Sive Morten
Special Consultant to the FPA
- Messages
- 22,083
FUNDAMENTALS
A contradictive week has come to an end. I call it "contradictive" because a few issues, that mostly passed unsigned have happened. The Fed meeting was mostly about nothing, but the consequences were interesting. Once the rate has been held untouched - long-term yields have jumped immediately. And in general the US dollar has shown very poor performance this week. Why? Because bond holders demand more prize from the US Treasury to compensate inflation and credit risks if the Fed doesn't want to do this. Second - BoJ and US Treasury have taken united intervention. This is important signal. In fact, this means that S. Bessent directly provides liquidity to intervene avoiding sell-off in the Japanese foreign reserves, i.e. US Treasuries. It is done to avoid extra pressure on the US yields. Thus, drop of the dollar and raising of the US yields with external financing of BoJ intervention shows big change in investors' mind. Now the raising of the US yields is not necessary the attractive factor, supporting dollar demand. This might be the first step in a big changes in the Fed (and other central banks) policy.
MARKET OVERVIEW
The dollar fell against the Japanese yen on Friday, with traders braced for a second round of intervention after Japanese authorities stepped in to prop up their currency a day earlier. The U.S. Treasury has informed a number of banks that it may intervene in the yen market on Friday and that they should "stand ready for future action," a source familiar with the matter told Reuters. Japan was also receiving support from the U.S. that "goes beyond psychological support", Japan's top foreign exchange diplomat said on Friday.
The U.S. Treasury bought yen on Friday to support the battered Japanese currency, the Financial Times reported, marking Washington's first yen-buying intervention with Tokyo in more than a decade as it languishes near 40-year lows.
The dollar was also weaker across the board after data showed U.S. inflation slowed in June, a day after the Federal Reserve left interest rates unchanged, dashing hopes for a rate hike. Data on Thursday showed the Personal Consumption Expenditures Price Index increased 3.7% in the 12 months through June after advancing by an unrevised 4.1% in May, which was the largest gain since April 2023, the Commerce Department's Bureau of Economic Analysis said. U.S. economic growth slowed in the second quarter amid a widening in the trade deficit. Gross domestic product increased at a 1.5% annualized rate last quarter.
A divided Fed left interest rates unchanged. Fed Chair Kevin Warsh pledged an unwavering commitment to bring inflation down, a message that left markets confused about just what he was prepared to do in coming months. Three of the 12 members of the policy-setting Federal Open Market Committee dissented from the move that left the benchmark interest rate in the 3.50%-3.75% range in favor of a quarter-percentage-point hike. Traders are betting a 67% chance on a 25-basis-point rate hike in September, according to CME Group's FedWatch tool.
Fed policymakers are embracing the idea that current borrowing costs are creating enough friction in the economy to reduce any inflation that isn't, like the effect of tariffs on goods prices, expected to fade on its own. Referring to the three dissenting votes favoring rate hikes versus the Federal Open Market Committee decision to hold the federal funds rate steady, Warsh said at a press conference that
Eric Theoret, FX strategist at Scotiabank, said it was unclear if Friday's modest rise in the yen was a result of actual intervention, or traders reacting to the possibility of one in the near future.
Strategists at Goldman Sachs said they see intervention as an effective tool for authorities to buy some time before fundamental factors turn more positive.
Thursday's moves resulted in spot yen trading volumes surging to their highest in 10 years on the EBS trading platform and futures trading volumes hitting their highest on record, the CME Group said. In a rare coordinated move, South Korea also conducted dollar-selling intervention on Thursday to support its currency, a market source told Reuters.
Global markets have been volatile this month as investors question the sustainability of the AI spending boom amid signs that major U.S. companies are deepening a web of AI-linked investments and continuing to funnel billions into the technology at the expense of free cash flow.
A selloff in U.S. Treasuries this week signaled the need for the Federal Reserve to earn its inflation-fighting "credibility" with interest rate increases, St. Louis Fed President Alberto Musalem told the Financial Times. He had "expressed a preference" towards a quarter-percentage-point interest rate increase at this week's policy meeting.
