look at the US. Market expectations now is gradual rate cut, starting in summer but not steady. We think that this is either intentional disinformation or misunderstanding. We do not agree with this statement and keep our own view that hardly the Fed will cut rate in 2024 at all. If even this happens, it will happen in IIIQ and we will not get 75 bp cut this year.
First is let's take a look at dynamic of the bond market. It is 43 weeks in a row in red. The dynamic of interest yield curve also doesn't suggest any rate cut at all, and I would say the opposite - yields are raising on long-term tail. Bond market seems to begin tired from endless US Treasury appetites. Although 7- year auction was in market, the 2-year auction looks weak - yield on them went up, which is not surprising, because the placement volume increased to $63 billion. This was the largest two-year auction in history. The demand-to-supply ratio fell to 2.492 from 2.571 last month, the lowest since March 2023. Recall that week ago it was awful 20-year auction - we talked about it last week.
Once US Treasury has stopped to cut money supply - prices across the board start moving higher. Oil prices began to rise. It all started after something went wrong in the Repo market again and the Fed put the brakes on reducing its balance sheet. Trafigura, by the way, also relates rising oil prices to returning demand. It looks like this is just the beginning - and the longer this monetary pro-inflation fest continues, the higher oil will rise. Because PSR strategic reserve will no longer be drained. Because its done - Biden Administration has purchased SPR oil in 12 of the last 14 weeks (+743K last week).
Now let's go further. NFIB's small business survey asked 10,000 firms whether they planned to increase selling prices over the next three months. The recent increase in the share of companies saying "yes" suggests that CPI inflation may increase in the coming months.
The Fed Reverse Repo is keep dropping and now stands around 500 Bln down from ~ $2.5 Trln, despite that RRPO rate stands around 5.3%. As WSJ writes, Last fall, a committee that advises the Treasury suggested that the Fed's pile of money-market fund cash could finance a flood of short-term bill issuance. It's an unusual market shift that has allowed U.S. authorities to keep long-term interest rates relatively low in recent months despite accelerating debt issuance.
The Treasury bill market has now reached nearly $6 trillion , up from less than $2 trillion at the end of 2017. Much of the reverse repo flow is also the result of record amounts of money that investors have poured into money market funds (assets now total more than $6 trillion). Many analysts and portfolio managers expect usage of the program to continue to decline, which they say will likely limit the functioning of an important shock absorber in the U.S. Treasury market ."
In fact, the bubble of super expectations of the Fed's "soon cut", mentioned above will be replaced by a bubble of "fear and horror" from rising long bond yields and falling short yields. Now everything speaks for it. The US Treasury's plans to place more long-term treasuries instead of short ones will create an overhang of supply in the market and push the price of bonds down, which means holes in banks' balance sheets will begin to expand.
If we also take into account the fact that literally in 10 days BTFP will be canceled and some banks will have to repay the money borrowed from the Fed (those who took money a year ago), and in return get their long-term treasuries back, then this will also add to the reduction in liquidity, according to various estimates, from 80 to 100 billion dollars.
At the same time, money market funds will continue to seek refuge and will find it, again, in short treasuries and reverse repo. If the yield on it, of course, becomes more attractive compared to short-term treasuries. In general, we could see the yield curve inversion disappear, not because the Fed will lower rates, as it usually happens, but because yields on long treasuries will finally become higher than on short ones. But this is bad news.
Now let's take a look at some stats:
1) The basic indicators of trend inflation are growing;
3) Super-base inflation, the inflation rate preferred by Fed Chairman Powell, tends to rise - just take a look at "Services" component in recent PCE data;
4) After the Fed's reversal in December, the labor market remains tense, applications for unemployment benefits are very low, and wage inflation is steady between 4% and 5%.
5) Small business surveys show that more and more small businesses are planning to raise selling prices (shown above).
6) Surveys of production show a trend towards higher prices, another leading indicator of inflation.
7) Prices for ISM services also tend to increase.
8) Small business surveys show that more and more small businesses are planning to increase employee wages.
9) Asking rents are rising and more cities are seeing rents rise and home prices are rising.
Therefore, analysts believe that the Fed will spend most of 2024 fighting inflation. As a result, bond yields will remain high. Inflation is really accelerating. In fact, as we have seen, the situation on the labor market is far from being so clear-cut, and market expectations NEVER come true, no matter what they are. That is, any market forecasts speak only about internal sensations, and not about what reality will be like in the foreseeable future.
Thus, taking it all together, the most likely scenario that can be considered is stagflation rather than a soft landing. When inflation accelerates, the Fed may need to not only keep rates stable, but raise it following the rise in inflation to the next peak, which will most likely lead to an increase in holes in the balance sheets of banks, an increase in funding rates for corporations and individuals and, in ultimately, to a decline in consumption and a financial crisis against the backdrop of high inflation, which will have to be extinguished by easing financial conditions, the rigidity or softness of which depends not only on the rate.
When finally this BoJ soap opera of inflation/deflation and interest rates will be over? 
