Sive Morten
Special Consultant to the FPA
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Fundamentals
It is huge amount of data this week guys, as political as fundamental and mostly all of them are important. The majority of these events we've covered in Telegram, so, you should be familiar with them - not only CPI report but also Fico incident, Putin-Xi meeting, new India-Iran agreement and some others. There are some very interesting events have happened that are mostly ignored by big media. I'll try to keep report as short as possible, some information we postpone on tomorrow's Gold report, because events are of macro politics and macro economy, so make similar impact on all markets. Today we try to focus only on some of them that have direct relation to currencies.
Market overview
The dollar slumped against major currencies on Wednesday after U.S. consumer prices in April showed inflation had resumed trending lower in the second quarter, raising hopes the Federal Reserve can deliver an interest rate cut as early as September. Also boosting optimism that the Fed was closer to a rate cut was a reading of U.S. retail sales that was unexpectedly flat last month, as higher gasoline prices pulled spending away from other goods in a sign the consumer was retrenching a bit.
After inflation proved "sticky" in the first quarter, with housing rental rates and other prices remaining stubbornly high, the market welcomed the CPI data. But slowing retail sales provided the real news for the market.
The consumer price index rose 0.3% last month after advancing 0.4% in March and February, the Labor Department's Bureau of Labor Statistics said. In the 12 months through April, the CPI increased 3.4% after climbing 3.5% in March. The unchanged reading in retail sales last month followed a slightly downwardly revised 0.6% increase in March, the Commerce Department's Census Bureau said on Wednesday. Retail sales were previously reported to have risen 0.7% in March.
The Atlanta Fed’s flexible and sticky CPI indices show a slowing in near-term momentum for sticky CPI, with its three-month annualized rate easing to 4.5% from 5.2%, following a cyclical trough of 3.6% last July. A core measure of sticky prices that excludes housing costs shows a similar drop on a three-month annualized basis.
Futures markets reduced the outlook for lower U.S. rates, with less than 45 basis points of cuts seen by December, down from almost 50 on Wednesday, and a cut of 21 bps in September, down from almost 25 bps. Hopes that the U.S. inflation genie is back in the bottle has given investors globally the confidence to snap up stocks and riskier currencies, at the notable expense of the dollar.
The Federal Open Market Committee (FOMC) has a dual mandate: inflation and employment. If inflationary dynamics continue to soften, or at least stop getting worse, then the labour market picture will come back into greater focus. And there continue to be signs of cooling. April’s payrolls data missed to the downside, with a 175,000 increase in net employment against expectations for a 243,000 increase. Meanwhile, the employment index of the ISM survey of non-manufacturing firms dropped to 45.9 in April.
The new market sentiment shows that economic surprises have generally been trending downward recently. All told, investors suggest that the data are moving in a direction that appears consistent with a FOMC rate cut this year. For now, investors are pricing that to occur in September. But with a hotly contested presidential election due in November, the FOMC might be tempted to move sooner rather than later, opening up July as a potentially underpriced month for a policy easing.
Policymakers said on Thursday that still-high inflation warrants keeping rates at current levels, and that reaching the Fed's 2% inflation target will take longer than previously thought. A surprisingly large 0.9% jump in import prices on Thursday kindled worries that rising import costs will only add to inflationary pressures.
Almost 50 U.S. lenders could fail in the coming years under pressure from higher interest rates and operational problems, Nomura analyst Greg Hertrich told reporters at the company's New York office on Tuesday.
Last month, regulators seized Philadelphia-based Republic First, and agreed to sell it to Fulton Bank, a unit of Fulton Financial Corp. Republic First had been under pressure from higher costs and sluggish earnings. Nomura's projection is broadly in line with the Federal Deposit Insurance Corp's list of "problem banks" There were 52 on the list at the end of December, the highest since 55 lenders were on the FDIC list in the first quarter of 2021, according to a report by S&P.
Hertrich said he expects more industry consolidation. The U.S. currently has more than 4,500 banks, government data showed.
