Sive Morten
Special Consultant to the FPA
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- 18,639
Fundamentals
Well, well, guys. Tough Friday, indeed. In general, JP has said nothing new, just confirmed what we saw in Fed minutes last week, but this was enough to spook markets and crush stocks. Tactically, Jackson Hole meeting confirms our strategic view on EUR/USD, but we also could make a bit deeper conclusion from current situation. Now it looks ordinary that EUR stands below the parity but in reality it is big deal that stands on the back.
Why is this so important? As economists tell - any economic structure (in particular, the Bretton Woods dollar system) has a number of basic proportions. Roughly speaking, the cost of product "A" is about three times the cost of product "B". It may fluctuate, sometime it will decrease to twice the increase, sometime it will grow to 3.5, but in general the proportions are quite stable.
The entire world economy actively resists to strong deviations from the basic proportions (this is clearly seen in the reaction to major crop failures or similar disasters). And the interaction of the economies of the European Union and the United States within the framework of a stable model of the last 20 years showed that all attempts to lower the euro ended with the fact that it stubbornly returns back up.
Today the situation is different. And this means two fundamental phenomena at once. The first is that the United States has successfully implemented its plan to transfer capital from the Old World to the New One. More precisely, they have successfully started this project and there is no reason to believe that they will not keep going with it. Only single center of power and stability should be and we have repeatedly talked about it previously.
But the second one is the Bretton Woods model in its "post—Soviet" version, that has taken completed shape somewhere in late 90s (that is, the moment of the bombing of Yugoslavia), has come to an end. On the one hand, there is nothing special about that, as you could recall, say, the changes of the early 70s after the US default on August 15, 1971 and the "oil" crisis". But on the other hand, there is no alternative model on horizon by far.
At least the dollar emission was a main tool that allowed to build new economic institutions and structures. And today, on what basis can an alternative model be built? If you look closely at the policy of the US monetary authorities since 2008, it was purely defensive, they tried to preserve what they have at any cost, in no case to discuss the fact that the entire system is under threat.
Today, the issue of the dollar is used only to maintain aggregate demand, but it is still not enough to preserve the model. This means that the potential of the existence of the current incarnation of Bretton Woods model is exhausted. And, as we have already noted, there is no resource for building a new one. The collapse of the world into currency zones begins, and it is clear to everyone, even non-economists, that the potential of a possible "EUR zone" is far inferior to the potential of the "USD zone". With all foregoing consequences.
Market Overview
An index of global stock markets fell, while short-term U.S. Treasury yields rose on Friday, after Federal Reserve Chair Jerome Powell said the U.S. economy will need tight monetary policy "for some time" before inflation is under control.
Tight monetary policy "for some time" means slower growth, a weaker job market and "some pain" for households and businesses, Powell said in a speech to the central banking conference in Jackson Hole, Wyoming.
"It was hawkish as expected. Powell's message is clear: the Fed is far from done in its fight against inflation," said Antoine Bouvet, senior rates strategist at ING in London.
Americans are headed for a painful period of slow economic growth and possibly rising joblessness as the Federal Reserve raises interest rates to fight high inflation, U.S. central bank chief Jerome Powell warned on Friday in his bluntest language yet about what is in store for the world's biggest economy.
In a speech kicking off the Jackson Hole central banking conference in Wyoming, Powell said the Fed will raise rates as high as needed to restrict growth, and would keep them there "for some time" to bring down inflation that is running at more than three times the Fed's 2% goal.
As that pain increases, Powell said, people should not expect the Fed to dial back its monetary policy quickly until the inflation problem is fixed.
To the contrary, Powell and other policymakers are signaling that even a recession would not budge them if inflation is not convincingly heading back to the Fed's target. Powell gave no indication on Friday of how high rates might rise before the Fed is finished, only that they will go as high as needed.