Meantime, U.S. Federal Reserve Chairman Kevin Warsh at this week's interest-rate-setting meeting raised the idea of reducing the number of the Fed's regularly scheduled meetings where it sets monetary policy, the New York Times reported on Friday. The Fed has held eight scheduled meetings a year since 1981, a cadence established under former Chair Paul Volcker. It would significantly cut back on the information Wall Street and the wider public would receive about the direction of interest rate policy and the Fed's interpretation of the state of inflation and the job market.
Finally, the return of money supply measurements to Federal Reserve thinking may help officials better identify longer-term inflation trends but will likely remain a peripheral factor for monetary policy deliberations, Fed watchers say. Warsh tucked a short section on money supply into the Fed's latest Monetary Policy Report earlier this month, the first formal nod to it in a decade.
After briefly contracting in the face of Fed rate hikes, M2's annual growth is back to a four-year high, though at 5.6%. Meanwhile, the Fed's inflation measure was 4.1% in its most recent reading for May, more than twice its target.
Economists and some former central bankers agree turning an eye toward M2 might help with longer-run inflation trend spotting at a time when the Fed has been wrestling with five years of inflation above its 2% target.
But Bill Nelson, chief economist with lobbying group the Bank Policy Institute and also a former Fed staffer, as some others warned against connecting money supply to the Fed’s still large holdings of bonds.
Next week markets get a fresh read on the U.S. economy on Friday when closely watched non-farm payrolls data are released. Economists polled by Reuters expect the July report to show payrolls increased by 91,000 jobs and the unemployment rate held at 4.3%.
COMMENTS
Well, it's finally happened. Even the Federal Reserve is starting to realize that the key interest rate isn't a magic switch that can be flipped to lower prices, increase production, and maybe even make it rain. After years of focusing on interest rates, unemployment, and inflation expectations, the central bank has brought back monetary aggregate M2 to the main report. For now, it's being used cautiously, as just one piece of the puzzle. But perhaps, with a little more attention, it will become clear that it's not a bad idea to sometimes look at the money supply in monetary policy.
The next level of complexity is to understand that, during a structural crisis of rising costs, M2 will increase almost regardless. And if you don't let it grow, real output will begin to shrink. When raw materials, logistics, equipment, labor, taxes, and debt servicing become more expensive, businesses need more working capital just to produce the same amount of goods. The money is no longer needed for rapid economic growth, but to finance the preservation of yesterday's physical output.
Raising interest rates can slow down credit, investment, demand, and the entire economy. But you can't force imported equipment, logistics, or scarce labor to become cheaper. Moreover, high interest rates add another cost to existing expenses: expensive credit. It's a very clever way to put out a fire – first, raise the price of water.
But why complicate things? If inflation doesn't decrease with a high interest rate, you can always raise the rate even higher. And if, after that, the economy stops growing, then monetary policy is working. Just not in the direction that this economy needs to go.
In the United States, 372 large companies filed for bankruptcy in the first 6 months of 2026, making it the highest number for the first half of the year in 16 years. By industry, industrial companies are leading, with 50 companies having gone bankrupt since the beginning of the year. They are followed by companies in the consumer discretionary sector – 35 bankruptcies, and companies in the healthcare sector – 26 bankruptcies.
Meantime, Foreign central banks are continuing to divest themselves of U.S. government bonds, and this trend is now systemic. Recent data from the Federal Reserve shows that the volume of Treasury securities held by foreign central banks has reached multi-year lows. The main trigger for this process has been the prolonged energy crisis and consistently high oil prices.
In the face of expensive raw materials, developing countries are facing pressure on their national currencies and enormous import costs. To prevent their financial systems from collapsing, central banks are forced to spend their reserves, i.e., directly sell U.S. bonds in order to obtain liquid U.S. dollars for currency interventions. That's actually what BoJ deed. It seems that the pressure has reached some painful levels, where 10-year bonds are coming to 5% level, which forced the US to participate in intervention and reduce direct selling of the US bonds.
Many try to attribute this to purely technical reasons, but behind the current actions of central banks lies the very real process of de-dollarization. First, the Global South clearly saw the risks of asset freezing, and then, after Trump came to power, they began to change the structure of their reserves, transferring the funds released from the sale of bonds into physical gold. And also to cover the losses from tariffs.