Market folk still see the ECB as likely the first among the biggest global central banks to cut rates, with June all but locked in by traders. The BoE could follow in just a matter of days though, with its June 20 policy decision a coin toss. Even though markets are pricing European rate cuts beginning in June, recent data has shown some upside surprises. Germany's economy grew more than expected last quarter and investor morale is at a two-year high. Euro zone policymakers have increased confidence that inflation will ease back to target next year due to easing price pressures, ECB Vice-President Luis de Guindos said on Friday.
To more interesting stuff...
You do not need to be genius to suggest this market reaction on recent data. And why should we surprise if we saw it a few times already just in recent 6 months - promised US bonds rally in December 2023 when rate cut expectations were very high (Just look at the chart above) fizzled - investors missed, and this is not the first time when markets celebrate the victory over inflation. But once again we tell - it is too early. First is - the US statistics is not good representation any more of real inflation level due too often adjustments and revisions. This time Statistics Bureau has excluded coffee (+72% in IQ), canned tomatoes and some other rows from food component calculation. You easily could check it by yourself - over the past 20 years, the average annual increase in the price of a Big Mac in the United States has been 4%. During the same time, the CPI added an average of 2.6% per year. This simple test makes the problem evident. But the real "scale of adjustment" is larger. Some experts suggest that real GDP decrease pace now is near the level of Great Depression, i.e. around 0.7-1% per month.
It is nothing need to comment if you take a look at Bloomberg commodities index, US electricity inflation and even on PPI "all commodities" index that we usually use, to understand that inflation is still here. For the first time in almost a year, prices have risen rather than fallen, which indicates that inflationary processes in the United States are continuing. This is what should be taken into account when assessing the real situation.
We could bring a lot more indicators of inflation that sooner rather than later will find the way into statistics or, at least into the real life of Americans. Still, 15 years ago was the same, why we should be surprised with cheating now?
Now, taking "2+2" - comparing PPI and CPI tendencies we see that inflationary processes are not gone away. Because the difference between PPI and CPI is a source of capital return for companies. Which, in turn is one of the major sources of consumer inflation...
New tricks from JPow and JYow
During the week, the Fed continued to actively reduce its balance sheet: government bonds by $31 billion, BTFP by $3 billion, and other assets by $15 billion. In total, Fed assets fell by $49 billion to $7.3 trillion, but Fed operations did not dominate the dot.
A️t the same time the US Treasury spent $110 billion from its accounts in a week, the size of the “stash” is below the target level of $706 billion. In fact, Yellen has spent everything that she had difficulty collecting in April and even more. A significant part was the payment of coupons on government bonds worth $60 billion on May 15, but other expenses were showing progress as well. Additionally the reverse repo by the New York Fed has dropped by $50 billion over the week, although $22 billion of this was disposed of by foreign central banks, which reduced their reverse repo portfolio (they also reduced their portfolio of US government bonds by $18 billion) - this is due to the fact that on May 15 there was a large volume of government debt repayments of $155 billion (loans amounted to only $141 billion).
Dollars in bank reserves increased – another +$86 billion over the week to $3.42 trillion. The coupons received and debt payments had to be shoveled away, so it’s clear where such market optimism came from as it was big flow from the US Treasury on the markets. By the end of the quarter, liquidity should tighten a little, but at the moment there are a lot of dollars in the system - Yellen spent all of the April tax collections.
So, US Treasury already starts spending reserves to cover budget spending. Meantime, China is selling US debt with record tempo. Some analysts suggest that recent yields jump partially was raising supply from China. We will talk about this in details tomorrow.
Here we just show very interesting cycle of the rate policy. The Fed's soft monetary policy implies not only approximately doubling the balance sheet with each new quantitative easing (QE) program, but also has a strict cyclicality of 4-5 years, which is close to Kitchin's economic cycles of 3-4 years.
These cycles have been known for a century and are explained by the operational dynamics of business: the natural stocking of warehouses after shortages at the beginning of the cycle; Filled warehouses cause a decrease in production - the usual smooth “breathing” of the economy. However, for each new “breath” the Fed is forced to print money.That is, the patient has been in the intensive care unit for 15 years.
