Sive Morten
Special Consultant to the FPA
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Fundamentals
The major event of this week was a release of PPI numbers, of course. But it doesn't make the Fed's life easier, and I would say the headache even is becoming stronger. As Fed was thinking last two weeks on what to do next - either to keep tightening or to take a pause. PPI numbers itself also was mixed. The producer price index for final demand climbed 0.3% for a third month and was up 7.4% from a year earlier, Labor Department data showed Friday. The monthly gains for October and September were revised higher.
Thus, although our primary PPI Commodity indicators shows downside direction:
Common PPI indicator and Core monthly PPI show upside tick for 0.3%. The most important thing is Core PPI growth, which stands in recent three months. This is the process that is typical for structural crisis. Inflation data is losing some volatility, as major outbreaks are smoothing, especially in energy sector. But, general inflation becomes stable and spreads over all economy spheres.
Excluding the volatile food and energy components, the so-called core PPI rose 0.4% in November and increased 6.2% on an annual basis. With core-goods inflation easing, attention is shifting to price growth in the services side of the economy. The housing components, which are currently a key driver of consumer inflation, are expected to eventually turn, but wages may prove key to the ultimate path of inflation.
Friday’s report showed goods prices crept up 0.1%, driven by higher food costs. Services prices registered the strongest advance in three months, with a 0.4% gain. The gain reflected higher costs for securities brokerage advice, machinery and vehicle wholesaling and portfolio management.
Fed Chair Jerome Powell said in a recent speech that core services ex-housing, as measured by an index tied to personal consumption, “may be the most important category for understanding the future evolution of core inflation.” And that the “labor market holds the key to understanding inflation in this category.”
So, the Fed's leaders will have to make a difficult decision. At the same time, it should be borne in mind that there is no improvement in the macroeconomic situation.
Last time we've considered the wide array of statistics as in US as in EU, that shows major trend in a whole economy. We've considered PMI, Labor, Housing market, consumption etc. Business activity is slowing across the board:
If we take a look at weekly employment data then we see that Continuing claims are keep going higher:
Although we do not see effect directly in NFP or Unemployment data. But indirectly more and more headlines appear concerning layoffs in big companies. This week they are Morgan Stanley and BlackRock:
BlackRock has frozen hires, reduced spending, says CFO. Earlier in October, BlackRock said its assets under management dropped 16% year-on-year to $7.96 billion, as a stronger dollar dampened the value of investments in Europe and Asia. Its net income also fell 17%. Shedlin warned earlier in October, when the company announced its third-quarter results, that it had begun "to more aggressively manage the pace of certain discretionary spend."
Morgan Stanley cuts about 2% of its workforce. The job cuts, first reported by CNBC, affect about 1,600 positions and follow workforce reductions at Goldman Sachs Group Inc. and Citigroup Inc. Morgan Stanley is making modest job cuts worldwide, Chief Executive Officer James Gorman said last week. The bank had more than 81,000 employees worldwide as of Sept. 30, according to a quarterly filing.
Indeed, the US labor statistic by itself is a very distorted and cannot be the basis for objective conclusions. But the fact that the unemployment data has been deteriorating for more than a month may be an indirect indication that the situation in this area is not the best.
So, crisis processes, as it should be in a structural crisis, develop gradually. No jerks, collapses or other negative phenomena. This is how the situation developed from the spring of 1930 to the end of 1932. But there is one nuance. 1930s structural crisis was preceded by the collapse of the stock market in the fall of 1929. Today, the crisis follows an inflationary, but not deflationary scenario, and no real collapse has happened yet, but there are dangerous symptoms - 3-month US yields exceed 30 year yields for 25%. Usually, the yield of short US Treasury securities is lower than long-term ones. This is natural, since the yield on them accumulates several times during the duration of the "long" paper. But now the yield of "short" securities is higher, and the gap has reached record values.
The current situation means that market participants are afraid of sudden events, possibly a collapse. It should be noted that there has been no experience of a structural inflationary crisis with an overheated market so far. In the 70s, inflation was low, and there was practically no danger of a collapse of financial markets, because the "bubble" had not formed. And before that, structural crises were in a "gold standard" situation, which excluded inflationary options for their development.