The current energy crisis and the shortage of other resources in the global market are another reason to continue changing this structure, but now not voluntarily, but out of necessity, in order to ensure the stability of the financial system with U.S. dollar liquidity. The structural crisis will not end soon, as it will take at least a year, and probably even longer, to unwind the reduction in reserves after the end of the second phase of Trump's Hormuz operation.
This means that the pressure on the currencies of importing countries will remain, and central banks will continue to steadily deplete their portfolios of U.S. government debt. The process of moving away from dependence on the U.S. debt market has moved from the theoretical plane to the practical phase, which will no longer be able to be reversed.
The current energy crisis and the shortage of other resources in the global market are another reason to continue changing this structure, but now not voluntarily, but out of necessity, in order to ensure the stability of the financial system with U.S. dollar liquidity. The structural crisis will not end soon, as it will take at least a year, and probably even longer, to unwind the reduction in reserves after the end of the second phase of Trump's Hormuz operation.
This means that the pressure on the currencies of importing countries will remain, and central banks will continue to steadily deplete their portfolios of U.S. government debt. The process of moving away from dependence on the U.S. debt market has moved from the theoretical plane to the practical phase, which will no longer be able to be reversed.
Consumer Spending Drives Growth in the Second Quarter. The US economy grew by 0.4% quarter-over-quarter, or 1.5% (SAAR), in the second quarter. The annual growth rate slowed to 2.1% year-over-year. Personal consumption contributed 2.1 percentage points to the GDP growth. In fact, virtually all of the growth, and even a little more, was driven by consumer demand and investment (+1.1 percentage points of GDP), with a significant portion of this growth related to investments in AI. Consumer and investment demand was primarily driven by a decrease in inventories (-0.6 percentage points of GDP) and imports (-1.7 percentage points of GDP), rather than by increased domestic production.
Spending growth continues to outpace income growth, although not as significantly as in previous months. As a result, the savings rate for US households has fallen to a minimum of 2.7% since 2022, which already indicates that household savings are likely negative. Overall, the picture is that Americans are spending more than they earn and receive from the government, resulting in minimum savings. However, the AI market bubble is already starting to burst in some places... In South Korea, a market crash of over 40% has "buried" 1.2 million margin accounts (leading to social problems, as many young people had invested heavily). In the US, a hedge fund run by AI enthusiast Leopold Ashenbrenner has "collapsed".
The US doesn't have a problem repaying its nearly $40 trillion debt. The problem is repaying it with dollars that have the same value as the original dollars. Interest is financed by new debt. New debt creates new interest. New interest requires even more new debt. A house of cards doesn't have to collapse in one day. It can simply become increasingly expensive to maintain, until maintenance becomes its primary function.
Strictly speaking, debt sustainability requires not that the interest rate be lower than inflation every month. It requires that the average cost of servicing the debt be lower than the rate of growth of the nominal economy. But when the real economy grows slowly and falls into recession, and the debt grows rapidly, it is easiest to achieve this through the old state method - financial repression.
The longer the Fed keeps real interest rates high, the more difficult the budget arithmetic becomes. The faster it gives in and returns to negative real interest rates, the stronger the argument in favor of gold. It turns out to be a rather convenient fork in the road. Either the high interest rate begins to break the debt structure.
Or the low interest rate begins to devalue the currency in which this structure is denominated.
This particularly explains why markets recently sold off US bonds despite that the rate remains the same. On a long end of the yield curve they are pricing in these issues, demanding higher premium and understanding that current Fed's policy is aiming on devaluation of its obligations - either interest or notional. If no conclusions will be made and the Fed will not start rate hike even together with QE of any kind - situation on FX market could change. Dollar could keep dropping together with the yields. Because first - investors will sell US assets, second - they convert the dollar into other currencies. This in turn with the 99% will hurt the stock market, which leads to big subtract from total GDP levels and leads to official recession. In election year, where is less than 6 months until voting nobody will let it to happen. Thus, September rate hike from the Fed is almost granted.
Recent combined intervention of the US, Japan and Korea has broken the natural currency performance and technical picture that we were following in last 2-3 weeks. Now it will be interesting to see how stable this effect will be. Because at the end, it will set the market's direction.