Based on the indicated timing, in the second half of this year, the edge in the first half of next year, the Fed will return to expanding its balance sheet. And based on previous QE programs, it can be assumed that the size of the Fed's assets will reach an astronomical $15 trillion. $7.5 trillion of new helicopter money will not only cause a new inflation storm, but will also heat up the price of stocks and bonds:
Meantime, the situation in credit sphere raising big concerns. The Commerce Department's April 2024 report shows that the growth of retail trade over the year in nominal terms amounted to 3+-0.5%. Consumer inflation data for April is 3.4% y/y. GDP growth in IIH 2023 was about 4%, in IQ 2024 is 1.6%. How real GDP seems to be actively growing, but retail sales are not? Either GDP growth is flat (which is likely), or Retail sales are depressed (which is unlikely), or fiscal stimulus is going somewhere other than the pockets of the public. The population, at the same time, accumulated during Covid times has already eaten everything.
The Federal Reserve Bank of New York shows, U.S. household debt hit a record high at the end of the first quarter, and more borrowers are struggling to keep up with its servicing: Total U.S. household debt rose to $17.69 trillion . That's an increase of $184 billion. , or 1.1%, compared to the fourth quarter. Continuously rising prices for essentials such as food and rent have strained family budgets, forcing people to take out credit card loans to pay for essentials.
This is only about "legal" loans that we could calculate, but what about BNPL? This is the Pandora Box. As Bloomberg reports, there is a problem with installment plans, because it is not clear how much such debt exists in principle. By the way, food and household chemicals are popular in installments. Moreover, the figure of those who used installment plans (at 30% per annum) is, frankly, amazing - a year ago it was 46% of all consumers. Add here the information that we've discussed last time, that all Covid savings are eaten already. So the consumer is clearly not very strong anymore. And you say “the Fed will under no circumstances reduce the Fed rate?”
Conclusion:
Now we see the process that we already have seen before, at least two times, or even three times. First one was when everybody were telling that "inflation is transitory". Now we see that it is. Second is when we saw temporal drop in inflation by the end of 2023 and finally, when J. Powell already has started declaring of coming rate cut. As a result we saw rates above 5% few months later. Now is another one moment. Investors have caught the rush and start pumping risky assets and dollar rivals, supporting by liquidity, provided from US Treasury. Now we see the dollar weakness that could be treated as "tactical" of "first dollar weakness". It is based on wrong conclusion concerning the inflation level.
But tactically it is correct because data suggest raising tensions and problems in the US economy, deteriorating of consumption and increasing chances for softer Fed policy. Finally - not the dry inflation data is moving market but the Fed rates. Released statistics just helps investors to make suggestions about next Fed step. But if Fed takes steps without any relation to the data - it takes priority.
Now, we suggest with high degree of probability that the Fed and US Treasury chose the way of stimulus providing on a background existed inflation level that will be artificially undervaluing by manipulations with data or muted by stimulus providing and supporting rally on stock market. So investors will not care too much about the nominal inflation rate. Situation stands really tough becomes stimulus are coming from everywhere. It inevitably will lead to inflation acceleration.
This will become "the moment of truth" that at the first stage should trigger rally on US dollar as it was before. And this will be the 2nd time in two years when bond investors will be robbed. Although the Fed could do nothing with the rate actually, or even start cutting it already. Jump in inflation will boost market yields level anyway and support the USD. This is the reason why we still think that 0.9 EUR/USD target and 1.20 on GBP are still possible in longer-term perspective.
Finally, the "second USD weakness" will come. But this time it will be because of recognition of US economy collapse, record inflation and USD devaluation when Money supply is raising astronomically, together with US budget deficit, demand for new issues of the US Debt is falling. Japan and China accelerate US debt selling. But this will happen not earlier than in 2025.
So, here we repeat the same thing - while it is raising, this is good time to out from all US assets. Follow the example of insiders. Although we see bad perspectives but for now we will play in the same game of anticipation of sooner rate cut, which is indeed could happen, if we silence about inflation boost... And see for how long market euphoria stands.
