Sive Morten
Special Consultant to the FPA
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Fundamentals
Despite that market has spent the week in relatively tight range - a lot of important events have happened, that could make impact later in time. First is, we've got strong CPI data, JP speech in Congress, some other data as US sentiment and consumer spending. All of them are important and made impact on sentiment as we will see below from COT report. Although this impact is not visible yet in price action. Pandemic theme stands a bit in the shadow, but nevertheless, this is important topic as delta variant spreads fast and makes hurts across the Globe. On a background of Fed meeting and ECB we expect strong action next week.
Market overview
The Delta variant of COVID-19 is now the dominant strain worldwide, accompanied by a surge of deaths around the United States almost entirely among unvaccinated people, U.S. officials said on Friday.
U.S. cases of COVID-19 are up 70% over the previous week and deaths are up 26%, with outbreaks occurring in parts of the country with low vaccination rates, U.S. Centers for Disease Control and Prevention Director Rochelle Walensky said during a press briefing. The seven-day-average number of daily cases is now more than 26,000, more than twice its June low of around 11,000 cases, according to CDC data.
"We are dealing with a formidable variant" of COVID-19, U.S. infectious disease expert Anthony Fauci saidduring the call.
Cities from Seoul to Sydney are under lockdown as the infectious Delta variant sweeps the globe. Infection rates are rising in the United States, Singapore reported its sharpest jump in cases in 10 months on Thursday and Indonesia is living its government's worst-case COVID scenario.
England plans to lift almost all COVID-related restrictions on Monday, even as cases climb.
The U.S. dollar climbed to a 5-day high against a basket of currencies on Tuesday after data showed U.S. inflation data for June coming in hotter than expected, raising the prospect that inflationary concerns are set to linger. U.S. consumer prices rose by the most in 13 years in June amid supply constraints and a continued rebound in the costs of travel-related services from pandemic-depressed levels as the economic recovery gathered momentum.
The consumer price index increased 0.9% last month after advancing 0.6% in May, the Labor Department said on Tuesday. Year to year, the CPI jumped 5.4%, the largest gain since August 2008, following a 5.0% increase in the 12 months through May.
Excluding the volatile food and energy components, the CPI accelerated 0.9% after increasing 0.7% in May. Core CPI surged 4.5% on a year-on-year basis, the largest increase since November 1991, after rising 3.8% in May.
The possibility of U.S. stimulus withdrawal - brought to the fore by a surprise shift in tone last month from the Fed - has boosted the dollar in recent weeks despite a renewed rise in coronavirus cases in many parts of the world. U.S. consumer price inflation data is likely to help boost the dollar higher.
Federal Reserve Chair Jerome Powell on Wednesday pledged “powerful support” to complete the U.S. economic recovery from the coronavirus pandemic, but faced sharp questions from Republican lawmakers concerned about recent spikes in inflation. In testimony to the U.S. House of Representatives Financial Services Committee, Powell said he is confident recent price hikes are associated with the country’s post-pandemic reopening and will fade, and that the Fed should stay focused on getting as many people back to work as possible.
The U.S. job market “is still a ways off” from the progress the Federal Reserve wants to see before reducing its support for the economy, while current high inflation will ease “in coming months,” Fed Chair Jerome Powell said in remarks prepared for delivery at a congressional hearing on Wednesday.
The remarks pulled the dollar back from a three-month high against the euro and from a one-week high on the yen, though it soon found a footing in the Asia session as traders nervously awaited Chinese data to see whether it indicated a slowdown.
Powell returns to Capitol Hill later on Thursday for further testimony before Congress, following remarks that toppled the dollar from a three-month high on the euro on Wednesday. He had soothed rate hike fears by saying high inflation seemed linked to the U.S. economy's reopening, that it would be a mistake to act prematurely and that economic conditions for tapering bond buying was "still a ways off".
