Sive Morten
Special Consultant to the FPA
- Messages
- 18,654
Fundamentals
Data of this week shows that structural crisis continues - poor data on Retail Sales in UK, raising of unemployment in EU, continuing drop on real estate market and games on how will cut rate first among ECB and the Fed. On macroeconomic stage it seems that the decision on abandoning of Bretton-Woods system mentally is taken, which raises a lot of secondary questions - who will be the boss, what currency zones will be and who will control them. But this topic has more relation to gold market analysis.
Market overview
The dollar jumped in a volatile session on Tuesday as investors dialed back expectations for a March rate cut from the U.S. Federal Reserve, fueled in part by comments by Board Governor Christopher Waller, who said that the U.S. is "within striking distance" of the Federal Reserve's 2% inflation goal, but that the central bank should not rush toward cuts in its benchmark interest rate until it is clear that lower inflation will be sustained.
The greenback briefly cut gains after a weak report on the manufacturing sector in the New York region.
Several policymakers from the ECB on Tuesday maintained a cloud of uncertainty over the timing of the moves, although interest rates are still likely to come down this year. An ECB survey on Tuesday showed consumer expectations of euro zone inflation three years ahead fell in a November poll to 2.2% from 2.5%. The median household expected prices to grow by 3.2% in the following 12 months, down from 4.0% a month earlier. This is likely to mirror a sharp fall in inflation in November as well as a contraction in lending as a result of the ECB's steep increases in interest rates.
Financial markets are too complacent about risks around an expected shift in U.S. monetary policy, political uncertainty in the United States and geopolitical tensions with China, an investment chief at one of the world's biggest hedge funds said on Tuesday.
For inflation to decline further, economic growth needs to weaken and this was not priced into equity markets, Jensen told a panel on potential financial vulnerabilities at the World Economic Forum in Davos. He said he did not see risk accurately priced in longer dated U.S. government bonds nor the risk of default appropriately accounted for in corporate bonds, either.
Jensen added that markets were also not pricing in the risk of "two cold wars brewing". These included "the cold war with China and the internal cold civil war going in the U.S. that is going to play out dramatically over the course of this year", he added, referring to the run-up to the U.S. presidential election.
Jensen and Lim Chow-Kiat, CEO of Singapore sovereign wealth fund GIC, also on the panel, meanwhile expressed concern about the impact of de-globalisation. Chow-Kiat described the fragmentation of the world's supply chains as a trend that was "non-reversible". "The implications are not great for investors, for sure," he said.
U.S. retail sales data signaled economic strength, dimming expectations for imminent rate cuts from the Federal Reserve. Retail sales rose 0.6% last month after an unrevised 0.3% gain in November, the Commerce Department's Census Bureau said. Economists polled by Reuters had forecast retail sales gaining 0.4%.
While markets still see the Fed as likely to trim rates in March, expectations for a first cut of at least 25 basis points (bps) are down to 53.2%, according to CME's FedWatch Tool, opens new tab, from 65.1% on Tuesday.
The Fed's "Beige Book" of economic activity showed the majority of the 12 districts reported little or no change since the prior period, while nearly all noted a cooling labor market.
Also supporting the dollar was data showing China's economy grew 5.2% in 2023, slightly more than the official target, but it was a far shakier recovery than many expected while its property crisis deepened.
Dutch central bank chief Klaas Knot told CNBC on Wednesday that investor bets for ECB rate cuts were excessive and possibly self-defeating because they could actually hold back monetary easing. ECB President Christine Lagarde told Bloomberg TV in Davos the central bank was on track to get inflation back to its 2% target but victory has not yet been won.
The European Central Bank will reduce interest rates next quarter, according to a Reuters poll, with 45% of respondents saying the reduction in borrowing costs would happen in June. The poll, which was released on Thursday, also showed the first ECB rate cut was more likely to occur earlier than expected than later.
The central bank will cut rates in the second quarter, said 59 of 85 economists in the poll. Three saw a cut happening in March. The more than 70% of respondents in the latest poll calling for rate cuts before July
27 of 43 - said the first cut was more likely to come earlier than they expected.
The Federal Reserve won't start easing policy until May, traders bet on Friday, capping a week during which stronger-than-expected economic data and commentary from central bankers chipped away at financial market confidence in the idea of an earlier start to interest-rate cuts.
On Friday, a widely watched measure of consumer sentiment rose to its highest level in 2-1/2 years, and Chicago Fed President Austan Goolsbee said the U.S. central bank won't commit itself to rate cuts until it is surer that inflation is on track to a healthy 2%.
Economic data showed the University of Michigan's preliminary reading on the overall index of consumer sentiment came in at 78.8 this month, the highest reading since July 2021,
Futures contracts that settle to the Fed's policy rate fell, and now reflect about a 47% chance of a Fed rate cut by March, down from 55% earlier in the day.
New signs of structural crisis
This week, guys we also have got new data across the board. While in the US it was mostly positive as it is mentioned above, other countries couldn't be happy with their own numbers. Thus, in UK the pound sagged and UK government bond prices rose on Friday, after a shock drop in British consumer spending in December raised the risk of recession, putting a stop to the currency's recent gains.
