Sive Morten
Special Consultant to the FPA
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Fundamentals
This week, investors' minds were mostly twisted around Fed minutes and different comments from Fed representatives, concerning further steps on inflation control. Still, as we've mentioned last week and actually through the whole previous month, some "not very popular" statistics, such as mortgage rates, real estate market, loans market start showing some problems. Since now we get March data, that already includes consequences of sanctions as in the US as in EU, we could say that economical situation is deteriorating fast, especially in EU. This makes us think that EU politicians pay low attention to economy situation, trying to distance from these problems, which, might lead to catastrophe. All in all, we could say that global economy will change drastically by the end of this year.
Market overview
The U.S. dollar index on Friday posted its largest weekly percentage gain in a month, supported by the prospect of a more aggressive pace of Federal Reserve tightening to curb soaring inflation. The greenback gained ground against a basket of six currencies over the past month, particularly versus the euro, which has been pressured by investor concerns about the economic costs of war in Ukraine and a potentially nail-biting presidential election in France.
A tightening election race in France between President Emmanuel Macron and far-right candidate Le Pen has added pressure on the euro, raising investor concerns about the future direction of the euro zone's second-biggest economy. Macron is still ahead in polls. French presidential election risk was also evident in bond markets as French borrowing costs rose while yields of other core European government bonds fell.
This week's release of the minutes of the Fed's March meeting showed "many" participants were prepared to raise rates in 50-basis-point increments in coming months. On the other side of the dollar's rally, the euro dropped to a one-month low of $1.0837. The euro has fallen in seven straight sessions. Meeting minutes from the European Central Bank published on Thursday suggested its policymakers are keen to act to combat inflation, but the euro zone has so far taken a more cautious tack than other central banks, weakening the euro.
In Treasuries, the 10-year yield hit 2.73%, its highest since March 2019, and the yield on 10-year inflation-protected securities went within 15 basis points of turning positive for the first time in over two years. With a half-point interest rate rise mostly baked in for May, the debate has moved on to whether the Fed could kick off balance sheet reduction next month as well.
On Tuesday two normally dovish Fed officials, governor Lael Brainard and San Francisco Fed chief Mary Daly, precipitated a fresh Treasury selloff with suggestions the run-off might commence next month -- alongside a rate hike. Ten-year Treasury yields have jumped to the highest in three years, up some 20 basis points since Friday. And with the Fed apparently poised to become even more aggressive on inflation, the 2-year/10-year Treasury curve has normalised, having been inverted for around a week.
Federal Reserve officials in March "generally agreed" to cut up to $95 billion a month from the central bank's asset holdings as another tool in the fight against surging inflation, even as the war in Ukraine tempered the first U.S. interest rate increase.
Minutes of the Fed's March 15-16 meeting showed deepening concern among policymakers that inflation had broadened through the economy, which convinced them to not only raise the target policy rate by a quarter of a percentage point from its near-zero level but also to "expeditiously" push it to a "neutral posture," estimated to be around 2.4%.
But they also moved forward with plans to pull out of key financial markets that have been benefiting from massive Fed support since March of 2020, when the coronavirus pandemic prompted the central bank to buy trillions of dollars in Treasury bonds and mortgage-backed securities (MBS). After months of debate, policymakers rallied around a plan to as soon as next month reduce the Fed's holdings of Treasury bonds by up to $60 billion per month and its MBS holdings by up to $35 billion per month, with the amounts phased in over three months or slightly longer, the minutes said.
The pace of the planned balance-sheet rundown, which should have the effect of increasing long-term interest rates, is nearly double that of the Fed's "quantitative tightening" from 2017 to 2019, and could also include outright sales of MBS down the road, said the minutes.
By Bloomberg calculation and MXFond report, rising of the Fed rate could cost $5200 per year to every household in the US. As its amount stands around 110 mln, the total expenses could rise for $57.2 Bln, that never intends to compensate with closing CV19 supportive programs. Whether Fed intends to cut households' consumption power and their wealth in electing year we should treat as rhetoric question.
Last week we already mentioned that with recent mortgage rate jump, the debt service burden reaches as much as 20% of households' expenses, on average. As a result, you could see clear downside trend in mortgage applications for the few months in a row:
With the strong increasing of mortgage rate:
As a result, more and more households starts feeling lack of short-term liquidity and turning to consumer loans, which shows big growth in recent month:
Consumer credit m/m change
By our view, Fed were waiting for too long with starting tightening policy. Now, we the piking inflation, with rate increase they contract ability of households to refinance existed loans, make them expensive and hurt consumption power of population. As a result, last week we've mentioned student loans, that could start meeting problems with payouts.