The subsequent support for the dollar, which still sits above its 20- and 200-day moving averages against a basket of six major currencies suggests investors were not entirely convinced. The dollar index was last steady at 92.434.
Indeed the even sharp contrast in tone between Powell and other central banks that are charting far faster courses away from super-easy policy hasn't broken recent currency ranges. In New Zealand, for example, the central bank said on Wednesday it would end its bond purchase programme next week, but the resultant jump in the kiwi only took it to a one-week high.
U.S. retail sales unexpectedly increased in June as demand for goods remained strong even as spending is shifting back to services, supporting expectations that economic growth accelerated in the second quarter.
Retail sales rose 0.6% last month. Data for May was revised down to show sales falling 1.7% instead of declining 1.3% as previously reported. Economists polled by Reuters had forecast retail sales dropping 0.4% in June. Sales advanced 18.0% compared to June last year and are now 18.0% above their pre-pandemic level. Retail sales mostly capture the goods component of consumer spending, with services such as healthcare, education, travel and hotel accommodation making up the remaining portion. Restaurants and bars are the only services category in the retail sales report.
Though worries about inflation hurt consumer sentiment this month, spending was likely to remain underpinned by record savings and rising wealth. The University of Michigan's consumer sentiment index fell to 80.8 early this month from 85.5 in June. The survey's inflation expectations over the next 12 months shot up to 4.8% from 4.2% in June.
The government reported this week that consumer prices increased by the most in 13 years in June, while producers prices accelerated.
Households accumulated at least $2.5 trillion in excess savings during the pandemic. Starting this month through December some households will receive income under the expanded Child Tax Credit program, which should help middle- and lower-income households to maintain spending.
Despite the downward revision to May core retail sales, economists remained steadfast in their belief that consumer spending, which accounts for more than two-thirds of U.S. economic activity, logged double-digit growth in the second quarter. Consumer spending grew at an 11.4% annualized rate in the first quarter.
Gross domestic product growth estimates for this quarter are around a 9% rate, which would be an acceleration from the 6.4% pace notched in the first quarter. Economists believe the economy could achieve growth of at least 7% this year. That would be the fastest growth since 1984. The economy contracted 3.5% in 2020, its worst performance in 74 years.
U.S. Treasury yields pared most of Friday's gains as doubts about the economic recovery's strength and dovish Federal Reserve policy were seen as likely to cap yields in the near-term, even after U.S. retail sales unexpectedly rose in June. Demand for goods remained strong even as spending shifts back to services, bolstering expectations that economic growth accelerated in the second quarter.
Retail sales rebounded 0.6% last month, the Commerce Department said on Friday. May's sales decline was revised to 1.7% from the previously reported 1.3%. Yields have dropped since Federal Reserve Chair Jerome Powell on Wednesday and Thursday pledged "powerful support" to complete the U.S. economic recovery, and indicated he saw no need to rush withdrawing economic support because of a recent jump in inflation.
Some analysts say long-dated yields may be too low relative to expected growth.
The U.S. Treasury Department on Friday asked its primary bond dealers for their outlook on issuance sizes across the yield curve and when reductions should be considered by the government. The dealer questionnaire, released on Friday, starts the process for the Treasury's next quarterly debt refunding announcement in August.
U.S. consumer sentiment fell sharply and unexpectedly in early July to the lowest level in five months as inflation worries dented confidence in the economic recovery, a survey showed on Friday.
The University of Michigan said its preliminary consumer sentiment index fell to 80.8 in the first half of this month - the lowest since February - from a final reading of 85.5 in June. Economists polled by Reuters had forecast the index would rise to 86.5.
“Consumers’ complaints about rising prices on homes, vehicles, and household durables has reached an all-time record,” Richard Curtin, the survey director, said in a statement.
Supply constraints nationwide have led to a surge in consumer prices, as they increased by the most in 13 years in June.