Job opportunities in London's financial sector plummeted nearly 40% last year, recruiter Morgan McKinley said on Monday, as market turbulence and high inflation led employers to tighten their belts on costs. Many banks are cutting jobs.
Big job contraction stands among EU companies as well. At the same time, expectations on EU salary inflationary indexation is raising. The ECB has singled out wages as the single biggest risk to its 1-1/2 year crusade against inflation. It expects salary growth across the euro zone of 4.6% this year, far more than the 3% pace it considers consistent with inflation at its 2% target. Higher wage settlements would be a risk to interest-rate cuts that financial markets are betting will start in April.
The ECB meets on Thursday next week, ECB has halted rate hikes and clarified how it will wind down its pandemic-era bond-buying scheme. Lagarde could be pushed on the impact of supply chain disruptions in the Red Sea on inflation.
The US single-family housing starts, which account for the bulk of homebuilding, fell 8.6% to a seasonally adjusted annual rate of 1.027 million units last month, the Commerce Department's Census Bureau said on Thursday. Data for November was revised lower to show single-family starts rising to a rate of 1.124 million units instead of the previously reported 1.143 million units.
Defaults by U.S. companies with low junk credit ratings are likely to rise further in the first quarter of 2024, according to a Thursday report by credit rating agency Moody's Investors Service.
British lenders expect the biggest rise since 2009 in defaults by households with unsecured loans, a Bank of England survey showed on Thursday. The BoE's quarterly Credit Conditions Survey showed a reading of +31.7 in an index of lenders' expectations for unsecured household loan defaults for the three months to the end of February.
Here are few additional pics, indicating that situation doesn't turn to better:
Banking sector is on a first stage again
Markets are forgotten about banks for a long time. Since November 2023, it was no big hype in media concerning banking sector. So, it was mutual mass agreement that banking crisis is overcome and stands in the past. But, unpleasantly this week a kind of "soft" article start to appear, recovering this topic from archive. And there are two major reasons for that - new rules of minimal banking capital requirement in the US, ending of BTFP program in March 2024. And we could call also the 3rd probably - eroding of banking safety margin and profitability.
Now take a look at charts below:
Banking sector faces a number of obstacles associated with a 40 percent reduction in prices per sq.m. office space due to higher interest rates and more people working from home, $3 trillion in commercial mortgages and $684 billion in unrealized losses on Treasuries and mortgages. They say the end result of this negativity is a continued decline in weekly bank lending data, which, based on the trend, will soon go into negative territory.
With the potential loss equals to 35% of capital on average, new rules of raising capital just will kill banks totally. Besides, started from March 2024, when BTFP programme will be closed banks will not be able to borrow against full notional value of US Bonds on their balances. Although they have one more year to return already borrowed money.
That is, here additional liquidity based on the difference between the market price and the par value is taken out of thin air. More precisely from the Fed. The market value of the collateral/security does not correspond to the amount raised and does not cover it.
$200 Blns by the end of the month taken through BTFP - these are still flowers. Taking into account the fact that after March 11, it will be impossible to take money from there (and what will be taken on March 11, 2024 will have to be returned before March 11, 2025), banks will take as much as they could from BTFP and put it into reserves in Fed.
If inflation doesn't rise. Because if it jumps, then the yields on long-term treasuries will soar and the holes in the balance sheets of banks will grow.
But this is only the half of the story. Around the same time, by mid-March, funds in the reverse repo with the Fed should run out. These funds are now flowing not somewhere, but into short-term treasuries, for which higher rates are offered.
Therefore, after the money in the reverse repo runs out, one of the sources of demand for short-term treasuries will disappear. All other things being equal, this should lead to an increase in the yield of short-term treasuries, which means that the trend of money outflow from bank deposits ( $2.5 trillion over 16 months) into money market funds will accelerate significantly.
That is, both because one of the powerful sources will dry up, and because the yield on short-term treasuries will become even more attractive than on deposits. And, if BTFP ceases to be available to banks, this may create certain difficulties for them in terms of liquidity.
There may be several solutions to this situation. First, as Logan said, the Fed may stop shrinking its balance sheet. Secondly, the Ministry of Finance may begin to issue more long-term securities, although it will increase in unrealized losses of banks, as in March 2023. And thirdly, the Ministry of Finance may simply start borrowing less and start spending 0.7 trillion dollars that have been accumulated since mid-2023.
Lowering rates in a situation where there is a bubble in the stock market, and all bonds, except short ones, give a very small return above inflation, there is a huge amount of liquidity in the system, lowering rates can have unexpected consequences. Theoretically the Fed could start issuing more long-term debt that will lead to normalization of yield curve and cash inflow in longer-term debt due higher interest rates level. But this could be done only together with some supportive programme to banking sector. Once inflation will jump again - take off the shoes of everyone who buys long-term treasuries. It happened once already 2 years ago.