Underscoring the same "raise-and-hold" message on interest rates, Atlanta Fed President Raphael Bostic told Bloomberg TV that once the central bank's policy rate is 100 to 125 basis points higher than the current 2.25%-2.50% range, "we should stay there for a long time."
He did not hint at what the Fed might do at its upcoming Sept. 20-21 policy meeting. Officials are expected to approve either a 50- or 75-basis-point rate increase.
After Powell's remarks, interest rate futures traders beefed up bets on a third straight 75-basis-point rate hike at the Fed's Sept. 20-21 policy meeting and priced in expectations the policy rate will get to the 3.75%-4.00% range by next March.
But rate futures trading continued to reflect expectations for such a pivot later next year, with the Fed seen cutting its policy rate by about 40 basis points by the end of 2023 and further in 2024.
The decision of how much to increase rates "will depend on the totality of the incoming data and the evolving outlook," Powell said, with further jobs and inflation reports to come. The Fed has become increasingly open that its policies may lead to a rise in the U.S. unemployment rate, currently at 3.5%, a level that has not been stronger in more than 50 years.
To quell inflation, though, Fed policymakers have said they need to curb demand for goods and services by raising borrowing costs and making it more costly to finance homes, cars and business investment. As the process bites, as it is beginning to do, particularly in the housing market, companies may adjust their hiring plans or even resort to layoffs.
The tradeoffs facing global central bankers - between jobs, inflation and growth - are likely to get worse in coming years as the world struggles to right job markets and supply chains, and price pressures continue, Gita Gopinath, the International Monetary Fund's first deputy managing director, told global policymakers on Friday. Given the risks of inflation becoming embedded, Gopinath said top central banks will need to be uniformly tough despite the possible costs.
Consumer morale in the euro zone's two biggest economies diverged starkly in August as French consumers benefited from fresh government measures while concerns over rising energy bills hit their German counterparts, surveys showed on Friday. The survey from the GfK institute showed its consumer sentiment index falling to -36.5 heading into September, against expectations in a Reuters poll for a reading of -31.8. German households, already grappling with the prospect of gas levies, may be asked to foot an even greater bill in the current energy crisis, said Hauck Aufhaeuser Lampe chief economist Alexander Krueger, further weighing on consumer spending in Europe's biggest economy.
The euro , which had edged higher following a Reuters report that some European Central Bank policymakers want to discuss a 75-basis-point interest rate hike at their September policy meeting, gave up those gains to trade down 0.07% at $0.9965. The ECB raised its deposit rate by 50 basis points to zero last month in an unexpectedly big move and another similar increase is also priced in for the Sept. 8 meeting as inflation is now approaching double digit territory with months to go before its peak.
While no policy maker has publicly advocated such a large move, back-to-back 75 basis point hikes from the U.S. Federal Reserve and a stubborn deterioration of the euro area inflation outlook strengthen the case for such a discussion.
Next 9 months seem to be vital
Today, unlike in 2003, we look at the probability of the sustainable existence of EUR zone pessimistically, but so far the EU exists and therefore the monetary EUR-zone really exists either. And it adapts significantly during the crisis.
If, on a back of Bretton Woods model, the EU has secured a fairly comfortable existence within the framework of the model "cheap import of raw materials - average cost labor — high-price export of expensive technological products", then this system will not work in the new conditions. The quarrel with Russia and the countries of South-East Asia (no matter for what reason) deprived the EU of cheap raw materials, and the fall in aggregate demand in the world (as part of the regular development of the structural crisis) led to a reduction in exports.
Accordingly, the trade deficit has grown (we have noted this many times) and the source of internal development has disappeared. This is particularly why the rise in gas prices is so indicative — it is a symbol of the collapse of the previously existing economic model. The quite comfortable state of the EU existence inside the dollar zone is shifting to the necessity to exist as a self-sufficient economic mechanism. This new model could be stable only with a sharp drop in living standards and population wealth within the EU. And given the extreme political instability of this formation, it seems few chances of its surviving.