The survey’s gauge of current economic conditions also fell to a reading of 84.5, the lowest since August 2020, from 88.6 in June. Its measure of consumer expectations slid to 78.4, the lowest since February, from 83.5.
The survey’s one-year inflation expectation shot to the highest level since August 2008 at 4.8%, up from 4.2%, while its five-year inflation outlook ticked up to 2.9% from 2.8% in June.
Fathom expects to see a period of very strong economic growth through this year, as a portion of the pandemic savings — worth close to 10% of GDP in several major economies — is spent. Survey evidence from the US and UK central banks suggests around a quarter of excess savings will be spent. In our judgment this will, in turn, produce a sustained period of above-target inflation. The flipside of high pandemic savings in the major economies is rapid growth in the broad money aggregates. The chart below shows that, after adjusting for inflation, US real broad money balances increased by more than 20% last year. Over the past 150 years real broad money growth has been more rapid on just one occasion, and that was in the aftermath of World War II.
It is becoming increasingly apparent that the pick-up in inflation, particularly in the US, is cyclical. It is not just a consequence of base effects. Traditionally, any cyclical pick-up in inflation has required a monetary policy response. But that is not the intention of policymakers at present. The FOMC continues to believe that the pick-up will be transitory. We have our doubts. Inflation overshoots driven by a spike in the oil price, by a change in tax rates, or by a depreciation of the currency, tend ultimately to subtract from household real incomes. In that sense, they can be self-limiting, and deflationary in the long run, and it is often appropriate for policymakers to look through them. But that is not what we are seeing here. Only in the unlikely event that higher product prices do not feed through at all to higher wages, which would require a very strong degree of faith in policymakers’ ability to rapidly bring inflation back to target, would a cyclical pick-up in inflation be self limiting.
If we are right, and households try to make up for lost time in their spending rather than smooth their pandemic savings over the remainder of their lifetimes, causing a material, cyclical increase in inflation that does not go away of its own accord, how will policymakers respond? They are likely to be faced with a choice of either ‘dealing with it’, and tightening policy sooner than many imagine, triggering a recession; or ‘rolling with it’, and moving to a higher inflation target. We believe the latter would be a better response.
Since its inception, the European Central Bank (ECB) had appeared more concerned by inflation overshoots than undershoots, defining price stability in 1998 as “a year-on-year increase in the Harmonised Index of Consumer Prices (HICP)…of below 2%”, before modifying that only slightly in 2003 to an inflation rate that is “below, but close to, 2%”. All that changed last week when the ECB joined both the US Federal Reserve and the Bank of England in adopting a symmetric inflation target of 2%. More importantly, perhaps, the ECB acknowledged that it would tolerate a transition period in which inflation was moderately above target.
The single currency bloc has experienced several periods of outright deflation since the Global Financial Crisis. In the ten years up to June 2021, the targeted measure averaged just over 1%, as our chart shows. With policymakers struggling to reach even the old target, is now really the time to target higher inflation? In Fathom’s view, yes. Euro area inflation is running at 2.0%, on the latest figures, and is set to rise further as economies reopen, and pandemic savings are spent. In the coming months, inflation is likely to move materially higher across the major economies. Rather than tighten aggressively, risking a correction in bond and equity markets, we argued that policymakers should move the goalposts, and opportunistically raise their inflation targets above 2%. Last week’s modest relaxation from the ECB may not be the final word on the matter.
COT Report
Although EUR was standing in tight trading range this week, sentiment on the market has changed significantly and not in favor of the EUR, despite dovish statement from the Fed. Open interest has dropped for 18+K contracts, but net short position has increased for 11K contracts. Besides, hedgers have closed more than 30K contracts against EUR growth. With this baggage, it is difficult to count on positive price dynamic next week. Fed meeting could just release the growing pressure and let market move futher:
Source: cftc.gov
Charting by Investing.com
Next week to watch
Two weeks after unveiling its closely anticipated strategy review, the ECB will face questions at its Thursday meeting on what its new 2% inflation target might mean for policy.