A contradictive week has come to an end. I call it "contradictive" because a few issues, that mostly passed unsigned have happened. The Fed meeting was mostly about nothing, but the consequences were interesting. Once the rate has been held untouched - long-term yields have jumped immediately. And in general the US dollar has shown very poor performance this week. Why? Because bond holders demand more prize from the US Treasury to compensate inflation and credit risks if the Fed doesn't want to do this. Second - BoJ and US Treasury have taken united intervention. This is important signal. In fact, this means that S. Bessent directly provides liquidity to intervene avoiding sell-off in the Japanese foreign reserves, i.e. US Treasuries. It is done to avoid extra pressure on the US yields. Thus, drop of the dollar and raising of the US yields with external financing of BoJ intervention shows big change in investors' mind. Now the raising of the US yields is not necessary the attractive factor, supporting dollar demand. This might be the first step in a big changes in the Fed (and other central banks) policy.
MARKET OVERVIEW
The dollar fell against the Japanese yen on Friday, with traders braced for a second round of intervention after Japanese authorities stepped in to prop up their currency a day earlier. The U.S. Treasury has informed a number of banks that it may intervene in the yen market on Friday and that they should "stand ready for future action," a source familiar with the matter told Reuters. Japan was also receiving support from the U.S. that "goes beyond psychological support", Japan's top foreign exchange diplomat said on Friday.
The U.S. Treasury bought yen on Friday to support the battered Japanese currency, the Financial Times reported, marking Washington's first yen-buying intervention with Tokyo in more than a decade as it languishes near 40-year lows.
The dollar was also weaker across the board after data showed U.S. inflation slowed in June, a day after the Federal Reserve left interest rates unchanged, dashing hopes for a rate hike. Data on Thursday showed the Personal Consumption Expenditures Price Index increased 3.7% in the 12 months through June after advancing by an unrevised 4.1% in May, which was the largest gain since April 2023, the Commerce Department's Bureau of Economic Analysis said. U.S. economic growth slowed in the second quarter amid a widening in the trade deficit. Gross domestic product increased at a 1.5% annualized rate last quarter.
A divided Fed left interest rates unchanged. Fed Chair Kevin Warsh pledged an unwavering commitment to bring inflation down, a message that left markets confused about just what he was prepared to do in coming months. Three of the 12 members of the policy-setting Federal Open Market Committee dissented from the move that left the benchmark interest rate in the 3.50%-3.75% range in favor of a quarter-percentage-point hike. Traders are betting a 67% chance on a 25-basis-point rate hike in September, according to CME Group's FedWatch tool.
Fed policymakers are embracing the idea that current borrowing costs are creating enough friction in the economy to reduce any inflation that isn't, like the effect of tariffs on goods prices, expected to fade on its own. Referring to the three dissenting votes favoring rate hikes versus the Federal Open Market Committee decision to hold the federal funds rate steady, Warsh said at a press conference that
Eric Theoret, FX strategist at Scotiabank, said it was unclear if Friday's modest rise in the yen was a result of actual intervention, or traders reacting to the possibility of one in the near future.
Strategists at Goldman Sachs said they see intervention as an effective tool for authorities to buy some time before fundamental factors turn more positive.
Thursday's moves resulted in spot yen trading volumes surging to their highest in 10 years on the EBS trading platform and futures trading volumes hitting their highest on record, the CME Group said. In a rare coordinated move, South Korea also conducted dollar-selling intervention on Thursday to support its currency, a market source told Reuters.
Global markets have been volatile this month as investors question the sustainability of the AI spending boom amid signs that major U.S. companies are deepening a web of AI-linked investments and continuing to funnel billions into the technology at the expense of free cash flow.
A selloff in U.S. Treasuries this week signaled the need for the Federal Reserve to earn its inflation-fighting "credibility" with interest rate increases, St. Louis Fed President Alberto Musalem told the Financial Times. He had "expressed a preference" towards a quarter-percentage-point interest rate increase at this week's policy meeting.
Meantime, U.S. Federal Reserve Chairman Kevin Warsh at this week's interest-rate-setting meeting raised the idea of reducing the number of the Fed's regularly scheduled meetings where it sets monetary policy, the New York Times reported on Friday. The Fed has held eight scheduled meetings a year since 1981, a cadence established under former Chair Paul Volcker. It would significantly cut back on the information Wall Street and the wider public would receive about the direction of interest rate policy and the Fed's interpretation of the state of inflation and the job market.
