Sive Morten
Special Consultant to the FPA
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Fundamentals
This week, beyond some statistics, such as PMI's across the Globe, there were two major events - BRICS summit and Jackson Hole meeting in Wyoming. At first glance these events are totally independent. Because BRICS is political organisation, while Central banks meeting in Wyoming have discussed financial questions and interest rates policy. But this is only on the surface. In fact they have relation to each other. The topic of BRICS currency has triggered big resonance in media, although we've said that hardly any decisive steps will be taken right now in this direction, and they didn't, but still, some foundation has been put for next summit in Russia, in 2024.
So, I think it makes sense to split these two topics, by two reasons. First is - to not overload FX report and keep BRICS summit discussion for tomorrow. Second - because it has more relation to global finance, rather than just EUR/USD and mutual EU and the US economies balance. Finally, BRICS currency is also a geopolitical tool, so it would be better to talk about it in context of Gold market tomorrow. And today we have a lot of things to discuss even without it.
Market overview
The U.S. dollar held steady on Friday, on pace to finish the week strong, after Federal Reserve Chair Jerome Powell said the central bank may need to raise interest rates further to ensure inflation is contained, but promised to move "carefully" at upcoming meetings. Powell, in a speech at an economic summit in Jackson Hole, Wyoming, said policymakers would "proceed carefully as we decide whether to tighten further," but also made clear that the central bank has not yet concluded that its benchmark interest rate is high enough to be sure that inflation returns to the 2% target.
While not as hawkish a message as he delivered this time a year ago at the annual Jackson Hole Economic Policy Symposium, Powell's remarks still delivered a punch, with investors now seeing one more rate hike by year-end more likely than not. Although the decline was a "welcome development," Powell said, inflation "remains too high."
In interviews on the sidelines of the conference, other Fed policymakers expressed a range of views. "We probably have some work to do," Cleveland Fed President Loretta Mester said. Chicago Fed President Austan Goolsbee felt the focus may turn to figuring out how long to keep rates high, rather than on how much higher they should go.
The index, up 0.6% for the week, was on course for its sixth straight week of gains, aided by signs of resilience in the U.S. economy that has bolstered the case for rates staying higher for longer.
At day's end, futures contracts tied to the Fed policy rate were pricing in just less than a 20% chance of a rate hike in September, but a better-than-50% chance of the policy rate ending the year in a 5.5%-5.75% range, a quarter-point higher than the current range. Fed policymakers will also meet in November and December.
Both the euro and sterling have been hit this week by weak business activity data that has prompted investors to scale back bets on further rate hikes in the euro area and Britain. The common currency has come under pressure as ECB policymakers are increasingly worried about weakening growth prospects and, while the debate is still open, momentum for a pause in its interest rate increases is building, Reuters reported, citing eight sources with direct knowledge of the discussion.
The mood among German businesses deteriorated more than expected in August, data showed, falling for the fourth month in a row and adding to fears that the economy may be heading for its second recession inside a year.
The British pound dropped to a 10-week low on Friday as investors reined in expectations of where they think the Bank of England's interest rate might peak after recent soft activity data.
At lunch in Wyoming, Lagarde was asked about the idea of "moving the goalposts" to accommodate that new reality. Like Powell, she said no.
Traders on Wednesday scaled back bets for a September interest rate hike in the euro area following much weaker-than-expected business activity data from Germany, Europe's biggest economy.
Money market futures now price just a 40% chance of a quarter point rate hike from the European Central Bank next month, compared with roughly a 60% chance priced in ahead of the data . German business activity contracted at the fastest pace for more than three years in August, a preliminary survey showed on Wednesday. We will show you charts below. Not only Germany IFO, but PMI data across EU shows poor numbers.
The rate of contraction in business activity in the euro area accelerated in August. The decline in production dragged the service sector along with it. In Europe, PMI reached the reduction zone of the crisis years of 2012-2013. The three largest economies are falling - Germany, France, Britain.
Meantime, German property developer Gerch said on Thursday it had filed an application for restructuring proceedings with a local court, the latest real estate firm to run into financial trouble as the sector suffers its biggest crisis in decades. Duesseldorf-based Gerch, founded in 2016 and with a current project volume valued at 4 billion euros ($4.3 billion), said in a statement the move was "due to imminent inability to pay".
