Sive Morten
Special Consultant to the FPA
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Fundamentals
So, we've got very dramatic Friday's action, as ADP on Thu and NFP on Friday have made the day. Earlier in the week FOMC minutes release has brought more mess, as markets first have reacted down on hawkish Fed and later have had to change the mind on new NFP data. Somehow markets treat recent employment data in positive way, building positive plans on 2023, and as we will show you below, expecting economy recovery as soon as in the IIIQ of 2023. Our opinion is based on dynamic of other statistics, which makes us think that structural crisis is not over yet, and will last at least for 2-3 years more. The fact that job market still could show some positive numbers is a short term and means that economy infrastructural degradation is not started yet at full capacity. Additionally, the overall crisis processes are slowing by Fed stimulus. This makes us think that recent upside spike is mostly emotional and have no chances to last for too long.
Market overview
Gold held near seven-month highs reached on Wednesday after the minutes of the Federal Reserve's last meeting showed all its policymakers remained committed to fighting inflation, but agreed on the need to slow rate hikes in 2023. The eagerly-anticipated Fed minutes arrived and failed to surprise, with markets broadly shrugging off the hawkish tone and still pining for a rate cut sometime this year.
The minutes of the meeting, which were released on Wednesday, showed policymakers still focused on controlling the pace of price increases that threatened to run hotter than anticipated, and worried about any "misperception" in financial markets that their commitment to fighting inflation was flagging. The central bank now needed to balance its fight against rising prices with the risks of slowing the economy too much and "potentially placing the largest burdens on the most vulnerable groups" through higher-than-necessary unemployment.
Interest-rate futures, too, showed traders largely sticking to bets the Fed will lift the target interest rate to just shy of 5% in coming months and then begin cutting it in the second half of the year. Fed officials in December projected that rate, currently in the 4.25%-4.50% range, would rise to just over 5% by the end of 2023 and likely remain there for some time. How long "restrictive" monetary policy will be needed could become an emerging topic of debate.
Kansas City Federal Reserve leader Esther George said on Thursday that she hopes the central bank will continue its efforts to shrink its balance sheet, while also warning that she believes the Fed will need to press forward with rate rises and keep them high for some time once the tightening process ends.
Inflation in the United States has not "turned the corner yet" and it is too early for the Federal Reserve to declare victory in the fight on rising prices, a top IMF official said in an interview with the Financial Times on Thursday. Gita Gopinath, a deputy managing director of the Fund, urged the U.S. central bank to press ahead with rate rises this year.
In the interview Gopinath added that she expected China's economy to suffer significantly in the near term. A rebound is possible later this year, however, as Chinese demand recovers, the report quoted her as saying.
Global equity funds witnessed net outflows for a ninth straight week. According to Refinitiv Lipper data, global equity funds recorded a net $15.42 billion worth of withdrawals, compared with just $791 million worth of disposals in the previous week. Last year, investors pulled out $172 billion and $354 billion from global equity and bond funds, respectively, as U.S. interest rates marched higher due to monetary policy rate hikes from the Federal Reserve.
Here is how markets treat recent job report. Later in this research that it is far from reality, if you take a complex view... But here is why markets across the board have shown impressive rally on Friday:
The U.S. economy added jobs at a solid clip in December, pushing the unemployment rate back to a pre-pandemic low of 3.5% as the labor market remains tight, but Federal Reserve officials could draw some solace from a moderation in wage gains. Still, the U.S. central bank's fight against inflation is far from being won. The Labor Department's closely watched employment report on Friday also showed household employment rebounding by a whopping 717,000 jobs last month.
Recent declines in household employment had fanned speculation that nonfarm payrolls, the main measure of employment gains, were overstating job growth.
A jump in the workforce and easing wage growth suggests the U.S. job market is starting to move the way the Federal Reserve has hoped it will, to bring the supply and demand for workers into better balance and help in its battle against inflation. Nearly 165 million people were either in jobs or looking for them last month, a record high that showed a long-hoped-for improvement in labor supply. U.S. firms added 223,000 payroll jobs to cap a year in which 4.5 million people were hired, a total exceeded in the post-World War Two era only by 2021's 6.7 million.