Finally, the return of money supply measurements to Federal Reserve thinking may help officials better identify longer-term inflation trends but will likely remain a peripheral factor for monetary policy deliberations, Fed watchers say. Warsh tucked a short section on money supply into the Fed's latest Monetary Policy Report earlier this month, the first formal nod to it in a decade.
After briefly contracting in the face of Fed rate hikes, M2's annual growth is back to a four-year high, though at 5.6%. Meanwhile, the Fed's inflation measure was 4.1% in its most recent reading for May, more than twice its target.
Economists and some former central bankers agree turning an eye toward M2 might help with longer-run inflation trend spotting at a time when the Fed has been wrestling with five years of inflation above its 2% target.
At the same time, they cautioned against too great a reliance on it for policymaking, which jibes with Warsh’s view that it should simply be part of policymakers' mix of data to watch.
But Bill Nelson, chief economist with lobbying group the Bank Policy Institute and also a former Fed staffer, as some others warned against connecting money supply to the Fed’s still large holdings of bonds.
Next week markets get a fresh read on the U.S. economy on Friday when closely watched non-farm payrolls data are released. Economists polled by Reuters expect the July report to show payrolls increased by 91,000 jobs and the unemployment rate held at 4.3%.
COMMENTS
Well, it's finally happened. Even the Federal Reserve is starting to realize that the key interest rate isn't a magic switch that can be flipped to lower prices, increase production, and maybe even make it rain. After years of focusing on interest rates, unemployment, and inflation expectations, the central bank has brought back monetary aggregate M2 to the main report. For now, it's being used cautiously, as just one piece of the puzzle. But perhaps, with a little more attention, it will become clear that it's not a bad idea to sometimes look at the money supply in monetary policy.
The next level of complexity is to understand that, during a structural crisis of rising costs, M2 will increase almost regardless. And if you don't let it grow, real output will begin to shrink. When raw materials, logistics, equipment, labor, taxes, and debt servicing become more expensive, businesses need more working capital just to produce the same amount of goods. The money is no longer needed for rapid economic growth, but to finance the preservation of yesterday's physical output.
Raising interest rates can slow down credit, investment, demand, and the entire economy. But you can't force imported equipment, logistics, or scarce labor to become cheaper. Moreover, high interest rates add another cost to existing expenses: expensive credit. It's a very clever way to put out a fire – first, raise the price of water.
But why complicate things? If inflation doesn't decrease with a high interest rate, you can always raise the rate even higher. And if, after that, the economy stops growing, then monetary policy is working. Just not in the direction that this economy needs to go.
In the United States, 372 large companies filed for bankruptcy in the first 6 months of 2026, making it the highest number for the first half of the year in 16 years. By industry, industrial companies are leading, with 50 companies having gone bankrupt since the beginning of the year. They are followed by companies in the consumer discretionary sector – 35 bankruptcies, and companies in the healthcare sector – 26 bankruptcies.
Meantime, Foreign central banks are continuing to divest themselves of U.S. government bonds, and this trend is now systemic. Recent data from the Federal Reserve shows that the volume of Treasury securities held by foreign central banks has reached multi-year lows. The main trigger for this process has been the prolonged energy crisis and consistently high oil prices.
In the face of expensive raw materials, developing countries are facing pressure on their national currencies and enormous import costs. To prevent their financial systems from collapsing, central banks are forced to spend their reserves, i.e., directly sell U.S. bonds in order to obtain liquid U.S. dollars for currency interventions. That's actually what BoJ deed. It seems that the pressure has reached some painful levels, where 10-year bonds are coming to 5% level, which forced the US to participate in intervention and reduce direct selling of the US bonds.
Many try to attribute this to purely technical reasons, but behind the current actions of central banks lies the very real process of de-dollarization. First, the Global South clearly saw the risks of asset freezing, and then, after Trump came to power, they began to change the structure of their reserves, transferring the funds released from the sale of bonds into physical gold. And also to cover the losses from tariffs.