WHAT J. POWELL's SPEECH MEANS
Here we could start from our own analysis, but some most clever analysts do it for us. Once Wyoming official part was over, some interest articles have appeared in media. We just want to point on another thing that J. Powell said, but somehow this point was not widely announced. We've specified it in our Telegram channel - Falling inflation is likely to require a cooling in labor markets. Signs that the labor market is not cooling down may require additional action from the Fed.
And we think that this is probably most important phrase in all statement. Taking it in consideration together with wage growth expectations makes us think that market underestimates the hawkishness the Fed's future interest rates policy.
Second moment, which is actually the major one and that perfectly describes the Fed's problems, why they are trapped in the corner - they have absolutely opposite dynamic in manufacturing sector and services. We see strong deflation in production, which means industry destruction and contraction, and simultaneously inflation in service sector. Whatever tools the Fed will use - they will have the opposite impact on these two spheres and can't resolve the problem. But let's go step by step.
Powell's remarks and indecision showed the Fed wrestling with conflicting signals from an economy where inflation has by some readings slowed a lot without much cost to the economy - a good outcome, but one that has raised the possibility that Fed policy is not restrictive enough to complete the job. But longer term restrictive policy is a big hazard for manufacturing sector which already shows clear signs of contraction that are evident to everybody.
We talked about it for a long time, but now other analysts start talking about the same - Central bank efforts to slow inflation, by raising borrowing costs and cooling demand for goods and services, may also undermine investments in innovative technologies that could make the economy stronger in the long-run, according to research presented on Friday at a Federal Reserve economic symposium.
Yueran Ma, an economist at the University of Chicago Booth School of Business, and Kaspar Zimmermann, an economist at Germany's Leibniz Institute for Financial Research SAFE, found that an unanticipated 1-percentage-point tightening of monetary policy cut company research and development spending by up to 3%, reduced venture capital spending by an even deeper 25%, and reduced patents in what were considered "important" technologies by 9%.
They said correctly, but let's try to explain it a bit further - what is the real problem for the Fed. Despite that BRICS haven't announced any currency yet, but all Global economy society understands that this is just a question of time. BRICS's GDP, population, resource base are larger than G7, and with including S. Arabia, Iran and UAE now they de-facto could control 80% of crude oil market. taking into account the expansion of the number of participants, there is no doubt that in the fairly near future the issue of at least the settlement system will arise again. And this, of course, will be a very serious blow to the Bretton Woods system.
So, the US petrodollar system stands at the edge. And it is logical that western politicians, investors would like to hear from the leader what will be in the dollar world, and with the Bretton-Wood system. Powell did not say any clear explanations of what and how will happen in the dollar world, which cannot cause nothing but alarm among all economic entities.
Roughly speaking, since the situation in the US and other centers of western economy is clearly deteriorating and everyone can already see it, despite attempts to introduce optimism on the part of the US monetary authorities, the latter should say something. And their evasion of the answer creates high nervousness, especially on a background of the activity of the BRICS countries (of which there are already more than ten). And although these countries cannot have a single economic policy, but a single settlement system based on an alternative currency is quite can be.
Moreover, as the problems with the dollar increase, including due to the destruction of the Bretton Woods rules through the introduction of sanctions against Russia, the desire to create such a system is growing all the time. And a year later, at the summit in Kazan, this issue may arise in an absolutely constructive way. That, as it is clear, the stability of the dollar system will significantly shake.
But this is only half of the story. This challenge happens on evident worsening of global macroeconomics data, especially in production and manufacturing sector. Take a look:
And a few more:
Also you could take a look some data on the US domestic market - total households card loans hits 1 Trln level, Home price to households earnings ratio exceeds 2008 level, consumers interest rates payments and many more - just watch posts for the Friday. Our european colleagues make correct conclusion - inflation has finished its dirt job in production now turns to service sector. Hiring stumbles and despite output drop in real sector - the wage growth expectations (i.e. wage inflation) is growing:
Taking in consideration major Fed's points on Wyoming press conference, we wonder why J. Powell so indecisive and scared? By economists opinion, this is because of strong contraction of money supply that has led to huge degradation of real economy sector - production and manufacturing. The pace of contraction has never seen before. This is M1 supply (cash). And with QT and massive new bond issues from the US Treasury - this contraction is not over yet.