The Biden administration is expected to announce on Wednesday an extension of the student loan repayment pause through Aug. 31, an administration official familiar with White House's decision making said on Tuesday. The repayment moratorium has been extended multiple times since it was first put in place in March 2020 due to the COVID-19 pandemic. The current pause was set to expire on May 1. Nearly 41 million borrowers have benefited from a freeze on interest accruals and about 27 million borrowers have not had to pay their monthly bills since the forbearance began.
Rising interest rates on home mortgages, bonds and other longer-term debt are already accounting for the Fed getting rid of perhaps $80 billion to $100 billion of assets per month, economists say, so the immediate market response may be muted. But the plan will send a powerful signal of officials' intent to make credit steadily more expensive and, by doing so, help lower inflation currently running at more than triple the Fed's 2% target.
As the Fed begins its withdrawal, economists expect it may end up targeting a balance sheet level equivalent to perhaps 20% of GDP, or around $6 trillion depending on how fast the economy grows and, perhaps more importantly, what level of reserves commercial banks require.
Not only FPA sees structural problems in economy of the US and EU. The Bank of America tells that the macro-economic picture is deteriorating fast and could push the U.S. economy into recession as the Federal Reserve tightens its monetary policy to tame surging inflation, BofA strategists warned in a weekly research note. "'Inflation shock' worsening, 'rates shock' just beginning, 'recession shock' coming", BofA chief investment strategist Michael Hartnett wrote in a note to clients, adding that in this context, cash, volatility, commodities and crypto currencies could outperform bonds and stocks.
Thus, Fathom consulting tells:
The decline in the G7 economies’ share of world GDP and trade is unlikely to reverse anytime soon. The group faces structural headwinds that are likely to keep growth rates lower than the global average. All have high levels of debt, which Fathom Consulting has previously found works to reduce structural growth rates. An injection of credit can be used to buy additional growth in the short term, but it is not sustainable; and the more an economy relies on credit, the smaller the bang it gets for its buck. High debt levels are made worse by deteriorating demographics, which reduce structural growth rates due to the lower availability of labour.
Price pressures are greatest in the US but are higher across the board, as economies adjust to very strong demand against a backdrop of pandemic-related distortions in supply and high commodities prices. There remains a large degree of uncertainty about how long this cyclical bout of inflation will last — this will depend to a large degree on how well central banks are able to maintain well-anchored inflation expectations. Nonetheless, there remains a risk that central banks —and in particular, the Federal Reserve — will increase their policy rates to levels over and above what is currently priced in by financial markets.
While the outlook for short-term interest rates remains highly uncertain, there is more reason to believe that long-term interest rates will remain historically low. These tend to reflect slower-moving factors such as potential growth rates and levels of debt within an economy. Since these only adjust gradually over time, it is likely that the low level of long-term interest rates that prevailed pre-pandemic has not been significantly shifted by what has been an unusual economic cycle. Investors are pricing such an outcome, with G7 yield curves pointing to long-term interest rates in the range 0.5% to 2.5%
Although this is Fathom opinion, we are not sure with this outcome as current situation is absolutely unique and the way how it will develop could be out of historical patterns. Not all big market participants see recession signs. For example, a U.S. recession is not imminent despite the inversion of a part of the U.S. Treasury yield curve which has been "artificially pressured" by some investors, BlackRock Inc, the world's largest asset manager, said in a note on Friday.
BlackRock's Chaudhuri said more hawkish signals by the central bank - increasingly determined to tighten financial conditions through rate hikes and balance-sheet reduction to fight inflation - have contributed to the curve steepening.
In the Europe, that carry the whole burden of sanctions, economy is preparing to nosedive.
The same story about the food pricing:
The U.S. dollar will remain dominant for now so long as the Federal Reserve stays a hawkish course on interest rate hikes and its intentions to unload some of its pandemic-related bond purchases, according to a Reuters poll of forex strategists. More than two-thirds of analysts who answered a separate question, 37 of 53, said the strong dollar trade would last for at least another three months, including 17 who said more than six months.
Thirteen respondents said under three months and the remaining three said the trade is already over.