Thus, there was no analogue of the current situation in history, which makes it very difficult to assess the situation. We cannot refer to analogies, so it is quite difficult to determine when the market collapse will begin. If the structural crisis itself is developing quite stably and in full accordance with the theory (not liberal, of course as they recognize only cyclical ones), then everything is much more complicated with the behavior of the stock market in this situation.
The biggest U.S. banks are bracing for a worsening economy next year as inflation threatens consumer demand, according to executives Tuesday. JPMorgan Chase & Co Chief Executive Jamie Dimon told CNBC that consumers and companies are in good shape, but noted that may not last much longer as the economy slows down and inflation erodes consumer spending power.
Consumers have $1.5 trillion in excess savings from pandemic stimulus programs, but it may run out some time in mid-2023, he told CNBC. Dimon also said the Federal Reserve may pause for three to six months after raising benchmark interest rates to 5%, but that may "not be sufficient" to curb high inflation.
FED/ECB Balance
Situation was relatively clear in recent few months. Fed was pushing the full throttle while ECB damaged at the starting point, so nobody had doubts on who was taking the lead. Now, with the Fed hints on slowdown the rate hike it is reasonable question appears - could EUR overcome the USD, if EUR will keep strong pace of rate change? Recent comments suggest that EUR success could be only on short distance and status quo will be re-established relatively fast.
Though the greenback has stumbled in recent weeks, recession worries may keep it elevated in 2023. At its September peak, the dollar stood at its highest level in nearly two decades after rising some 20% against a basket of currencies. Those year-to-date gains have been roughly cut in half as investors bet the Federal Reserve is closer to slowing the pace of the rate increases that helped fuel the dollar's gains.
Even after paring some of its gains, the dollar is still on track for its best year since 2014. Fund managers surveyed by BoFA Global Research named it the market's most crowded trade for the fifth straight month in November and a record number of survey participants said the currency was overvalued. Still, the Dec. 1-6 Reuters poll of 66 foreign exchange strategists suggested the greenback will trade around current levels a year from now and hold on to its near-10% gains so far this year, despite its recent setback. Nearly two-thirds or 33 of 51 strategists who answered an additional question said the greater dollar risk over the coming month was that it would rebound rather than falling further.
While relatively better U.S. economic performance and higher interest rates compared to its major peers helped the dollar to outperform nearly every currency, that trade based on rate differentials was mostly nearing its end. Most major central banks, including the Fed, are expected to end their tightening campaigns in early 2023. An overwhelming 80% majority, or 42 of 51 respondents, said there was not much scope for dollar upside based on monetary policy.
So, many investors expect that global central bank policy tightening hurts growth and boosts the greenback’s safe-haven appeal once again. Despite the dollar's recent pullback, major currencies are not expected to recoup their 2022 losses against the USD until at least late 2023, the survey showed.
The euro , up 10% against the dollar since its record low in September but still down nearly 8% this year, was expected to lose around 3% by end-February to trade at $1.02. It was expected to climb higher to trade around $1.07 in a year.
So, from this information we could set two major drivers for EUR/USD performance. First is - ECB rate change, as Fed rate cycle is coming to an end, with expectations of 0.5% step in December and 0.25% in Feb 2023. Second, which is not obvious now but it is correct - the exchange rate will be driven by real yields as ability of rate hiking by Central Banks are exhausted. Other words speaking, as greater (interest rate - inflation rate) will be as weaker currency we get. After both, as the Fed as ECB will stop change rates, reaching of threshold national economy level which will be dangerous to break, the currency dynamic will be based on domestic inflation. Something tells me that hardly EU data will be better than in US. And other analysts also hint on this.
European Central Bank interest rates will go up again but are now "very near" their neutral level, ECB policymaker Constantinos Herodotou said on Tuesday.
Having raised rates by a combined 200 basis points since July, the ECB is expected to hike by another 50 basis points on Dec 15, slowing the pace of policy tightening after back-to-back 75 point moves. So, ECB is already decreasing the pace, having rate two times lower than the US but inflation 1.5 times higher.