At the same time, hourly wages - the price of labor - grew at the slowest annual pace in 16 months and has dropped by a full percentage point since the end of the first quarter of 2022. Weekly average earnings gained 3.1%, the slowest pace since May 2021.
Traders took the report as evidence the Fed's work is near to being done. U.S. stocks rose and interest-rate futures traders added to bets the Fed will slow its rate hike pace further at its Jan. 31-Feb. 1 meeting and ultimately stop short of the 5.00%-5.25% policy rate range that nearly all U.S. central bankers have signaled they believe will be needed to bring inflation to heel.
Atlanta Fed President Raphael Bostic on Friday said he expects the policy rate this year to get to the range just above 5.00% that he and his colleagues signaled last month and stay there until "well" into 2024. That's a stark contrast to traders' expectations for the policy rate, now in the 4.25%-4.50% range, to top out at 4.75%-5.00% and then for the Fed to begin cutting borrowing costs in the second half of this year.
More inflation data due next week will play into the Fed's calculus about where to go in the months ahead, with the Labor Department's Consumer Price Index expected to show price pressures had softened further in December. The annual CPI rate is expected to have dropped to a 14-month low of 6.5% in December from 7.1% in the prior month, and the month-to-month rate is forecast to have been unchanged, an abrupt turnaround for a measure that had been running at its highest rate since the early 1980s just six months earlier.
So, why it is so big contract of market expectations and Fed plans?
Come Back to Earth - (instead of bottom line)
First, let's take a look at some additional statistics and try to combine it together with recent NFP data and positive mood as a result of it. So, please explain me, how we could combine higher employment with shorter average work week? So, we're hiring to make people work less? How we could combine constant rising of continues claims in recent 3-4 months, decreasing of the vacancies amount with the new jobs created at high tempo? If we have so perfect job market with near the "soft landing" for Fed, why employees report on 364K job cuts in 2022 - 13% above 2021 and the 2nd worst result in 30 years?
Finally let's take a look at cross sector statistics. US recently has significantly improved Trade Balance. It dropped to "just 60 Bln", and becomes almost two times smaller. But this is not because of increasing national economy capacity. This is because of drastic cut of import. This is deflationary sign and sign of drop in economy, as people start consume less. This is also confirms by other countries, for example Taiwan export has dropped for 12.1% in December - 4th month in a row, which is perfectly agrees with the US Trade balance dynamic.
People are loosing consumption power. Tell me, how it is possible with high employment? We should see opposite picture. Finally - why we have decrease production in all spheres - industry, service, manufacturing etc. PMI's are dropping across the board. If 96% of population are working, wages are rising at high rate (6-10% this year) - PMI in all spheres should rise. At least we have 2.3% GDP growth, don't we? Why people are working but do not consume? Whether they do save for future? No - savings stand around 2.34% - lowest level ever. What is going on?
The answer is - job market has not reached yet the threshold level due to government support and disbalances in banking sector. People are loosing wealth, real income value but due to money over-supply, banks could provide them loans with the rates under Fed level. This lets small and mid business stay on the surface by far. We think that this is short term situation. Very soon it starts to change. Previously we've said many times that we're now in "structural crisis", this is not the cyclical recession. It calls structural also because the economy infrastructure (logistics, producing powers, business models etc) was structured for high level of consumption. Now, with the drop in demand and consumption, the constant expenses are rising, triggering the chain reaction. For example, if you have production line. Usually you sell 10 units of some goods per month. But now you could sell only 5 units. You could get even the same revenue due higher price level, but your capital is not reproduced itself, so you can't just keeping produce 10 units anymore as it will lead to rising expenses on over-supply and excess of goods storage. You probably could stop the line for half time, but you anyway have to keep engineers that serve it. So your constant expenses takes larger part in cost of goods. It means that your business infrastructure doesn't fit to new economy and you have to restructure it for less consumption level. And this has to be done everywhere. Do you understand the scale of the problem?