CFTC Data
Speculators' net long positioning on the U.S. dollar fell in the latest week, according to calculations by Reuters and U.S. Commodity Futures Trading Commission data released on Friday. The value of the net long dollar position slid to $14.13 billion for the week ended April 5, from $16.11 billion the previous week. U.S. dollar net long positioning declined for the first time in five weeks.
So far this year, the dollar index, a measure of the greenback's value against six major currencies, has gained 4.4%, after a 6.3% gain in 2021. The greenback has benefited all year from safe-haven flows during the war in Ukraine, as well as expectations of aggressive Federal Reserve tightening to control the surge in inflation.
U.S. rate futures have priced in an 85% chance of a 50 basis point hike at the May meeting, with roughly 220 basis points of cumulative hikes for 2022.
It was also an eight week of outflows for European equities at $1.6 billion while U.S. stocks enjoyed their second week of inflows, adding $1.5 billion in the week to Wednesday.There is no big shift in net position on EUR this week, as both bulls and bears were opening new positions, that just led to increasing of open interest for 14K contracts.
This week, investors' minds were mostly twisted around Fed minutes and different comments from Fed representatives, concerning further steps on inflation control. Still, as we've mentioned last week and actually through the whole previous month, some "not very popular" statistics, such as mortgage rates, real estate market, loans market start showing some problems. Since now we get March data, that already includes consequences of sanctions as in the US as in EU, we could say that economical situation is deteriorating fast, especially in EU. This makes us think that EU politicians pay low attention to economy situation, trying to distance from these problems, which, might lead to catastrophe. All in all, we could say that global economy will change drastically by the end of this year.
Market overview
The U.S. dollar index on Friday posted its largest weekly percentage gain in a month, supported by the prospect of a more aggressive pace of Federal Reserve tightening to curb soaring inflation. The greenback gained ground against a basket of six currencies over the past month, particularly versus the euro, which has been pressured by investor concerns about the economic costs of war in Ukraine and a potentially nail-biting presidential election in France.
A tightening election race in France between President Emmanuel Macron and far-right candidate Le Pen has added pressure on the euro, raising investor concerns about the future direction of the euro zone's second-biggest economy. Macron is still ahead in polls. French presidential election risk was also evident in bond markets as French borrowing costs rose while yields of other core European government bonds fell.
Jonas Goltermann, senior markets economist at Capital Economics, said that "the Fed's hawkish message on quantitative tightening, renewed sanction risks in Europe and the polling shift in favor of far-right candidate Marine Le Pen ahead of France's presidential election has put pressure on risk sentiment, especially in Europe."
This week's release of the minutes of the Fed's March meeting showed "many" participants were prepared to raise rates in 50-basis-point increments in coming months. On the other side of the dollar's rally, the euro dropped to a one-month low of $1.0837. The euro has fallen in seven straight sessions. Meeting minutes from the European Central Bank published on Thursday suggested its policymakers are keen to act to combat inflation, but the euro zone has so far taken a more cautious tack than other central banks, weakening the euro.
"ECB minutes presented little in contrast to recent comments by policymakers, though the sense is that the bank is merely awaiting data over the coming months showing the impact of higher energy prices and the war in Ukraine to decide when to hike first - whether it's in Q3 or Q4," wrote Shaun Osborne, chief FX strategist, at Scotiabank in Toronto, in a research note. "In either scenario, we don't anticipate more than 50 basis points in tightening from the ECB this year, which is only as much as the Fed is set to roll out in one meeting, next month."
In Treasuries, the 10-year yield hit 2.73%, its highest since March 2019, and the yield on 10-year inflation-protected securities went within 15 basis points of turning positive for the first time in over two years. With a half-point interest rate rise mostly baked in for May, the debate has moved on to whether the Fed could kick off balance sheet reduction next month as well.
On Tuesday two normally dovish Fed officials, governor Lael Brainard and San Francisco Fed chief Mary Daly, precipitated a fresh Treasury selloff with suggestions the run-off might commence next month -- alongside a rate hike. Ten-year Treasury yields have jumped to the highest in three years, up some 20 basis points since Friday. And with the Fed apparently poised to become even more aggressive on inflation, the 2-year/10-year Treasury curve has normalised, having been inverted for around a week.
Federal Reserve officials in March "generally agreed" to cut up to $95 billion a month from the central bank's asset holdings as another tool in the fight against surging inflation, even as the war in Ukraine tempered the first U.S. interest rate increase.