Personal consumption is becoming worse and worse in EU. As in the US, demand is supported by depletion of savings and credit activity, but the supply of resources is limited because in terms of income, the situation in Europe is much worse than in the USA.
Retail sales in the Eurozone are only 2.2% higher than in January 2020 (the last month without offensive restrictions). Compared to last year, retail sales are down 2.7%, and across Europe minus 2.4%. There is an accelerated decrease in food and beverage consumption by 3.9% YoY against the background of record inflation in this segment, which highlights the blow to the least affluent class of the population in Europe.
In general, the lower the income cluster of the population (poorer), the higher the inflation, because for fuel, electricity, food and utilities, inflation is the highest, which collectively exceeds 20% per annum. Here is the greatest rout. Among the major countries, the most unstable situation is in most developed countries, such as Germany (-4.9%), Belgium (-5.7%), Denmark (-9.7%), Sweden (-6.4%) and some others.
At the same time Europe is actively de-industrializing due to fight for energy independence. Thus, gas consumption has dropped for 23% this year. This is more than suggested EU plan of gas consumption reducing for 15%. The leading European countries (Germany, France, Italy and Spain) have reduced gas consumption by 20-32% in industry, where Germany has reduced demand the most, but in the electric power industry, gas consumption has fallen only for 12% on average. So, Electricity takes the priority over industrial sector. This is not the EU policy measures, but the economy rules. Gas prices have increased so much that the profitability of production becomes negative.
Thus, Industry statistics for November should be devastating, because the main effect of demand compression began in October and continues to the present.
The bottom line
I would say it in few points:
The major event of this week was a release of PPI numbers, of course. But it doesn't make the Fed's life easier, and I would say the headache even is becoming stronger. As Fed was thinking last two weeks on what to do next - either to keep tightening or to take a pause. PPI numbers itself also was mixed. The producer price index for final demand climbed 0.3% for a third month and was up 7.4% from a year earlier, Labor Department data showed Friday. The monthly gains for October and September were revised higher.
Thus, although our primary PPI Commodity indicators shows downside direction:
Common PPI indicator and Core monthly PPI show upside tick for 0.3%. The most important thing is Core PPI growth, which stands in recent three months. This is the process that is typical for structural crisis. Inflation data is losing some volatility, as major outbreaks are smoothing, especially in energy sector. But, general inflation becomes stable and spreads over all economy spheres.
Excluding the volatile food and energy components, the so-called core PPI rose 0.4% in November and increased 6.2% on an annual basis. With core-goods inflation easing, attention is shifting to price growth in the services side of the economy. The housing components, which are currently a key driver of consumer inflation, are expected to eventually turn, but wages may prove key to the ultimate path of inflation.
Friday’s report showed goods prices crept up 0.1%, driven by higher food costs. Services prices registered the strongest advance in three months, with a 0.4% gain. The gain reflected higher costs for securities brokerage advice, machinery and vehicle wholesaling and portfolio management.
Fed Chair Jerome Powell said in a recent speech that core services ex-housing, as measured by an index tied to personal consumption, “may be the most important category for understanding the future evolution of core inflation.” And that the “labor market holds the key to understanding inflation in this category.”
So, the Fed's leaders will have to make a difficult decision. At the same time, it should be borne in mind that there is no improvement in the macroeconomic situation.
Last time we've considered the wide array of statistics as in US as in EU, that shows major trend in a whole economy. We've considered PMI, Labor, Housing market, consumption etc. Business activity is slowing across the board:
If we take a look at weekly employment data then we see that Continuing claims are keep going higher:
Although we do not see effect directly in NFP or Unemployment data. But indirectly more and more headlines appear concerning layoffs in big companies. This week they are Morgan Stanley and BlackRock:
BlackRock has frozen hires, reduced spending, says CFO. Earlier in October, BlackRock said its assets under management dropped 16% year-on-year to $7.96 billion, as a stronger dollar dampened the value of investments in Europe and Asia. Its net income also fell 17%. Shedlin warned earlier in October, when the company announced its third-quarter results, that it had begun "to more aggressively manage the pace of certain discretionary spend."