It is huge amount of data this week guys, as political as fundamental and mostly all of them are important. The majority of these events we've covered in Telegram, so, you should be familiar with them - not only CPI report but also Fico incident, Putin-Xi meeting, new India-Iran agreement and some others. There are some very interesting events have happened that are mostly ignored by big media. I'll try to keep report as short as possible, some information we postpone on tomorrow's Gold report, because events are of macro politics and macro economy, so make similar impact on all markets. Today we try to focus only on some of them that have direct relation to currencies.
Market overview
The dollar slumped against major currencies on Wednesday after U.S. consumer prices in April showed inflation had resumed trending lower in the second quarter, raising hopes the Federal Reserve can deliver an interest rate cut as early as September. Also boosting optimism that the Fed was closer to a rate cut was a reading of U.S. retail sales that was unexpectedly flat last month, as higher gasoline prices pulled spending away from other goods in a sign the consumer was retrenching a bit.
After inflation proved "sticky" in the first quarter, with housing rental rates and other prices remaining stubbornly high, the market welcomed the CPI data. But slowing retail sales provided the real news for the market.
The consumer price index rose 0.3% last month after advancing 0.4% in March and February, the Labor Department's Bureau of Labor Statistics said. In the 12 months through April, the CPI increased 3.4% after climbing 3.5% in March. The unchanged reading in retail sales last month followed a slightly downwardly revised 0.6% increase in March, the Commerce Department's Census Bureau said on Wednesday. Retail sales were previously reported to have risen 0.7% in March.
The Atlanta Fed’s flexible and sticky CPI indices show a slowing in near-term momentum for sticky CPI, with its three-month annualized rate easing to 4.5% from 5.2%, following a cyclical trough of 3.6% last July. A core measure of sticky prices that excludes housing costs shows a similar drop on a three-month annualized basis.
Futures markets reduced the outlook for lower U.S. rates, with less than 45 basis points of cuts seen by December, down from almost 50 on Wednesday, and a cut of 21 bps in September, down from almost 25 bps. Hopes that the U.S. inflation genie is back in the bottle has given investors globally the confidence to snap up stocks and riskier currencies, at the notable expense of the dollar.
The Federal Open Market Committee (FOMC) has a dual mandate: inflation and employment. If inflationary dynamics continue to soften, or at least stop getting worse, then the labour market picture will come back into greater focus. And there continue to be signs of cooling. April’s payrolls data missed to the downside, with a 175,000 increase in net employment against expectations for a 243,000 increase. Meanwhile, the employment index of the ISM survey of non-manufacturing firms dropped to 45.9 in April.
The new market sentiment shows that economic surprises have generally been trending downward recently. All told, investors suggest that the data are moving in a direction that appears consistent with a FOMC rate cut this year. For now, investors are pricing that to occur in September. But with a hotly contested presidential election due in November, the FOMC might be tempted to move sooner rather than later, opening up July as a potentially underpriced month for a policy easing.
Policymakers said on Thursday that still-high inflation warrants keeping rates at current levels, and that reaching the Fed's 2% inflation target will take longer than previously thought. A surprisingly large 0.9% jump in import prices on Thursday kindled worries that rising import costs will only add to inflationary pressures.
Almost 50 U.S. lenders could fail in the coming years under pressure from higher interest rates and operational problems, Nomura analyst Greg Hertrich told reporters at the company's New York office on Tuesday.
Last month, regulators seized Philadelphia-based Republic First, and agreed to sell it to Fulton Bank, a unit of Fulton Financial Corp. Republic First had been under pressure from higher costs and sluggish earnings. Nomura's projection is broadly in line with the Federal Deposit Insurance Corp's list of "problem banks" There were 52 on the list at the end of December, the highest since 55 lenders were on the FDIC list in the first quarter of 2021, according to a report by S&P.
Hertrich said he expects more industry consolidation. The U.S. currently has more than 4,500 banks, government data showed.