Now this process is already underway, and we see it in PMI, Production etc. But due to solid government support, excess of liquidity - consumption remains high by far. This lets companies to hire, and keep existed jobs. That's why job market now shows absolute outbreak compares to other economy statistics. With exhausting of Fed reserves, and QT programme, situation will start to change very soon. We do not believe in "soft landing" and situation improvement in 2nd half of 2024. Even vice versa - crisis processes should become evident and job market has to join the common tendency.
One of the major signs of this change should be the drop on stock market. But take a look - how positive markets are. They draw corporate profits rise, starting from 3Q of 2023:
It is no need to remind about Real Estate market. Take a look at the charts above - just minor up tick in Mortage rate has crushed Mortage applications for 10%+ in a week!
If you think that it is different in other countries - it is not. For example in Germany we see the same thing as in the US - massive drop of import and together with record drop of Consumption. This is evident sign of economy contraction and loose of personal purchasing power.
That's being said, the Fed minutes shows that the mood of the board members is returned to hawkish. In other words, they believe that it is necessary to raise rates further, it is impossible to lower them in 2023, too low rates are dangerous and harmful because of the constant threat of inflation.
The denying to slow down the rate suggests that the members of the Fed board realized that the effect of rate hiking policy doesn't match to their expectations. Other words, the rate of inflation slowdown is insignificant, and the economic downturn continues quite regularly, not very dependent on the rate increase.
There are not so many options. Roughly speaking, in order to stop the recession, it is necessary to stimulate the economy, and this will cause an increase in already high inflation. But if the rate is sharply increased again, then inflation maybe (!) will decrease and it will be possible to improve the economy.
Recall that the structural crisis is associated with the degradation and destruction of the excess part of the economy, which has grown over decades of excessive economic stimulation. Note that there were experts in the United States who talked about this for a long time, we can only recall former Congressman Ron Paul, who 15 years ago proposed raising the rate to values comparable to the late 70s (that is, up to about 20%). And then, Ron Paul said, the economy will shrink, but it will improve and it will be possible to "start from a solid bottom" and start sustainable growth.
But no one in the United States (including Ron Paul) understands how much the American economy will fall. According to expert opinions , today this decline will be at least 55-60%. From the real GDP of the United States, which is about $ 15 trillion. So it has to be around $5-7 Trln
In other words, the current leadership of the Fed, in fact, offers Ron Paul's plan, only stretched for many months and, very likely, not applicable in the logic of Paul himself. Because there was no structural crisis in 70's, but today it has already begun, and therefore the structural component of inflation will not go away, even if the rate, albeit gradually, is raised to 20%.
Just like a year ago, we saw record inflation figures in every report, now we see record indicators of the collapse of industry (for several months now), the service sector (in recent weeks) and the real estate market (primarily in the United States). Well, the drop in retail sales, which best show the general state of aggregate demand and the state of the economy, since the vast majority of the GDP of any developed countries is private demand.
In other words, the crisis is not just developing, it is developing very consistently and confidently. At the same time, the decrease in inflation does not have any positive effect, it is largely a deflationary effect associated with a decline in the economy and demand. Well, even taking into account the obvious decline, which cannot be hidden, inflation is still quite high.
Raising the cost of credit in such a situation is an incredible risk. Moreover, since poor citizens cannot reduce their already low consumption, we can only talk about reducing the demand of the "middle" class. That is, in fact, we are talking about a massive transition of representatives of this class to the state of the poor.
But the decline in the number of the "middle" class will inevitably affect the structure of consumption. The demand for more or less high-quality goods will fall more than the aggregate demand as a whole and this will only spur the degradation processes in the economy, the structural crisis will receive a new impetus. So we can safely say that there are no trends towards ending the crisis. Of course, this followed from the theory of structural crises, but theory is one thing, and observable reality is another.
That's why we do not to buy into the idea of "soft landing" and "Strong job market". By our opinion average positive NFP numbers just tell that the turn of job market is yet to come. In EU situation stands even worse - inflation is higher, drop of production and consumption stronger. Thus, it is early to speak of EUR/USD reversal either. Median forecasts showed the euro will trade at $1.04, $1.06 in the next three and six months respectively. It is then forecast to change hands around $1.10 in a year, a near 4% gain from current levels.