If the ECB is serious about boosting inflation to 2% (versus close to but below 2% before), surely hefty bond buying will continue for some time? Doves are already arguing that to remain credible, the ECB needs to highlight its room for manoeuvre.
The hawks though are already pressing for tapering stimulus as the economy rebounds. Perhaps concern about a resurgent coronavirus hurting growth will allow ECB chief Christine Lagarde to find common ground at Thursday's meeting. A quiet summer may be around the corner for most, not the ECB.
So, we could say that everything goes in a row with our long term view. First is, we haven't expected any revelations from JP as it is make no sense to do with Fed meeting standing in a week and Jackson Hole meeting in August. And JP said nothing new in Congress. This has chilled out the hot heads a bit, who were screaming for faster Fed reaction on growing inflation.
Second thing that we were warned about - rising inflation, that is not "transitionary" on "temporal", although we agree that it could get some relief in summer months. All inflation indicators - CPI, PPI, PCE hit the records and Michigan surveys show the risk of inflation factors as the primary in recent polls. Fathom suggests the same thing that inflation accelerates further. And here are just two ways possible - either Central Banks across the board keep their targets constant and apply tougher control measures, i.e. faster and stronger interest rate tightening, or they set higher inflation targets. Economically it might be useful and put lighter negative effect on economy, eliminating shock of too high rates in too fast time period. But since it is too long road yet till this moment, at first steps we expect strong reaction and support to US Dollar. In July Fed meeting we do not expect any breakthrough in statement.
Still, combination of recent statistics, negative sentiment and maybe some minor surprises from Fed and ECB could release markets and let them to follow major tendency, which is bearish on EUR.
Technical analysis in the post below...
Despite that market has spent the week in relatively tight range - a lot of important events have happened, that could make impact later in time. First is, we've got strong CPI data, JP speech in Congress, some other data as US sentiment and consumer spending. All of them are important and made impact on sentiment as we will see below from COT report. Although this impact is not visible yet in price action. Pandemic theme stands a bit in the shadow, but nevertheless, this is important topic as delta variant spreads fast and makes hurts across the Globe. On a background of Fed meeting and ECB we expect strong action next week.
Market overview
The Delta variant of COVID-19 is now the dominant strain worldwide, accompanied by a surge of deaths around the United States almost entirely among unvaccinated people, U.S. officials said on Friday.
U.S. cases of COVID-19 are up 70% over the previous week and deaths are up 26%, with outbreaks occurring in parts of the country with low vaccination rates, U.S. Centers for Disease Control and Prevention Director Rochelle Walensky said during a press briefing. The seven-day-average number of daily cases is now more than 26,000, more than twice its June low of around 11,000 cases, according to CDC data.
"This is becoming a pandemic of the unvaccinated," Walensky said, adding that 97% of people entering hospitals in the United States with COVID-19 are unvaccinated.
She said an increasing number of counties around the United States now exhibit a high risk of COVID-19 transmission, reversing significant declines in transmission risk in recent months. Around 1 in five new cases have occurred in Florida, Zients said.
"We are dealing with a formidable variant" of COVID-19, U.S. infectious disease expert Anthony Fauci saidduring the call.
Cities from Seoul to Sydney are under lockdown as the infectious Delta variant sweeps the globe. Infection rates are rising in the United States, Singapore reported its sharpest jump in cases in 10 months on Thursday and Indonesia is living its government's worst-case COVID scenario.
Mixed economic data in China - showing a largely expected growth slowdown, but signs of more resilient domestic demand - also did little to improve the mood"Growth momentum, business confidence and investor sentiment can be further crippled if lockdowns and restrictions are prolonged," analysts at Maybank in Singapore said in a note.