Crisis is underway, It is vital to cut inflation and it is possible to do only by money supply contraction. But to support households' income - money supply should keep expanding. This is vital topic not only for Forex market, the US economy but for the cryptocurrencies, as they have direct relation to the stock market. In last Fundamental BTC report we've taken in-depth view on this subject. Here we just tell that M2 money supply has to drop for 20-25% to make system more or less balanced. The growth of inflation with the stagnation of nominal M2 led to the fact that the real money supply for 7 months decreased by 5.2%:
The peak increment of M2 for 12 months amounted to 4.1 trillion by February 2021, which corresponded to 27% annual growth. To understand the scale of monetary madness – in the conditions of the inflationary crisis of the 70s-80s, the annual growth rate of M2 never exceeded 14% YoY. In 1971, 1976-1977 and 1983, at the moment, M2 grew by only 13% YoY. Thus, the monetary increment of 2020-2021 in relative terms has doubled the peaks of the inflationary crisis of the 70s-80s and has become the most significant increment in the history of the United States.
Thus, after a record growth of the real M2 by 25% (with previous records of 10-11%), the reduction should be about 15-20% more. If we compare the trend of real M2 growth from 2011 to 2019, the current M2 should be about 17 trillion in prices by 2021, which corresponds to a decrease of 14%. The principle is simple – any fake dollar (unsecured issue) will be destroyed through inflation sooner or later, so the processes of disposal of excess liquidity have just begun.
Our special attention to Money supply is not occasional. It has long-term correlation with the stock market. And if we expect 20% drop in money supply that is vital to set the balance in the US economy - the same performance we should expect on stock market. Previously it was 1:6 ratio of change M2 and S&P index. Now it might be a bit different. But anyway, by most conservative view, 14% drop in Money Supply could trigger 30-40% collapse on Stock market, which corresponds to our expectations of 2000-2500 S&P level in near term.
Population drops in poverty fast, personal income is deteriorating, simultaneously with vital drop of personal savings and sharp increase of consumer credits to all time high levels.
Thus, the Dollar remains the King, at least for 9-12 months, while Fed has reserves to push rates higher and support stock market. Until the moment when it will become obvious that the King is naked. The breakeven point should come in November elections. Democrats will loose, but if they will - they release the financial Kraken and sic it on D. Trump and Republicans.
For the EUR/USD it means no changes by far. We've warned that EU recession is already underway, and GDP statistics doesn't show it just because current numbers are calculated in relation to depressed Covid data. IIQ and IIIQ should be the ones where we have official recession confirmation. Thus, 0.9 target stands intact. It seems that ECB despairs to provide any meaningful support to the economy as well as with their tools against inflation, lagging behind the Fed too much. It might be nothing worse for the economy than despair and spineless central bank.
Next week to watch
#1 Monthly U.S. jobs data on Sept. 2 will test the argument that the world's biggest economy is in solid health, and indicate whether the Federal Reserve can engineer a "soft landing" even as it hikes interest rates to fight inflation that has been running at four-decade highs. In July, nonfarm payrolls increased by 528,000 jobs, the largest gain since February. Early estimates for August are projecting an increase of 290,000, according to Reuters data.
#2 Inflation in the euro area remains uncomfortably high, the flash August consumer price index on Wednesday is likely to show. That will only pile pressure on the European Central Bank to hike rates again in September even as recession risks mount. Gas prices are up 45% in August, and 300% this year . Where they go from here remains the key to when euro zone inflation will finally peak. As one economist put it, we're all becoming gas watchers now.
#3 Consumer Prices
This September, a number of factors could set investors on edge. Following the Jackson Hole central banking symposium in Wyoming, the Fed will hold its next policy meeting on Sept. 20-21. Ahead of that comes the latest reading on consumer prices that will indicate if inflation has peaked and is likely to cause volatility no matter where it lands.