Morgan Stanley cuts about 2% of its workforce. The job cuts, first reported by CNBC, affect about 1,600 positions and follow workforce reductions at Goldman Sachs Group Inc. and Citigroup Inc. Morgan Stanley is making modest job cuts worldwide, Chief Executive Officer James Gorman said last week. The bank had more than 81,000 employees worldwide as of Sept. 30, according to a quarterly filing.
Indeed, the US labor statistic by itself is a very distorted and cannot be the basis for objective conclusions. But the fact that the unemployment data has been deteriorating for more than a month may be an indirect indication that the situation in this area is not the best.
So, crisis processes, as it should be in a structural crisis, develop gradually. No jerks, collapses or other negative phenomena. This is how the situation developed from the spring of 1930 to the end of 1932. But there is one nuance. 1930s structural crisis was preceded by the collapse of the stock market in the fall of 1929. Today, the crisis follows an inflationary, but not deflationary scenario, and no real collapse has happened yet, but there are dangerous symptoms - 3-month US yields exceed 30 year yields for 25%. Usually, the yield of short US Treasury securities is lower than long-term ones. This is natural, since the yield on them accumulates several times during the duration of the "long" paper. But now the yield of "short" securities is higher, and the gap has reached record values.
The current situation means that market participants are afraid of sudden events, possibly a collapse. It should be noted that there has been no experience of a structural inflationary crisis with an overheated market so far. In the 70s, inflation was low, and there was practically no danger of a collapse of financial markets, because the "bubble" had not formed. And before that, structural crises were in a "gold standard" situation, which excluded inflationary options for their development.
Thus, there was no analogue of the current situation in history, which makes it very difficult to assess the situation. We cannot refer to analogies, so it is quite difficult to determine when the market collapse will begin. If the structural crisis itself is developing quite stably and in full accordance with the theory (not liberal, of course as they recognize only cyclical ones), then everything is much more complicated with the behavior of the stock market in this situation.
The biggest U.S. banks are bracing for a worsening economy next year as inflation threatens consumer demand, according to executives Tuesday. JPMorgan Chase & Co Chief Executive Jamie Dimon told CNBC that consumers and companies are in good shape, but noted that may not last much longer as the economy slows down and inflation erodes consumer spending power.
Consumers have $1.5 trillion in excess savings from pandemic stimulus programs, but it may run out some time in mid-2023, he told CNBC. Dimon also said the Federal Reserve may pause for three to six months after raising benchmark interest rates to 5%, but that may "not be sufficient" to curb high inflation.
FED/ECB Balance
Situation was relatively clear in recent few months. Fed was pushing the full throttle while ECB damaged at the starting point, so nobody had doubts on who was taking the lead. Now, with the Fed hints on slowdown the rate hike it is reasonable question appears - could EUR overcome the USD, if EUR will keep strong pace of rate change? Recent comments suggest that EUR success could be only on short distance and status quo will be re-established relatively fast.
Though the greenback has stumbled in recent weeks, recession worries may keep it elevated in 2023. At its September peak, the dollar stood at its highest level in nearly two decades after rising some 20% against a basket of currencies. Those year-to-date gains have been roughly cut in half as investors bet the Federal Reserve is closer to slowing the pace of the rate increases that helped fuel the dollar's gains.
Even after paring some of its gains, the dollar is still on track for its best year since 2014. Fund managers surveyed by BoFA Global Research named it the market's most crowded trade for the fifth straight month in November and a record number of survey participants said the currency was overvalued. Still, the Dec. 1-6 Reuters poll of 66 foreign exchange strategists suggested the greenback will trade around current levels a year from now and hold on to its near-10% gains so far this year, despite its recent setback. Nearly two-thirds or 33 of 51 strategists who answered an additional question said the greater dollar risk over the coming month was that it would rebound rather than falling further.
While relatively better U.S. economic performance and higher interest rates compared to its major peers helped the dollar to outperform nearly every currency, that trade based on rate differentials was mostly nearing its end. Most major central banks, including the Fed, are expected to end their tightening campaigns in early 2023. An overwhelming 80% majority, or 42 of 51 respondents, said there was not much scope for dollar upside based on monetary policy.