"The market is still on an uncertain path," said National Australia Bank strategist Rodrigo Catril. "The big experiment is really the full reopening in the UK - if that could be successful, we think it's going to be a huge factor in terms of confidence and pricing a broader and sustained recovery of the global economy." That could lead to a softer dollar as economies from Japan to Europe catch up with the robust rebound in the U.S., he said.
England plans to lift almost all COVID-related restrictions on Monday, even as cases climb.
The U.S. dollar climbed to a 5-day high against a basket of currencies on Tuesday after data showed U.S. inflation data for June coming in hotter than expected, raising the prospect that inflationary concerns are set to linger. U.S. consumer prices rose by the most in 13 years in June amid supply constraints and a continued rebound in the costs of travel-related services from pandemic-depressed levels as the economic recovery gathered momentum.
The consumer price index increased 0.9% last month after advancing 0.6% in May, the Labor Department said on Tuesday. Year to year, the CPI jumped 5.4%, the largest gain since August 2008, following a 5.0% increase in the 12 months through May.
Excluding the volatile food and energy components, the CPI accelerated 0.9% after increasing 0.7% in May. Core CPI surged 4.5% on a year-on-year basis, the largest increase since November 1991, after rising 3.8% in May.
The possibility of U.S. stimulus withdrawal - brought to the fore by a surprise shift in tone last month from the Fed - has boosted the dollar in recent weeks despite a renewed rise in coronavirus cases in many parts of the world. U.S. consumer price inflation data is likely to help boost the dollar higher.
"It kind of reinforced the Fed taper story and the dollar has been consolidating for the front of the week, and I think this was the kick that it needed to renew its gains," said Kathy Lien, managing director at BK Asset Management in New York.
“That came in pretty hot and we saw short end rates jump pretty solidly here and the move was very positive for the dollar. This is really going to excite the hawks on the Fed and intensify the debate to taper sooner, and if these inflation pressures are still elevated by the time we’re at the end of the year, you’re going to see the market start to move forward interest rate hike expectations," said Edward Moya from Oanda, NY.
"Another hotter-than-expected U.S. CPI print has got the market wondering whether the lift in inflation will prove to be transitory or more enduring," Tapas Strickland, an analyst at National Australia Bank, wrote in a research note. Markets have sided on the hawkish interpretation, bringing forward rate hike expectations to late 2022," leading to "broad-based gains" for the dollar, the note said.
Federal Reserve Chair Jerome Powell on Wednesday pledged “powerful support” to complete the U.S. economic recovery from the coronavirus pandemic, but faced sharp questions from Republican lawmakers concerned about recent spikes in inflation. In testimony to the U.S. House of Representatives Financial Services Committee, Powell said he is confident recent price hikes are associated with the country’s post-pandemic reopening and will fade, and that the Fed should stay focused on getting as many people back to work as possible.
The U.S. job market “is still a ways off” from the progress the Federal Reserve wants to see before reducing its support for the economy, while current high inflation will ease “in coming months,” Fed Chair Jerome Powell said in remarks prepared for delivery at a congressional hearing on Wednesday.
“The testimony conveys a stay-the-course attitude. This is not very surprising because testimonies are rarely the preferred venues to convey policy shifts and because the FOMC hasn’t had a chance to discuss recent events, including yesterday’s CPI print. The press conference following the July meeting should be much more informative about the future course of Fed policy. “
The remarks pulled the dollar back from a three-month high against the euro and from a one-week high on the yen, though it soon found a footing in the Asia session as traders nervously awaited Chinese data to see whether it indicated a slowdown.
Powell returns to Capitol Hill later on Thursday for further testimony before Congress, following remarks that toppled the dollar from a three-month high on the euro on Wednesday. He had soothed rate hike fears by saying high inflation seemed linked to the U.S. economy's reopening, that it would be a mistake to act prematurely and that economic conditions for tapering bond buying was "still a ways off".
The subsequent support for the dollar, which still sits above its 20- and 200-day moving averages against a basket of six major currencies suggests investors were not entirely convinced. The dollar index was last steady at 92.434.