The current energy crisis and the shortage of other resources in the global market are another reason to continue changing this structure, but now not voluntarily, but out of necessity, in order to ensure the stability of the financial system with U.S. dollar liquidity. The structural crisis will not end soon, as it will take at least a year, and probably even longer, to unwind the reduction in reserves after the end of the second phase of Trump's Hormuz operation.
This means that the pressure on the currencies of importing countries will remain, and central banks will continue to steadily deplete their portfolios of U.S. government debt. The process of moving away from dependence on the U.S. debt market has moved from the theoretical plane to the practical phase, which will no longer be able to be reversed.
The current energy crisis and the shortage of other resources in the global market are another reason to continue changing this structure, but now not voluntarily, but out of necessity, in order to ensure the stability of the financial system with U.S. dollar liquidity. The structural crisis will not end soon, as it will take at least a year, and probably even longer, to unwind the reduction in reserves after the end of the second phase of Trump's Hormuz operation.
This means that the pressure on the currencies of importing countries will remain, and central banks will continue to steadily deplete their portfolios of U.S. government debt. The process of moving away from dependence on the U.S. debt market has moved from the theoretical plane to the practical phase, which will no longer be able to be reversed.
Consumer Spending Drives Growth in the Second Quarter. The US economy grew by 0.4% quarter-over-quarter, or 1.5% (SAAR), in the second quarter. The annual growth rate slowed to 2.1% year-over-year. Personal consumption contributed 2.1 percentage points to the GDP growth. In fact, virtually all of the growth, and even a little more, was driven by consumer demand and investment (+1.1 percentage points of GDP), with a significant portion of this growth related to investments in AI. Consumer and investment demand was primarily driven by a decrease in inventories (-0.6 percentage points of GDP) and imports (-1.7 percentage points of GDP), rather than by increased domestic production.
Spending growth continues to outpace income growth, although not as significantly as in previous months. As a result, the savings rate for US households has fallen to a minimum of 2.7% since 2022, which already indicates that household savings are likely negative. Overall, the picture is that Americans are spending more than they earn and receive from the government, resulting in minimum savings. However, the AI market bubble is already starting to burst in some places... In South Korea, a market crash of over 40% has "buried" 1.2 million margin accounts (leading to social problems, as many young people had invested heavily). In the US, a hedge fund run by AI enthusiast Leopold Ashenbrenner has "collapsed".
The US doesn't have a problem repaying its nearly $40 trillion debt. The problem is repaying it with dollars that have the same value as the original dollars. Interest is financed by new debt. New debt creates new interest. New interest requires even more new debt. A house of cards doesn't have to collapse in one day. It can simply become increasingly expensive to maintain, until maintenance becomes its primary function.
Strictly speaking, debt sustainability requires not that the interest rate be lower than inflation every month. It requires that the average cost of servicing the debt be lower than the rate of growth of the nominal economy. But when the real economy grows slowly and falls into recession, and the debt grows rapidly, it is easiest to achieve this through the old state method - financial repression.
The longer the Fed keeps real interest rates high, the more difficult the budget arithmetic becomes. The faster it gives in and returns to negative real interest rates, the stronger the argument in favor of gold. It turns out to be a rather convenient fork in the road. Either the high interest rate begins to break the debt structure.
Or the low interest rate begins to devalue the currency in which this structure is denominated.
This particularly explains why markets recently sold off US bonds despite that the rate remains the same. On a long end of the yield curve they are pricing in these issues, demanding higher premium and understanding that current Fed's policy is aiming on devaluation of its obligations - either interest or notional. If no conclusions will be made and the Fed will not start rate hike even together with QE of any kind - situation on FX market could change. Dollar could keep dropping together with the yields. Because first - investors will sell US assets, second - they convert the dollar into other currencies. This in turn with the 99% will hurt the stock market, which leads to big subtract from total GDP levels and leads to official recession. In election year, where is less than 6 months until voting nobody will let it to happen. Thus, September rate hike from the Fed is almost granted.
Recent combined intervention of the US, Japan and Korea has broken the natural currency performance and technical picture that we were following in last 2-3 weeks. Now it will be interesting to see how stable this effect will be. Because at the end, it will set the market's direction.