Market folk still see the ECB as likely the first among the biggest global central banks to cut rates, with June all but locked in by traders. The BoE could follow in just a matter of days though, with its June 20 policy decision a coin toss. Even though markets are pricing European rate cuts beginning in June, recent data has shown some upside surprises. Germany's economy grew more than expected last quarter and investor morale is at a two-year high. Euro zone policymakers have increased confidence that inflation will ease back to target next year due to easing price pressures, ECB Vice-President Luis de Guindos said on Friday.
To more interesting stuff...
You do not need to be genius to suggest this market reaction on recent data. And why should we surprise if we saw it a few times already just in recent 6 months - promised US bonds rally in December 2023 when rate cut expectations were very high (Just look at the chart above) fizzled - investors missed, and this is not the first time when markets celebrate the victory over inflation. But once again we tell - it is too early. First is - the US statistics is not good representation any more of real inflation level due too often adjustments and revisions. This time Statistics Bureau has excluded coffee (+72% in IQ), canned tomatoes and some other rows from food component calculation. You easily could check it by yourself - over the past 20 years, the average annual increase in the price of a Big Mac in the United States has been 4%. During the same time, the CPI added an average of 2.6% per year. This simple test makes the problem evident. But the real "scale of adjustment" is larger. Some experts suggest that real GDP decrease pace now is near the level of Great Depression, i.e. around 0.7-1% per month.
It is nothing need to comment if you take a look at Bloomberg commodities index, US electricity inflation and even on PPI "all commodities" index that we usually use, to understand that inflation is still here. For the first time in almost a year, prices have risen rather than fallen, which indicates that inflationary processes in the United States are continuing. This is what should be taken into account when assessing the real situation.
We could bring a lot more indicators of inflation that sooner rather than later will find the way into statistics or, at least into the real life of Americans. Still, 15 years ago was the same, why we should be surprised with cheating now?
Now, taking "2+2" - comparing PPI and CPI tendencies we see that inflationary processes are not gone away. Because the difference between PPI and CPI is a source of capital return for companies. Which, in turn is one of the major sources of consumer inflation...
New tricks from JPow and JYow
During the week, the Fed continued to actively reduce its balance sheet: government bonds by $31 billion, BTFP by $3 billion, and other assets by $15 billion. In total, Fed assets fell by $49 billion to $7.3 trillion, but Fed operations did not dominate the dot.
A️t the same time the US Treasury spent $110 billion from its accounts in a week, the size of the “stash” is below the target level of $706 billion. In fact, Yellen has spent everything that she had difficulty collecting in April and even more. A significant part was the payment of coupons on government bonds worth $60 billion on May 15, but other expenses were showing progress as well. Additionally the reverse repo by the New York Fed has dropped by $50 billion over the week, although $22 billion of this was disposed of by foreign central banks, which reduced their reverse repo portfolio (they also reduced their portfolio of US government bonds by $18 billion) - this is due to the fact that on May 15 there was a large volume of government debt repayments of $155 billion (loans amounted to only $141 billion).
Dollars in bank reserves increased – another +$86 billion over the week to $3.42 trillion. The coupons received and debt payments had to be shoveled away, so it’s clear where such market optimism came from as it was big flow from the US Treasury on the markets. By the end of the quarter, liquidity should tighten a little, but at the moment there are a lot of dollars in the system - Yellen spent all of the April tax collections.
So, US Treasury already starts spending reserves to cover budget spending. Meantime, China is selling US debt with record tempo. Some analysts suggest that recent yields jump partially was raising supply from China. We will talk about this in details tomorrow.
Here we just show very interesting cycle of the rate policy. The Fed's soft monetary policy implies not only approximately doubling the balance sheet with each new quantitative easing (QE) program, but also has a strict cyclicality of 4-5 years, which is close to Kitchin's economic cycles of 3-4 years.
These cycles have been known for a century and are explained by the operational dynamics of business: the natural stocking of warehouses after shortages at the beginning of the cycle; Filled warehouses cause a decrease in production - the usual smooth “breathing” of the economy. However, for each new “breath” the Fed is forced to print money.