"Was anyone really expecting anything other than a dovish Powell," OCBC Bank analysts Terence Wu and Frances Cheung asked in a note. "No," they said. "He didn't provide new information in his comments, but gave the excuse to profit-take on the dollar ... we view the dip as part of the volatility and grind higher for the greenback."
Indeed the even sharp contrast in tone between Powell and other central banks that are charting far faster courses away from super-easy policy hasn't broken recent currency ranges. In New Zealand, for example, the central bank said on Wednesday it would end its bond purchase programme next week, but the resultant jump in the kiwi only took it to a one-week high.
"The market is still on an uncertain path," said National Australia Bank strategist Rodrigo Catril, with investors neither entirely convinced Powell can keep policy super easy nor sure about the trajectory of recovery as the coronavirus mutates. The dynamics of different currencies seem to be being overwhelmed by the dollar dynamic," he said, which is in turn being driven by data and by the spread of the delta variant. "The big experiment is really the full reopening in the UK," he added. "If that could be successful, we think it's going to be a huge factor in terms of confidence and pricing a broader and sustained recovery," which could weaken the dollar.
So far, even sharp contrasts in tone between Powell and other central banks that are charting faster courses away from super-easy policy have not kicked major currencies out of recent ranges against the greenback.
U.S. retail sales unexpectedly increased in June as demand for goods remained strong even as spending is shifting back to services, supporting expectations that economic growth accelerated in the second quarter.
Retail sales rose 0.6% last month. Data for May was revised down to show sales falling 1.7% instead of declining 1.3% as previously reported. Economists polled by Reuters had forecast retail sales dropping 0.4% in June. Sales advanced 18.0% compared to June last year and are now 18.0% above their pre-pandemic level. Retail sales mostly capture the goods component of consumer spending, with services such as healthcare, education, travel and hotel accommodation making up the remaining portion. Restaurants and bars are the only services category in the retail sales report.
Though worries about inflation hurt consumer sentiment this month, spending was likely to remain underpinned by record savings and rising wealth. The University of Michigan's consumer sentiment index fell to 80.8 early this month from 85.5 in June. The survey's inflation expectations over the next 12 months shot up to 4.8% from 4.2% in June.
The government reported this week that consumer prices increased by the most in 13 years in June, while producers prices accelerated.
"Consumers are flush with cash and their credit card utilization rates and debt burdens have dropped," said Scott Hoyt, senior economist at Moody's Analytics in West Chester, Pennsylvania. "Lack of available cash or credit to spend is as small a restraint on spending as it ever is. Combined with massive forced saving, wealth is likely higher than it would have been without the pandemic."
Households accumulated at least $2.5 trillion in excess savings during the pandemic. Starting this month through December some households will receive income under the expanded Child Tax Credit program, which should help middle- and lower-income households to maintain spending.
Despite the downward revision to May core retail sales, economists remained steadfast in their belief that consumer spending, which accounts for more than two-thirds of U.S. economic activity, logged double-digit growth in the second quarter. Consumer spending grew at an 11.4% annualized rate in the first quarter.
Gross domestic product growth estimates for this quarter are around a 9% rate, which would be an acceleration from the 6.4% pace notched in the first quarter. Economists believe the economy could achieve growth of at least 7% this year. That would be the fastest growth since 1984. The economy contracted 3.5% in 2020, its worst performance in 74 years.
U.S. Treasury yields pared most of Friday's gains as doubts about the economic recovery's strength and dovish Federal Reserve policy were seen as likely to cap yields in the near-term, even after U.S. retail sales unexpectedly rose in June. Demand for goods remained strong even as spending shifts back to services, bolstering expectations that economic growth accelerated in the second quarter.