Minutes of the Fed's March 15-16 meeting showed deepening concern among policymakers that inflation had broadened through the economy, which convinced them to not only raise the target policy rate by a quarter of a percentage point from its near-zero level but also to "expeditiously" push it to a "neutral posture," estimated to be around 2.4%.
But they also moved forward with plans to pull out of key financial markets that have been benefiting from massive Fed support since March of 2020, when the coronavirus pandemic prompted the central bank to buy trillions of dollars in Treasury bonds and mortgage-backed securities (MBS). After months of debate, policymakers rallied around a plan to as soon as next month reduce the Fed's holdings of Treasury bonds by up to $60 billion per month and its MBS holdings by up to $35 billion per month, with the amounts phased in over three months or slightly longer, the minutes said.
The pace of the planned balance-sheet rundown, which should have the effect of increasing long-term interest rates, is nearly double that of the Fed's "quantitative tightening" from 2017 to 2019, and could also include outright sales of MBS down the road, said the minutes.
By Bloomberg calculation and MXFond report, rising of the Fed rate could cost $5200 per year to every household in the US. As its amount stands around 110 mln, the total expenses could rise for $57.2 Bln, that never intends to compensate with closing CV19 supportive programs. Whether Fed intends to cut households' consumption power and their wealth in electing year we should treat as rhetoric question.
Last week we already mentioned that with recent mortgage rate jump, the debt service burden reaches as much as 20% of households' expenses, on average. As a result, you could see clear downside trend in mortgage applications for the few months in a row:
With the strong increasing of mortgage rate:
As a result, more and more households starts feeling lack of short-term liquidity and turning to consumer loans, which shows big growth in recent month:
Consumer credit m/m change
By our view, Fed were waiting for too long with starting tightening policy. Now, we the piking inflation, with rate increase they contract ability of households to refinance existed loans, make them expensive and hurt consumption power of population. As a result, last week we've mentioned student loans, that could start meeting problems with payouts.
The Biden administration is expected to announce on Wednesday an extension of the student loan repayment pause through Aug. 31, an administration official familiar with White House's decision making said on Tuesday. The repayment moratorium has been extended multiple times since it was first put in place in March 2020 due to the COVID-19 pandemic. The current pause was set to expire on May 1. Nearly 41 million borrowers have benefited from a freeze on interest accruals and about 27 million borrowers have not had to pay their monthly bills since the forbearance began.
Rising interest rates on home mortgages, bonds and other longer-term debt are already accounting for the Fed getting rid of perhaps $80 billion to $100 billion of assets per month, economists say, so the immediate market response may be muted. But the plan will send a powerful signal of officials' intent to make credit steadily more expensive and, by doing so, help lower inflation currently running at more than triple the Fed's 2% target.
The Fed "will continue tightening monetary policy methodically through a series of interest rate increases and by starting to reduce the balance sheet at a rapid pace as soon as our May meeting," Fed Governor and Vice-Chair nominee Lael Brainard said on Tuesday. Referring to the 2017-2019 period when the Fed took a year to reach a pace of $50 billion in monthly reductions of its holdings, Brainard said "I expect the balance sheet to shrink considerably more rapidly" this time
As the Fed begins its withdrawal, economists expect it may end up targeting a balance sheet level equivalent to perhaps 20% of GDP, or around $6 trillion depending on how fast the economy grows and, perhaps more importantly, what level of reserves commercial banks require.
"They want this to operate in the background so they will be very careful about the language they use," said Andrew Patterson, senior international economist for Vanguard. Patterson said he thought the Fed would aim to reduce the balance sheet to around "20ish" percent of GDP, but may take four or five years to get there, a slightly slower pace than Powell flagged to Congress.
Not only FPA sees structural problems in economy of the US and EU. The Bank of America tells that the macro-economic picture is deteriorating fast and could push the U.S. economy into recession as the Federal Reserve tightens its monetary policy to tame surging inflation, BofA strategists warned in a weekly research note. "'Inflation shock' worsening, 'rates shock' just beginning, 'recession shock' coming", BofA chief investment strategist Michael Hartnett wrote in a note to clients, adding that in this context, cash, volatility, commodities and crypto currencies could outperform bonds and stocks.