So, we've got very dramatic Friday's action, as ADP on Thu and NFP on Friday have made the day. Earlier in the week FOMC minutes release has brought more mess, as markets first have reacted down on hawkish Fed and later have had to change the mind on new NFP data. Somehow markets treat recent employment data in positive way, building positive plans on 2023, and as we will show you below, expecting economy recovery as soon as in the IIIQ of 2023. Our opinion is based on dynamic of other statistics, which makes us think that structural crisis is not over yet, and will last at least for 2-3 years more. The fact that job market still could show some positive numbers is a short term and means that economy infrastructural degradation is not started yet at full capacity. Additionally, the overall crisis processes are slowing by Fed stimulus. This makes us think that recent upside spike is mostly emotional and have no chances to last for too long.
Market overview
Gold held near seven-month highs reached on Wednesday after the minutes of the Federal Reserve's last meeting showed all its policymakers remained committed to fighting inflation, but agreed on the need to slow rate hikes in 2023. The eagerly-anticipated Fed minutes arrived and failed to surprise, with markets broadly shrugging off the hawkish tone and still pining for a rate cut sometime this year.
The minutes of the meeting, which were released on Wednesday, showed policymakers still focused on controlling the pace of price increases that threatened to run hotter than anticipated, and worried about any "misperception" in financial markets that their commitment to fighting inflation was flagging. The central bank now needed to balance its fight against rising prices with the risks of slowing the economy too much and "potentially placing the largest burdens on the most vulnerable groups" through higher-than-necessary unemployment.
Interest-rate futures, too, showed traders largely sticking to bets the Fed will lift the target interest rate to just shy of 5% in coming months and then begin cutting it in the second half of the year. Fed officials in December projected that rate, currently in the 4.25%-4.50% range, would rise to just over 5% by the end of 2023 and likely remain there for some time. How long "restrictive" monetary policy will be needed could become an emerging topic of debate.
Kansas City Federal Reserve leader Esther George said on Thursday that she hopes the central bank will continue its efforts to shrink its balance sheet, while also warning that she believes the Fed will need to press forward with rate rises and keep them high for some time once the tightening process ends.
Inflation in the United States has not "turned the corner yet" and it is too early for the Federal Reserve to declare victory in the fight on rising prices, a top IMF official said in an interview with the Financial Times on Thursday. Gita Gopinath, a deputy managing director of the Fund, urged the U.S. central bank to press ahead with rate rises this year.
In the interview Gopinath added that she expected China's economy to suffer significantly in the near term. A rebound is possible later this year, however, as Chinese demand recovers, the report quoted her as saying.
Global equity funds witnessed net outflows for a ninth straight week. According to Refinitiv Lipper data, global equity funds recorded a net $15.42 billion worth of withdrawals, compared with just $791 million worth of disposals in the previous week. Last year, investors pulled out $172 billion and $354 billion from global equity and bond funds, respectively, as U.S. interest rates marched higher due to monetary policy rate hikes from the Federal Reserve.
Here is how markets treat recent job report. Later in this research that it is far from reality, if you take a complex view... But here is why markets across the board have shown impressive rally on Friday:
The U.S. economy added jobs at a solid clip in December, pushing the unemployment rate back to a pre-pandemic low of 3.5% as the labor market remains tight, but Federal Reserve officials could draw some solace from a moderation in wage gains. Still, the U.S. central bank's fight against inflation is far from being won. The Labor Department's closely watched employment report on Friday also showed household employment rebounding by a whopping 717,000 jobs last month.
Recent declines in household employment had fanned speculation that nonfarm payrolls, the main measure of employment gains, were overstating job growth.
A jump in the workforce and easing wage growth suggests the U.S. job market is starting to move the way the Federal Reserve has hoped it will, to bring the supply and demand for workers into better balance and help in its battle against inflation. Nearly 165 million people were either in jobs or looking for them last month, a record high that showed a long-hoped-for improvement in labor supply. U.S. firms added 223,000 payroll jobs to cap a year in which 4.5 million people were hired, a total exceeded in the post-World War Two era only by 2021's 6.7 million.