Based on the indicated timing, in the second half of this year, the edge in the first half of next year, the Fed will return to expanding its balance sheet. And based on previous QE programs, it can be assumed that the size of the Fed's assets will reach an astronomical $15 trillion. $7.5 trillion of new helicopter money will not only cause a new inflation storm, but will also heat up the price of stocks and bonds:
Meantime, the situation in credit sphere raising big concerns. The Commerce Department's April 2024 report shows that the growth of retail trade over the year in nominal terms amounted to 3+-0.5%. Consumer inflation data for April is 3.4% y/y. GDP growth in IIH 2023 was about 4%, in IQ 2024 is 1.6%. How real GDP seems to be actively growing, but retail sales are not? Either GDP growth is flat (which is likely), or Retail sales are depressed (which is unlikely), or fiscal stimulus is going somewhere other than the pockets of the public. The population, at the same time, accumulated during Covid times has already eaten everything.
The Federal Reserve Bank of New York shows, U.S. household debt hit a record high at the end of the first quarter, and more borrowers are struggling to keep up with its servicing: Total U.S. household debt rose to $17.69 trillion . That's an increase of $184 billion. , or 1.1%, compared to the fourth quarter. Continuously rising prices for essentials such as food and rent have strained family budgets, forcing people to take out credit card loans to pay for essentials.
This is only about "legal" loans that we could calculate, but what about BNPL? This is the Pandora Box. As Bloomberg reports, there is a problem with installment plans, because it is not clear how much such debt exists in principle. By the way, food and household chemicals are popular in installments. Moreover, the figure of those who used installment plans (at 30% per annum) is, frankly, amazing - a year ago it was 46% of all consumers. Add here the information that we've discussed last time, that all Covid savings are eaten already. So the consumer is clearly not very strong anymore. And you say “the Fed will under no circumstances reduce the Fed rate?”
Conclusion:
Now we see the process that we already have seen before, at least two times, or even three times. First one was when everybody were telling that "inflation is transitory". Now we see that it is. Second is when we saw temporal drop in inflation by the end of 2023 and finally, when J. Powell already has started declaring of coming rate cut. As a result we saw rates above 5% few months later. Now is another one moment. Investors have caught the rush and start pumping risky assets and dollar rivals, supporting by liquidity, provided from US Treasury. Now we see the dollar weakness that could be treated as "tactical" of "first dollar weakness". It is based on wrong conclusion concerning the inflation level.
But tactically it is correct because data suggest raising tensions and problems in the US economy, deteriorating of consumption and increasing chances for softer Fed policy. Finally - not the dry inflation data is moving market but the Fed rates. Released statistics just helps investors to make suggestions about next Fed step. But if Fed takes steps without any relation to the data - it takes priority.
Now, we suggest with high degree of probability that the Fed and US Treasury chose the way of stimulus providing on a background existed inflation level that will be artificially undervaluing by manipulations with data or muted by stimulus providing and supporting rally on stock market. So investors will not care too much about the nominal inflation rate. Situation stands really tough becomes stimulus are coming from everywhere. It inevitably will lead to inflation acceleration.
This will become "the moment of truth" that at the first stage should trigger rally on US dollar as it was before. And this will be the 2nd time in two years when bond investors will be robbed. Although the Fed could do nothing with the rate actually, or even start cutting it already. Jump in inflation will boost market yields level anyway and support the USD. This is the reason why we still think that 0.9 EUR/USD target and 1.20 on GBP are still possible in longer-term perspective.
Finally, the "second USD weakness" will come. But this time it will be because of recognition of US economy collapse, record inflation and USD devaluation when Money supply is raising astronomically, together with US budget deficit, demand for new issues of the US Debt is falling. Japan and China accelerate US debt selling. But this will happen not earlier than in 2025.
So, here we repeat the same thing - while it is raising, this is good time to out from all US assets. Follow the example of insiders. Although we see bad perspectives but for now we will play in the same game of anticipation of sooner rate cut, which is indeed could happen, if we silence about inflation boost... And see for how long market euphoria stands.