Retail sales rebounded 0.6% last month, the Commerce Department said on Friday. May's sales decline was revised to 1.7% from the previously reported 1.3%. Yields have dropped since Federal Reserve Chair Jerome Powell on Wednesday and Thursday pledged "powerful support" to complete the U.S. economic recovery, and indicated he saw no need to rush withdrawing economic support because of a recent jump in inflation.
The data was "a little better," said Justin Lederer, an interest rate strategist at Cantor Fitzgerald in New York. However, yields are holding near last week's lows and "we're sort of just sitting nowhere now." "I think most people expected higher yields at this point, just given the economy's reopening ... but Powell's fairly dovish, so it's really hard to. It doesn't feel like it's ready to really go back to the year-to-date high yields," Lederer said.
Some analysts say long-dated yields may be too low relative to expected growth.
"The current level of Treasury yields imply a relatively pessimistic growth outlook: the current level of yields would be justified if we lowered our growth forecasts by nearly 3 percentage points, implying just 0.5% real growth over the next year," JPMorgan analysts said in a report late on Thursday. We think these concerns are overstated, but other recent episodes indicate this gap is unlikely to close quickly."
The U.S. Treasury Department on Friday asked its primary bond dealers for their outlook on issuance sizes across the yield curve and when reductions should be considered by the government. The dealer questionnaire, released on Friday, starts the process for the Treasury's next quarterly debt refunding announcement in August.
U.S. consumer sentiment fell sharply and unexpectedly in early July to the lowest level in five months as inflation worries dented confidence in the economic recovery, a survey showed on Friday.
The University of Michigan said its preliminary consumer sentiment index fell to 80.8 in the first half of this month - the lowest since February - from a final reading of 85.5 in June. Economists polled by Reuters had forecast the index would rise to 86.5.
“Consumers’ complaints about rising prices on homes, vehicles, and household durables has reached an all-time record,” Richard Curtin, the survey director, said in a statement.
Supply constraints nationwide have led to a surge in consumer prices, as they increased by the most in 13 years in June.
The survey’s gauge of current economic conditions also fell to a reading of 84.5, the lowest since August 2020, from 88.6 in June. Its measure of consumer expectations slid to 78.4, the lowest since February, from 83.5.
The survey’s one-year inflation expectation shot to the highest level since August 2008 at 4.8%, up from 4.2%, while its five-year inflation outlook ticked up to 2.9% from 2.8% in June.
“Inflation has put added pressure on living standards, especially on lower and middle income households, and caused postponement of large discretionary purchases, especially among upper income households,” Curtin said.
Fathom expects to see a period of very strong economic growth through this year, as a portion of the pandemic savings — worth close to 10% of GDP in several major economies — is spent. Survey evidence from the US and UK central banks suggests around a quarter of excess savings will be spent. In our judgment this will, in turn, produce a sustained period of above-target inflation. The flipside of high pandemic savings in the major economies is rapid growth in the broad money aggregates. The chart below shows that, after adjusting for inflation, US real broad money balances increased by more than 20% last year. Over the past 150 years real broad money growth has been more rapid on just one occasion, and that was in the aftermath of World War II.
It is becoming increasingly apparent that the pick-up in inflation, particularly in the US, is cyclical. It is not just a consequence of base effects. Traditionally, any cyclical pick-up in inflation has required a monetary policy response. But that is not the intention of policymakers at present. The FOMC continues to believe that the pick-up will be transitory. We have our doubts. Inflation overshoots driven by a spike in the oil price, by a change in tax rates, or by a depreciation of the currency, tend ultimately to subtract from household real incomes. In that sense, they can be self-limiting, and deflationary in the long run, and it is often appropriate for policymakers to look through them. But that is not what we are seeing here. Only in the unlikely event that higher product prices do not feed through at all to higher wages, which would require a very strong degree of faith in policymakers’ ability to rapidly bring inflation back to target, would a cyclical pick-up in inflation be self limiting.