Well, well, guys. Tough Friday, indeed. In general, JP has said nothing new, just confirmed what we saw in Fed minutes last week, but this was enough to spook markets and crush stocks. Tactically, Jackson Hole meeting confirms our strategic view on EUR/USD, but we also could make a bit deeper conclusion from current situation. Now it looks ordinary that EUR stands below the parity but in reality it is big deal that stands on the back.
Why is this so important? As economists tell - any economic structure (in particular, the Bretton Woods dollar system) has a number of basic proportions. Roughly speaking, the cost of product "A" is about three times the cost of product "B". It may fluctuate, sometime it will decrease to twice the increase, sometime it will grow to 3.5, but in general the proportions are quite stable.
The entire world economy actively resists to strong deviations from the basic proportions (this is clearly seen in the reaction to major crop failures or similar disasters). And the interaction of the economies of the European Union and the United States within the framework of a stable model of the last 20 years showed that all attempts to lower the euro ended with the fact that it stubbornly returns back up.
Today the situation is different. And this means two fundamental phenomena at once. The first is that the United States has successfully implemented its plan to transfer capital from the Old World to the New One. More precisely, they have successfully started this project and there is no reason to believe that they will not keep going with it. Only single center of power and stability should be and we have repeatedly talked about it previously.
But the second one is the Bretton Woods model in its "post—Soviet" version, that has taken completed shape somewhere in late 90s (that is, the moment of the bombing of Yugoslavia), has come to an end. On the one hand, there is nothing special about that, as you could recall, say, the changes of the early 70s after the US default on August 15, 1971 and the "oil" crisis". But on the other hand, there is no alternative model on horizon by far.
At least the dollar emission was a main tool that allowed to build new economic institutions and structures. And today, on what basis can an alternative model be built? If you look closely at the policy of the US monetary authorities since 2008, it was purely defensive, they tried to preserve what they have at any cost, in no case to discuss the fact that the entire system is under threat.
Today, the issue of the dollar is used only to maintain aggregate demand, but it is still not enough to preserve the model. This means that the potential of the existence of the current incarnation of Bretton Woods model is exhausted. And, as we have already noted, there is no resource for building a new one. The collapse of the world into currency zones begins, and it is clear to everyone, even non-economists, that the potential of a possible "EUR zone" is far inferior to the potential of the "USD zone". With all foregoing consequences.
Market Overview
An index of global stock markets fell, while short-term U.S. Treasury yields rose on Friday, after Federal Reserve Chair Jerome Powell said the U.S. economy will need tight monetary policy "for some time" before inflation is under control.
Tight monetary policy "for some time" means slower growth, a weaker job market and "some pain" for households and businesses, Powell said in a speech to the central banking conference in Jackson Hole, Wyoming.
"It was hawkish as expected. Powell's message is clear: the Fed is far from done in its fight against inflation," said Antoine Bouvet, senior rates strategist at ING in London.
Americans are headed for a painful period of slow economic growth and possibly rising joblessness as the Federal Reserve raises interest rates to fight high inflation, U.S. central bank chief Jerome Powell warned on Friday in his bluntest language yet about what is in store for the world's biggest economy.
In a speech kicking off the Jackson Hole central banking conference in Wyoming, Powell said the Fed will raise rates as high as needed to restrict growth, and would keep them there "for some time" to bring down inflation that is running at more than three times the Fed's 2% goal.
As that pain increases, Powell said, people should not expect the Fed to dial back its monetary policy quickly until the inflation problem is fixed.
To the contrary, Powell and other policymakers are signaling that even a recession would not budge them if inflation is not convincingly heading back to the Fed's target. Powell gave no indication on Friday of how high rates might rise before the Fed is finished, only that they will go as high as needed.
Underscoring the same "raise-and-hold" message on interest rates, Atlanta Fed President Raphael Bostic told Bloomberg TV that once the central bank's policy rate is 100 to 125 basis points higher than the current 2.25%-2.50% range, "we should stay there for a long time."