And this is M2:
The decline in consumer inflation is evident, although it is higher than the indicators desired by the Fed leadership. But another trouble came out, the industrial downturn, which we have been describing for several months. And a natural question arises: if even now consumer inflation is higher than normal, then what will happen to it if Fed will start actions to stimulate production?
It is not just "the industry is falling". It means that the general level of wages is falling, that is, the standard of living (let me remind you, elections are coming!). And we see the results, including in real estate sales and mortgage demand. So, and What they gonna do with all this stuff? And if the BRICS countries (whose GDP is already significantly higher than the G7 countries) start real actions about creating an alternative currency system, what should they do?
It should be noted that all this is happening on a background of a structural recession, which has clearly manifested itself in recent weeks, especially in the European Union. So it's understandable why Powell is nervous. It can't start stimulating production and manufacturing, because it will trigger another inflation spiral. And it can't not stimulate it, otherwise, the country will drop in poverty. People already hope for higher wages, but where they could come from, if productivity is falling? Households' savings are melting, delinquencies on consumer credits are raising, as well as total interest payments burden. This brings real hazard to mid and small size banks.
With the big budget problems in US, we suggest that inflation will be stubborn and stays for longer. This is the paradox of our times, but as worse the US feels as more demand comes for the USD. Due to global USD domination investors need more cash to plug holes in dropping value of the assets and maintain the margin. That is what going to happen soon again. And now we're not along in anticipation of further USD growth. Indirectly Fidelity tells the same, pointing on Fixed income instruments, which now offer a yield premium of 180 basis points over stock dividend yields. This is the biggest figure in 15 years and the gap is likely to remain or even widen as traders bet low rates won't be around for a very long time.
In EU situation is much more complex, economy space is too fractional and economy already sends signs of exhausting. They can't lead rate to 5% definitely. Which means that the gap between EUR and USD should keep widening by two factors. First - interest rates differential, second - accelerating of fiscal US problems, which sould trigger more demand for safe haven assets and currencies. JPY now stands in jeopardy and goes out from safe haven list while CHF market is too small, which means that SNB once again will have to start massive interventions, as it was in 2008. So, keep it short - it seems that we could be at the eve of next extension stage of USD dollar strength.
This week, beyond some statistics, such as PMI's across the Globe, there were two major events - BRICS summit and Jackson Hole meeting in Wyoming. At first glance these events are totally independent. Because BRICS is political organisation, while Central banks meeting in Wyoming have discussed financial questions and interest rates policy. But this is only on the surface. In fact they have relation to each other. The topic of BRICS currency has triggered big resonance in media, although we've said that hardly any decisive steps will be taken right now in this direction, and they didn't, but still, some foundation has been put for next summit in Russia, in 2024.
So, I think it makes sense to split these two topics, by two reasons. First is - to not overload FX report and keep BRICS summit discussion for tomorrow. Second - because it has more relation to global finance, rather than just EUR/USD and mutual EU and the US economies balance. Finally, BRICS currency is also a geopolitical tool, so it would be better to talk about it in context of Gold market tomorrow. And today we have a lot of things to discuss even without it.
Market overview
The U.S. dollar held steady on Friday, on pace to finish the week strong, after Federal Reserve Chair Jerome Powell said the central bank may need to raise interest rates further to ensure inflation is contained, but promised to move "carefully" at upcoming meetings. Powell, in a speech at an economic summit in Jackson Hole, Wyoming, said policymakers would "proceed carefully as we decide whether to tighten further," but also made clear that the central bank has not yet concluded that its benchmark interest rate is high enough to be sure that inflation returns to the 2% target.
While not as hawkish a message as he delivered this time a year ago at the annual Jackson Hole Economic Policy Symposium, Powell's remarks still delivered a punch, with investors now seeing one more rate hike by year-end more likely than not. Although the decline was a "welcome development," Powell said, inflation "remains too high."
In interviews on the sidelines of the conference, other Fed policymakers expressed a range of views. "We probably have some work to do," Cleveland Fed President Loretta Mester said. Chicago Fed President Austan Goolsbee felt the focus may turn to figuring out how long to keep rates high, rather than on how much higher they should go.
The index, up 0.6% for the week, was on course for its sixth straight week of gains, aided by signs of resilience in the U.S. economy that has bolstered the case for rates staying higher for longer.