If we are right, and households try to make up for lost time in their spending rather than smooth their pandemic savings over the remainder of their lifetimes, causing a material, cyclical increase in inflation that does not go away of its own accord, how will policymakers respond? They are likely to be faced with a choice of either ‘dealing with it’, and tightening policy sooner than many imagine, triggering a recession; or ‘rolling with it’, and moving to a higher inflation target. We believe the latter would be a better response.
Since its inception, the European Central Bank (ECB) had appeared more concerned by inflation overshoots than undershoots, defining price stability in 1998 as “a year-on-year increase in the Harmonised Index of Consumer Prices (HICP)…of below 2%”, before modifying that only slightly in 2003 to an inflation rate that is “below, but close to, 2%”. All that changed last week when the ECB joined both the US Federal Reserve and the Bank of England in adopting a symmetric inflation target of 2%. More importantly, perhaps, the ECB acknowledged that it would tolerate a transition period in which inflation was moderately above target.
The single currency bloc has experienced several periods of outright deflation since the Global Financial Crisis. In the ten years up to June 2021, the targeted measure averaged just over 1%, as our chart shows. With policymakers struggling to reach even the old target, is now really the time to target higher inflation? In Fathom’s view, yes. Euro area inflation is running at 2.0%, on the latest figures, and is set to rise further as economies reopen, and pandemic savings are spent. In the coming months, inflation is likely to move materially higher across the major economies. Rather than tighten aggressively, risking a correction in bond and equity markets, we argued that policymakers should move the goalposts, and opportunistically raise their inflation targets above 2%. Last week’s modest relaxation from the ECB may not be the final word on the matter.
COT Report
Although EUR was standing in tight trading range this week, sentiment on the market has changed significantly and not in favor of the EUR, despite dovish statement from the Fed. Open interest has dropped for 18+K contracts, but net short position has increased for 11K contracts. Besides, hedgers have closed more than 30K contracts against EUR growth. With this baggage, it is difficult to count on positive price dynamic next week. Fed meeting could just release the growing pressure and let market move futher:
Source: cftc.gov
Charting by Investing.com
Next week to watch
Two weeks after unveiling its closely anticipated strategy review, the ECB will face questions at its Thursday meeting on what its new 2% inflation target might mean for policy.
If the ECB is serious about boosting inflation to 2% (versus close to but below 2% before), surely hefty bond buying will continue for some time? Doves are already arguing that to remain credible, the ECB needs to highlight its room for manoeuvre.
The hawks though are already pressing for tapering stimulus as the economy rebounds. Perhaps concern about a resurgent coronavirus hurting growth will allow ECB chief Christine Lagarde to find common ground at Thursday's meeting. A quiet summer may be around the corner for most, not the ECB.
So, we could say that everything goes in a row with our long term view. First is, we haven't expected any revelations from JP as it is make no sense to do with Fed meeting standing in a week and Jackson Hole meeting in August. And JP said nothing new in Congress. This has chilled out the hot heads a bit, who were screaming for faster Fed reaction on growing inflation.
Second thing that we were warned about - rising inflation, that is not "transitionary" on "temporal", although we agree that it could get some relief in summer months. All inflation indicators - CPI, PPI, PCE hit the records and Michigan surveys show the risk of inflation factors as the primary in recent polls. Fathom suggests the same thing that inflation accelerates further. And here are just two ways possible - either Central Banks across the board keep their targets constant and apply tougher control measures, i.e. faster and stronger interest rate tightening, or they set higher inflation targets. Economically it might be useful and put lighter negative effect on economy, eliminating shock of too high rates in too fast time period. But since it is too long road yet till this moment, at first steps we expect strong reaction and support to US Dollar. In July Fed meeting we do not expect any breakthrough in statement.
Still, combination of recent statistics, negative sentiment and maybe some minor surprises from Fed and ECB could release markets and let them to follow major tendency, which is bearish on EUR.
Technical analysis in the post below...