He did not hint at what the Fed might do at its upcoming Sept. 20-21 policy meeting. Officials are expected to approve either a 50- or 75-basis-point rate increase.
After Powell's remarks, interest rate futures traders beefed up bets on a third straight 75-basis-point rate hike at the Fed's Sept. 20-21 policy meeting and priced in expectations the policy rate will get to the 3.75%-4.00% range by next March.
But rate futures trading continued to reflect expectations for such a pivot later next year, with the Fed seen cutting its policy rate by about 40 basis points by the end of 2023 and further in 2024.
The decision of how much to increase rates "will depend on the totality of the incoming data and the evolving outlook," Powell said, with further jobs and inflation reports to come. The Fed has become increasingly open that its policies may lead to a rise in the U.S. unemployment rate, currently at 3.5%, a level that has not been stronger in more than 50 years.
To quell inflation, though, Fed policymakers have said they need to curb demand for goods and services by raising borrowing costs and making it more costly to finance homes, cars and business investment. As the process bites, as it is beginning to do, particularly in the housing market, companies may adjust their hiring plans or even resort to layoffs.
The tradeoffs facing global central bankers - between jobs, inflation and growth - are likely to get worse in coming years as the world struggles to right job markets and supply chains, and price pressures continue, Gita Gopinath, the International Monetary Fund's first deputy managing director, told global policymakers on Friday. Given the risks of inflation becoming embedded, Gopinath said top central banks will need to be uniformly tough despite the possible costs.
Consumer morale in the euro zone's two biggest economies diverged starkly in August as French consumers benefited from fresh government measures while concerns over rising energy bills hit their German counterparts, surveys showed on Friday. The survey from the GfK institute showed its consumer sentiment index falling to -36.5 heading into September, against expectations in a Reuters poll for a reading of -31.8. German households, already grappling with the prospect of gas levies, may be asked to foot an even greater bill in the current energy crisis, said Hauck Aufhaeuser Lampe chief economist Alexander Krueger, further weighing on consumer spending in Europe's biggest economy.
The euro , which had edged higher following a Reuters report that some European Central Bank policymakers want to discuss a 75-basis-point interest rate hike at their September policy meeting, gave up those gains to trade down 0.07% at $0.9965. The ECB raised its deposit rate by 50 basis points to zero last month in an unexpectedly big move and another similar increase is also priced in for the Sept. 8 meeting as inflation is now approaching double digit territory with months to go before its peak.
While no policy maker has publicly advocated such a large move, back-to-back 75 basis point hikes from the U.S. Federal Reserve and a stubborn deterioration of the euro area inflation outlook strengthen the case for such a discussion.
But recent ECB minutes protocol shows that they have no intention to accelerate the pace of rate change.
Next 9 months seem to be vital
Today, unlike in 2003, we look at the probability of the sustainable existence of EUR zone pessimistically, but so far the EU exists and therefore the monetary EUR-zone really exists either. And it adapts significantly during the crisis.
If, on a back of Bretton Woods model, the EU has secured a fairly comfortable existence within the framework of the model "cheap import of raw materials - average cost labor — high-price export of expensive technological products", then this system will not work in the new conditions. The quarrel with Russia and the countries of South-East Asia (no matter for what reason) deprived the EU of cheap raw materials, and the fall in aggregate demand in the world (as part of the regular development of the structural crisis) led to a reduction in exports.
Accordingly, the trade deficit has grown (we have noted this many times) and the source of internal development has disappeared. This is particularly why the rise in gas prices is so indicative — it is a symbol of the collapse of the previously existing economic model. The quite comfortable state of the EU existence inside the dollar zone is shifting to the necessity to exist as a self-sufficient economic mechanism. This new model could be stable only with a sharp drop in living standards and population wealth within the EU. And given the extreme political instability of this formation, it seems few chances of its surviving.