At the same time, hourly wages - the price of labor - grew at the slowest annual pace in 16 months and has dropped by a full percentage point since the end of the first quarter of 2022. Weekly average earnings gained 3.1%, the slowest pace since May 2021.
Traders took the report as evidence the Fed's work is near to being done. U.S. stocks rose and interest-rate futures traders added to bets the Fed will slow its rate hike pace further at its Jan. 31-Feb. 1 meeting and ultimately stop short of the 5.00%-5.25% policy rate range that nearly all U.S. central bankers have signaled they believe will be needed to bring inflation to heel.
Atlanta Fed President Raphael Bostic on Friday said he expects the policy rate this year to get to the range just above 5.00% that he and his colleagues signaled last month and stay there until "well" into 2024. That's a stark contrast to traders' expectations for the policy rate, now in the 4.25%-4.50% range, to top out at 4.75%-5.00% and then for the Fed to begin cutting borrowing costs in the second half of this year.
More inflation data due next week will play into the Fed's calculus about where to go in the months ahead, with the Labor Department's Consumer Price Index expected to show price pressures had softened further in December. The annual CPI rate is expected to have dropped to a 14-month low of 6.5% in December from 7.1% in the prior month, and the month-to-month rate is forecast to have been unchanged, an abrupt turnaround for a measure that had been running at its highest rate since the early 1980s just six months earlier.
So, why it is so big contract of market expectations and Fed plans?
Come Back to Earth - (instead of bottom line)
First, let's take a look at some additional statistics and try to combine it together with recent NFP data and positive mood as a result of it. So, please explain me, how we could combine higher employment with shorter average work week? So, we're hiring to make people work less? How we could combine constant rising of continues claims in recent 3-4 months, decreasing of the vacancies amount with the new jobs created at high tempo? If we have so perfect job market with near the "soft landing" for Fed, why employees report on 364K job cuts in 2022 - 13% above 2021 and the 2nd worst result in 30 years?
Finally let's take a look at cross sector statistics. US recently has significantly improved Trade Balance. It dropped to "just 60 Bln", and becomes almost two times smaller. But this is not because of increasing national economy capacity. This is because of drastic cut of import. This is deflationary sign and sign of drop in economy, as people start consume less. This is also confirms by other countries, for example Taiwan export has dropped for 12.1% in December - 4th month in a row, which is perfectly agrees with the US Trade balance dynamic.
People are loosing consumption power. Tell me, how it is possible with high employment? We should see opposite picture. Finally - why we have decrease production in all spheres - industry, service, manufacturing etc. PMI's are dropping across the board. If 96% of population are working, wages are rising at high rate (6-10% this year) - PMI in all spheres should rise. At least we have 2.3% GDP growth, don't we? Why people are working but do not consume? Whether they do save for future? No - savings stand around 2.34% - lowest level ever. What is going on?
The answer is - job market has not reached yet the threshold level due to government support and disbalances in banking sector. People are loosing wealth, real income value but due to money over-supply, banks could provide them loans with the rates under Fed level. This lets small and mid business stay on the surface by far. We think that this is short term situation. Very soon it starts to change. Previously we've said many times that we're now in "structural crisis", this is not the cyclical recession. It calls structural also because the economy infrastructure (logistics, producing powers, business models etc) was structured for high level of consumption. Now, with the drop in demand and consumption, the constant expenses are rising, triggering the chain reaction. For example, if you have production line. Usually you sell 10 units of some goods per month. But now you could sell only 5 units. You could get even the same revenue due higher price level, but your capital is not reproduced itself, so you can't just keeping produce 10 units anymore as it will lead to rising expenses on over-supply and excess of goods storage. You probably could stop the line for half time, but you anyway have to keep engineers that serve it. So your constant expenses takes larger part in cost of goods. It means that your business infrastructure doesn't fit to new economy and you have to restructure it for less consumption level. And this has to be done everywhere. Do you understand the scale of the problem?