At day's end, futures contracts tied to the Fed policy rate were pricing in just less than a 20% chance of a rate hike in September, but a better-than-50% chance of the policy rate ending the year in a 5.5%-5.75% range, a quarter-point higher than the current range. Fed policymakers will also meet in November and December.
Both the euro and sterling have been hit this week by weak business activity data that has prompted investors to scale back bets on further rate hikes in the euro area and Britain. The common currency has come under pressure as ECB policymakers are increasingly worried about weakening growth prospects and, while the debate is still open, momentum for a pause in its interest rate increases is building, Reuters reported, citing eight sources with direct knowledge of the discussion.
The mood among German businesses deteriorated more than expected in August, data showed, falling for the fourth month in a row and adding to fears that the economy may be heading for its second recession inside a year.
The British pound dropped to a 10-week low on Friday as investors reined in expectations of where they think the Bank of England's interest rate might peak after recent soft activity data.
At lunch in Wyoming, Lagarde was asked about the idea of "moving the goalposts" to accommodate that new reality. Like Powell, she said no.
Traders on Wednesday scaled back bets for a September interest rate hike in the euro area following much weaker-than-expected business activity data from Germany, Europe's biggest economy.
Money market futures now price just a 40% chance of a quarter point rate hike from the European Central Bank next month, compared with roughly a 60% chance priced in ahead of the data . German business activity contracted at the fastest pace for more than three years in August, a preliminary survey showed on Wednesday. We will show you charts below. Not only Germany IFO, but PMI data across EU shows poor numbers.
The rate of contraction in business activity in the euro area accelerated in August. The decline in production dragged the service sector along with it. In Europe, PMI reached the reduction zone of the crisis years of 2012-2013. The three largest economies are falling - Germany, France, Britain.
Meantime, German property developer Gerch said on Thursday it had filed an application for restructuring proceedings with a local court, the latest real estate firm to run into financial trouble as the sector suffers its biggest crisis in decades. Duesseldorf-based Gerch, founded in 2016 and with a current project volume valued at 4 billion euros ($4.3 billion), said in a statement the move was "due to imminent inability to pay".
WHAT J. POWELL's SPEECH MEANS
Here we could start from our own analysis, but some most clever analysts do it for us. Once Wyoming official part was over, some interest articles have appeared in media. We just want to point on another thing that J. Powell said, but somehow this point was not widely announced. We've specified it in our Telegram channel - Falling inflation is likely to require a cooling in labor markets. Signs that the labor market is not cooling down may require additional action from the Fed.
And we think that this is probably most important phrase in all statement. Taking it in consideration together with wage growth expectations makes us think that market underestimates the hawkishness the Fed's future interest rates policy.
Second moment, which is actually the major one and that perfectly describes the Fed's problems, why they are trapped in the corner - they have absolutely opposite dynamic in manufacturing sector and services. We see strong deflation in production, which means industry destruction and contraction, and simultaneously inflation in service sector. Whatever tools the Fed will use - they will have the opposite impact on these two spheres and can't resolve the problem. But let's go step by step.
Powell's remarks and indecision showed the Fed wrestling with conflicting signals from an economy where inflation has by some readings slowed a lot without much cost to the economy - a good outcome, but one that has raised the possibility that Fed policy is not restrictive enough to complete the job. But longer term restrictive policy is a big hazard for manufacturing sector which already shows clear signs of contraction that are evident to everybody.
We talked about it for a long time, but now other analysts start talking about the same - Central bank efforts to slow inflation, by raising borrowing costs and cooling demand for goods and services, may also undermine investments in innovative technologies that could make the economy stronger in the long-run, according to research presented on Friday at a Federal Reserve economic symposium.
Yueran Ma, an economist at the University of Chicago Booth School of Business, and Kaspar Zimmermann, an economist at Germany's Leibniz Institute for Financial Research SAFE, found that an unanticipated 1-percentage-point tightening of monetary policy cut company research and development spending by up to 3%, reduced venture capital spending by an even deeper 25%, and reduced patents in what were considered "important" technologies by 9%.
They said correctly, but let's try to explain it a bit further - what is the real problem for the Fed. Despite that BRICS haven't announced any currency yet, but all Global economy society understands that this is just a question of time. BRICS's GDP, population, resource base are larger than G7, and with including S. Arabia, Iran and UAE now they de-facto could control 80% of crude oil market. taking into account the expansion of the number of participants, there is no doubt that in the fairly near future the issue of at least the settlement system will arise again. And this, of course, will be a very serious blow to the Bretton Woods system.