Thus, Fathom consulting tells:
The decline in the G7 economies’ share of world GDP and trade is unlikely to reverse anytime soon. The group faces structural headwinds that are likely to keep growth rates lower than the global average. All have high levels of debt, which Fathom Consulting has previously found works to reduce structural growth rates. An injection of credit can be used to buy additional growth in the short term, but it is not sustainable; and the more an economy relies on credit, the smaller the bang it gets for its buck. High debt levels are made worse by deteriorating demographics, which reduce structural growth rates due to the lower availability of labour.
Price pressures are greatest in the US but are higher across the board, as economies adjust to very strong demand against a backdrop of pandemic-related distortions in supply and high commodities prices. There remains a large degree of uncertainty about how long this cyclical bout of inflation will last — this will depend to a large degree on how well central banks are able to maintain well-anchored inflation expectations. Nonetheless, there remains a risk that central banks —and in particular, the Federal Reserve — will increase their policy rates to levels over and above what is currently priced in by financial markets.
While the outlook for short-term interest rates remains highly uncertain, there is more reason to believe that long-term interest rates will remain historically low. These tend to reflect slower-moving factors such as potential growth rates and levels of debt within an economy. Since these only adjust gradually over time, it is likely that the low level of long-term interest rates that prevailed pre-pandemic has not been significantly shifted by what has been an unusual economic cycle. Investors are pricing such an outcome, with G7 yield curves pointing to long-term interest rates in the range 0.5% to 2.5%
Although this is Fathom opinion, we are not sure with this outcome as current situation is absolutely unique and the way how it will develop could be out of historical patterns. Not all big market participants see recession signs. For example, a U.S. recession is not imminent despite the inversion of a part of the U.S. Treasury yield curve which has been "artificially pressured" by some investors, BlackRock Inc, the world's largest asset manager, said in a note on Friday.
We do not see a recession occurring in the near-term,” said Gargi Chaudhuri, head of iShares Investment Strategy, Americas, at BlackRock. “While we are hesitant to say that this time is different, we note that many factors now differ from previous yield curve inversions,” she wrote. Longer-dated yields had been pushed artificially low by investors such as pension funds with improved funding status, contributing to the curve inversion, she said.
BlackRock's Chaudhuri said more hawkish signals by the central bank - increasingly determined to tighten financial conditions through rate hikes and balance-sheet reduction to fight inflation - have contributed to the curve steepening.
"We still see room for longer end interest rates to move modestly higher from here", she said.
In the Europe, that carry the whole burden of sanctions, economy is preparing to nosedive.
The same story about the food pricing:
The U.S. dollar will remain dominant for now so long as the Federal Reserve stays a hawkish course on interest rate hikes and its intentions to unload some of its pandemic-related bond purchases, according to a Reuters poll of forex strategists. More than two-thirds of analysts who answered a separate question, 37 of 53, said the strong dollar trade would last for at least another three months, including 17 who said more than six months.
Thirteen respondents said under three months and the remaining three said the trade is already over.
"We've got some aggressive tightening coming up this year from the Fed. We think the fed funds rate will probably hit 3% in the first quarter of next year, but (they could) even be cutting rates by the final quarter of 2023," said Chris Turner, global head of markets research at ING. "I think the dollar could hold onto its gains for a lot of 2022...(and) we shouldn't be starting to look for weakening in the dollar until perhaps, next spring-summer 2023."
CFTC Data
Speculators' net long positioning on the U.S. dollar fell in the latest week, according to calculations by Reuters and U.S. Commodity Futures Trading Commission data released on Friday. The value of the net long dollar position slid to $14.13 billion for the week ended April 5, from $16.11 billion the previous week. U.S. dollar net long positioning declined for the first time in five weeks.
So far this year, the dollar index, a measure of the greenback's value against six major currencies, has gained 4.4%, after a 6.3% gain in 2021. The greenback has benefited all year from safe-haven flows during the war in Ukraine, as well as expectations of aggressive Federal Reserve tightening to control the surge in inflation.
U.S. rate futures have priced in an 85% chance of a 50 basis point hike at the May meeting, with roughly 220 basis points of cumulative hikes for 2022.
It was also an eight week of outflows for European equities at $1.6 billion while U.S. stocks enjoyed their second week of inflows, adding $1.5 billion in the week to Wednesday.There is no big shift in net position on EUR this week, as both bulls and bears were opening new positions, that just led to increasing of open interest for 14K contracts.