Now this process is already underway, and we see it in PMI, Production etc. But due to solid government support, excess of liquidity - consumption remains high by far. This lets companies to hire, and keep existed jobs. That's why job market now shows absolute outbreak compares to other economy statistics. With exhausting of Fed reserves, and QT programme, situation will start to change very soon. We do not believe in "soft landing" and situation improvement in 2nd half of 2024. Even vice versa - crisis processes should become evident and job market has to join the common tendency.
One of the major signs of this change should be the drop on stock market. But take a look - how positive markets are. They draw corporate profits rise, starting from 3Q of 2023:
It is no need to remind about Real Estate market. Take a look at the charts above - just minor up tick in Mortage rate has crushed Mortage applications for 10%+ in a week!
If you think that it is different in other countries - it is not. For example in Germany we see the same thing as in the US - massive drop of import and together with record drop of Consumption. This is evident sign of economy contraction and loose of personal purchasing power.
That's being said, the Fed minutes shows that the mood of the board members is returned to hawkish. In other words, they believe that it is necessary to raise rates further, it is impossible to lower them in 2023, too low rates are dangerous and harmful because of the constant threat of inflation.
The denying to slow down the rate suggests that the members of the Fed board realized that the effect of rate hiking policy doesn't match to their expectations. Other words, the rate of inflation slowdown is insignificant, and the economic downturn continues quite regularly, not very dependent on the rate increase.
There are not so many options. Roughly speaking, in order to stop the recession, it is necessary to stimulate the economy, and this will cause an increase in already high inflation. But if the rate is sharply increased again, then inflation maybe (!) will decrease and it will be possible to improve the economy.
Recall that the structural crisis is associated with the degradation and destruction of the excess part of the economy, which has grown over decades of excessive economic stimulation. Note that there were experts in the United States who talked about this for a long time, we can only recall former Congressman Ron Paul, who 15 years ago proposed raising the rate to values comparable to the late 70s (that is, up to about 20%). And then, Ron Paul said, the economy will shrink, but it will improve and it will be possible to "start from a solid bottom" and start sustainable growth.
But no one in the United States (including Ron Paul) understands how much the American economy will fall. According to expert opinions , today this decline will be at least 55-60%. From the real GDP of the United States, which is about $ 15 trillion. So it has to be around $5-7 Trln
In other words, the current leadership of the Fed, in fact, offers Ron Paul's plan, only stretched for many months and, very likely, not applicable in the logic of Paul himself. Because there was no structural crisis in 70's, but today it has already begun, and therefore the structural component of inflation will not go away, even if the rate, albeit gradually, is raised to 20%.
Just like a year ago, we saw record inflation figures in every report, now we see record indicators of the collapse of industry (for several months now), the service sector (in recent weeks) and the real estate market (primarily in the United States). Well, the drop in retail sales, which best show the general state of aggregate demand and the state of the economy, since the vast majority of the GDP of any developed countries is private demand.
In other words, the crisis is not just developing, it is developing very consistently and confidently. At the same time, the decrease in inflation does not have any positive effect, it is largely a deflationary effect associated with a decline in the economy and demand. Well, even taking into account the obvious decline, which cannot be hidden, inflation is still quite high.
Raising the cost of credit in such a situation is an incredible risk. Moreover, since poor citizens cannot reduce their already low consumption, we can only talk about reducing the demand of the "middle" class. That is, in fact, we are talking about a massive transition of representatives of this class to the state of the poor.
But the decline in the number of the "middle" class will inevitably affect the structure of consumption. The demand for more or less high-quality goods will fall more than the aggregate demand as a whole and this will only spur the degradation processes in the economy, the structural crisis will receive a new impetus. So we can safely say that there are no trends towards ending the crisis. Of course, this followed from the theory of structural crises, but theory is one thing, and observable reality is another.
That's why we do not to buy into the idea of "soft landing" and "Strong job market". By our opinion average positive NFP numbers just tell that the turn of job market is yet to come. In EU situation stands even worse - inflation is higher, drop of production and consumption stronger. Thus, it is early to speak of EUR/USD reversal either. Median forecasts showed the euro will trade at $1.04, $1.06 in the next three and six months respectively. It is then forecast to change hands around $1.10 in a year, a near 4% gain from current levels.