Crisis is underway, It is vital to cut inflation and it is possible to do only by money supply contraction. But to support households' income - money supply should keep expanding. This is vital topic not only for Forex market, the US economy but for the cryptocurrencies, as they have direct relation to the stock market. In last Fundamental BTC report we've taken in-depth view on this subject. Here we just tell that M2 money supply has to drop for 20-25% to make system more or less balanced. The growth of inflation with the stagnation of nominal M2 led to the fact that the real money supply for 7 months decreased by 5.2%:
The peak increment of M2 for 12 months amounted to 4.1 trillion by February 2021, which corresponded to 27% annual growth. To understand the scale of monetary madness – in the conditions of the inflationary crisis of the 70s-80s, the annual growth rate of M2 never exceeded 14% YoY. In 1971, 1976-1977 and 1983, at the moment, M2 grew by only 13% YoY. Thus, the monetary increment of 2020-2021 in relative terms has doubled the peaks of the inflationary crisis of the 70s-80s and has become the most significant increment in the history of the United States.
Thus, after a record growth of the real M2 by 25% (with previous records of 10-11%), the reduction should be about 15-20% more. If we compare the trend of real M2 growth from 2011 to 2019, the current M2 should be about 17 trillion in prices by 2021, which corresponds to a decrease of 14%. The principle is simple – any fake dollar (unsecured issue) will be destroyed through inflation sooner or later, so the processes of disposal of excess liquidity have just begun.
Our special attention to Money supply is not occasional. It has long-term correlation with the stock market. And if we expect 20% drop in money supply that is vital to set the balance in the US economy - the same performance we should expect on stock market. Previously it was 1:6 ratio of change M2 and S&P index. Now it might be a bit different. But anyway, by most conservative view, 14% drop in Money Supply could trigger 30-40% collapse on Stock market, which corresponds to our expectations of 2000-2500 S&P level in near term.
Population drops in poverty fast, personal income is deteriorating, simultaneously with vital drop of personal savings and sharp increase of consumer credits to all time high levels.
Thus, the Dollar remains the King, at least for 9-12 months, while Fed has reserves to push rates higher and support stock market. Until the moment when it will become obvious that the King is naked. The breakeven point should come in November elections. Democrats will loose, but if they will - they release the financial Kraken and sic it on D. Trump and Republicans.
For the EUR/USD it means no changes by far. We've warned that EU recession is already underway, and GDP statistics doesn't show it just because current numbers are calculated in relation to depressed Covid data. IIQ and IIIQ should be the ones where we have official recession confirmation. Thus, 0.9 target stands intact. It seems that ECB despairs to provide any meaningful support to the economy as well as with their tools against inflation, lagging behind the Fed too much. It might be nothing worse for the economy than despair and spineless central bank.
Next week to watch
#1 Monthly U.S. jobs data on Sept. 2 will test the argument that the world's biggest economy is in solid health, and indicate whether the Federal Reserve can engineer a "soft landing" even as it hikes interest rates to fight inflation that has been running at four-decade highs. In July, nonfarm payrolls increased by 528,000 jobs, the largest gain since February. Early estimates for August are projecting an increase of 290,000, according to Reuters data.
#2 Inflation in the euro area remains uncomfortably high, the flash August consumer price index on Wednesday is likely to show. That will only pile pressure on the European Central Bank to hike rates again in September even as recession risks mount. Gas prices are up 45% in August, and 300% this year . Where they go from here remains the key to when euro zone inflation will finally peak. As one economist put it, we're all becoming gas watchers now.
#3 Consumer Prices
This September, a number of factors could set investors on edge. Following the Jackson Hole central banking symposium in Wyoming, the Fed will hold its next policy meeting on Sept. 20-21. Ahead of that comes the latest reading on consumer prices that will indicate if inflation has peaked and is likely to cause volatility no matter where it lands.
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