So, the US petrodollar system stands at the edge. And it is logical that western politicians, investors would like to hear from the leader what will be in the dollar world, and with the Bretton-Wood system. Powell did not say any clear explanations of what and how will happen in the dollar world, which cannot cause nothing but alarm among all economic entities.
Roughly speaking, since the situation in the US and other centers of western economy is clearly deteriorating and everyone can already see it, despite attempts to introduce optimism on the part of the US monetary authorities, the latter should say something. And their evasion of the answer creates high nervousness, especially on a background of the activity of the BRICS countries (of which there are already more than ten). And although these countries cannot have a single economic policy, but a single settlement system based on an alternative currency is quite can be.
Moreover, as the problems with the dollar increase, including due to the destruction of the Bretton Woods rules through the introduction of sanctions against Russia, the desire to create such a system is growing all the time. And a year later, at the summit in Kazan, this issue may arise in an absolutely constructive way. That, as it is clear, the stability of the dollar system will significantly shake.
But this is only half of the story. This challenge happens on evident worsening of global macroeconomics data, especially in production and manufacturing sector. Take a look:
And a few more:
Also you could take a look some data on the US domestic market - total households card loans hits 1 Trln level, Home price to households earnings ratio exceeds 2008 level, consumers interest rates payments and many more - just watch posts for the Friday. Our european colleagues make correct conclusion - inflation has finished its dirt job in production now turns to service sector. Hiring stumbles and despite output drop in real sector - the wage growth expectations (i.e. wage inflation) is growing:
Taking in consideration major Fed's points on Wyoming press conference, we wonder why J. Powell so indecisive and scared? By economists opinion, this is because of strong contraction of money supply that has led to huge degradation of real economy sector - production and manufacturing. The pace of contraction has never seen before. This is M1 supply (cash). And with QT and massive new bond issues from the US Treasury - this contraction is not over yet.
And this is M2:
The decline in consumer inflation is evident, although it is higher than the indicators desired by the Fed leadership. But another trouble came out, the industrial downturn, which we have been describing for several months. And a natural question arises: if even now consumer inflation is higher than normal, then what will happen to it if Fed will start actions to stimulate production?
It is not just "the industry is falling". It means that the general level of wages is falling, that is, the standard of living (let me remind you, elections are coming!). And we see the results, including in real estate sales and mortgage demand. So, and What they gonna do with all this stuff? And if the BRICS countries (whose GDP is already significantly higher than the G7 countries) start real actions about creating an alternative currency system, what should they do?
It should be noted that all this is happening on a background of a structural recession, which has clearly manifested itself in recent weeks, especially in the European Union. So it's understandable why Powell is nervous. It can't start stimulating production and manufacturing, because it will trigger another inflation spiral. And it can't not stimulate it, otherwise, the country will drop in poverty. People already hope for higher wages, but where they could come from, if productivity is falling? Households' savings are melting, delinquencies on consumer credits are raising, as well as total interest payments burden. This brings real hazard to mid and small size banks.
With the big budget problems in US, we suggest that inflation will be stubborn and stays for longer. This is the paradox of our times, but as worse the US feels as more demand comes for the USD. Due to global USD domination investors need more cash to plug holes in dropping value of the assets and maintain the margin. That is what going to happen soon again. And now we're not along in anticipation of further USD growth. Indirectly Fidelity tells the same, pointing on Fixed income instruments, which now offer a yield premium of 180 basis points over stock dividend yields. This is the biggest figure in 15 years and the gap is likely to remain or even widen as traders bet low rates won't be around for a very long time.
In EU situation is much more complex, economy space is too fractional and economy already sends signs of exhausting. They can't lead rate to 5% definitely. Which means that the gap between EUR and USD should keep widening by two factors. First - interest rates differential, second - accelerating of fiscal US problems, which sould trigger more demand for safe haven assets and currencies. JPY now stands in jeopardy and goes out from safe haven list while CHF market is too small, which means that SNB once again will have to start massive interventions, as it was in 2008. So, keep it short - it seems that we could be at the eve of next extension stage of USD dollar strength.