So, many investors expect that global central bank policy tightening hurts growth and boosts the greenback’s safe-haven appeal once again. Despite the dollar's recent pullback, major currencies are not expected to recoup their 2022 losses against the USD until at least late 2023, the survey showed.
The euro , up 10% against the dollar since its record low in September but still down nearly 8% this year, was expected to lose around 3% by end-February to trade at $1.02. It was expected to climb higher to trade around $1.07 in a year.
So, from this information we could set two major drivers for EUR/USD performance. First is - ECB rate change, as Fed rate cycle is coming to an end, with expectations of 0.5% step in December and 0.25% in Feb 2023. Second, which is not obvious now but it is correct - the exchange rate will be driven by real yields as ability of rate hiking by Central Banks are exhausted. Other words speaking, as greater (interest rate - inflation rate) will be as weaker currency we get. After both, as the Fed as ECB will stop change rates, reaching of threshold national economy level which will be dangerous to break, the currency dynamic will be based on domestic inflation. Something tells me that hardly EU data will be better than in US. And other analysts also hint on this.
European Central Bank interest rates will go up again but are now "very near" their neutral level, ECB policymaker Constantinos Herodotou said on Tuesday.
Having raised rates by a combined 200 basis points since July, the ECB is expected to hike by another 50 basis points on Dec 15, slowing the pace of policy tightening after back-to-back 75 point moves. So, ECB is already decreasing the pace, having rate two times lower than the US but inflation 1.5 times higher.
Personal consumption is becoming worse and worse in EU. As in the US, demand is supported by depletion of savings and credit activity, but the supply of resources is limited because in terms of income, the situation in Europe is much worse than in the USA.
Retail sales in the Eurozone are only 2.2% higher than in January 2020 (the last month without offensive restrictions). Compared to last year, retail sales are down 2.7%, and across Europe minus 2.4%. There is an accelerated decrease in food and beverage consumption by 3.9% YoY against the background of record inflation in this segment, which highlights the blow to the least affluent class of the population in Europe.
In general, the lower the income cluster of the population (poorer), the higher the inflation, because for fuel, electricity, food and utilities, inflation is the highest, which collectively exceeds 20% per annum. Here is the greatest rout. Among the major countries, the most unstable situation is in most developed countries, such as Germany (-4.9%), Belgium (-5.7%), Denmark (-9.7%), Sweden (-6.4%) and some others.
At the same time Europe is actively de-industrializing due to fight for energy independence. Thus, gas consumption has dropped for 23% this year. This is more than suggested EU plan of gas consumption reducing for 15%. The leading European countries (Germany, France, Italy and Spain) have reduced gas consumption by 20-32% in industry, where Germany has reduced demand the most, but in the electric power industry, gas consumption has fallen only for 12% on average. So, Electricity takes the priority over industrial sector. This is not the EU policy measures, but the economy rules. Gas prices have increased so much that the profitability of production becomes negative.
Thus, Industry statistics for November should be devastating, because the main effect of demand compression began in October and continues to the present.
The bottom line
I would say it in few points:
- Obviously EU has lower threshold for ultimate rate level than the US. We call the threshold is the one that could start hurting national economy and make devastating processes out of control;
- EU has higher inflation that in the US, but lower threshold - this is potentially weak combination for the EUR;
- We could use JP Morgan comments as a beacon now - reaching of 5% level by the Fed and pause for 3-6 months. And even this measures could be not sufficient to curb inflation by JP Morgan view. This is indirectly confirms what we've said last time. Fed takes the pause not because of Inflation's defeat but because of two reasons - tightening brings no fruits and they do not know what to do next. ECB is nowhere near the 5% rate by the way...
- Due to sophisticated economical structure of EU and its fragmentation, deteriorating processes as in heavy industry (mostly petro-chemistry, chemistry, metallurgy, production of building materials, production of fertilizers, etc) as in social sphere suggests that US economy should outperform EU one in near term.
- Here we do not mention the US "Tax law" that directly hurt EU rivals, massive run of EU companies to other countries (US, China). Recent E. Macron visit to the US suggest that EU would like to get answer from the US - what will happen to EU and what they now would going to do, but it seems he has got no answers. it's a sink-or-swim world. The US has got everything that they wanted from EU, and do not care all the other.