The financial conditions index shows that stimulation has actually started since the Fall 2023. Financial conditions are relaxing. Rates remain nominally high, yes, but other measures are used, such as BTFP.
The shares immediately went up. Given forecasts for further growth, banks are expecting new liquidity from somewhere. Coupled with geopolitics, transport, energy - this is all a reliable foundation for a new wave of inflation, of course.
In any case, the Fed is on track to end QT and resume QE in the coming months amid an accommodative fiscal policy and a still resilient economy, which opens the door to renewed inflationary pressures that the Fed may have little desire (or ability) to contain. But as it is becoming evident right now - the Fed doesn't use common things, such as "stop QT", "starting QE". In fact, with multiple non official QE tools, such as BTFP they do not need to cut rate at all, because they already provide liquidity to the market. At the same time, they present the vision of struggle against inflation, keeping rates high, avoiding big capital re-distribution out from the US to rival economies.
The IMF publicly announced a paradigm shift in monetary policy:
JPMorgan expects the Fed to decide on a schedule for tapering the QT (balance sheet reduction) program at its January meeting, which will be confirmed in the minutes of that January FOMC meeting in mid-February. It is expected that a formal agreement on the winding down of QT will be reached in mid-March, and the very beginning of winding down the program will be launched in early April 2024
—————————-
BofA said in early January that it expected the Fed to announce the start of a gradual unwinding of "quantitative tightening" (QT) in March, which would coincide with its first rate cut of 0.25%
And how it relates to EUR/USD (instead of conclusion)?
Very simple. We have shown you very clearly the way how the Fed could manipulate with markets without using evident QE and QT terms. In fact, by March when reverse repo and personal savings will exhaust, it is very probable that the Fed will keep nominal QT but start selling more long-term bonds, buying new issues of short-term bonds from US Treasury. This will lead to normalization of yield curve and higher longer-term yields. So, those who're now buying long-term bonds and idea of soon rate cut will be punished.
Then, in 2nd half of 2024 Fed will start buying longer-term bonds back, releasing Kraken recession and starting rate cut. So, via recession and financial crisis rates indeed will go lower, but it will happen later and big banks will make money on this move.
EU in turn, has no same ability and freedom to juggle with different sources of liquidity and redistribute them so fast. Besides, right to March 2024 the impact of Red Sea collapse will catch up with EU statistics. While Fed will keep disguising raising inflation and hidden QE (that already is started) under cover of high interest rates. This should support USD rate in perspective of nearest few months.
Data of this week shows that structural crisis continues - poor data on Retail Sales in UK, raising of unemployment in EU, continuing drop on real estate market and games on how will cut rate first among ECB and the Fed. On macroeconomic stage it seems that the decision on abandoning of Bretton-Woods system mentally is taken, which raises a lot of secondary questions - who will be the boss, what currency zones will be and who will control them. But this topic has more relation to gold market analysis.
Market overview
The dollar jumped in a volatile session on Tuesday as investors dialed back expectations for a March rate cut from the U.S. Federal Reserve, fueled in part by comments by Board Governor Christopher Waller, who said that the U.S. is "within striking distance" of the Federal Reserve's 2% inflation goal, but that the central bank should not rush toward cuts in its benchmark interest rate until it is clear that lower inflation will be sustained.
The greenback briefly cut gains after a weak report on the manufacturing sector in the New York region.
Several policymakers from the ECB on Tuesday maintained a cloud of uncertainty over the timing of the moves, although interest rates are still likely to come down this year. An ECB survey on Tuesday showed consumer expectations of euro zone inflation three years ahead fell in a November poll to 2.2% from 2.5%. The median household expected prices to grow by 3.2% in the following 12 months, down from 4.0% a month earlier. This is likely to mirror a sharp fall in inflation in November as well as a contraction in lending as a result of the ECB's steep increases in interest rates.
Financial markets are too complacent about risks around an expected shift in U.S. monetary policy, political uncertainty in the United States and geopolitical tensions with China, an investment chief at one of the world's biggest hedge funds said on Tuesday.
For inflation to decline further, economic growth needs to weaken and this was not priced into equity markets, Jensen told a panel on potential financial vulnerabilities at the World Economic Forum in Davos. He said he did not see risk accurately priced in longer dated U.S. government bonds nor the risk of default appropriately accounted for in corporate bonds, either.
Jensen added that markets were also not pricing in the risk of "two cold wars brewing". These included "the cold war with China and the internal cold civil war going in the U.S. that is going to play out dramatically over the course of this year", he added, referring to the run-up to the U.S. presidential election.
Jensen and Lim Chow-Kiat, CEO of Singapore sovereign wealth fund GIC, also on the panel, meanwhile expressed concern about the impact of de-globalisation. Chow-Kiat described the fragmentation of the world's supply chains as a trend that was "non-reversible". "The implications are not great for investors, for sure," he said.
U.S. retail sales data signaled economic strength, dimming expectations for imminent rate cuts from the Federal Reserve. Retail sales rose 0.6% last month after an unrevised 0.3% gain in November, the Commerce Department's Census Bureau said. Economists polled by Reuters had forecast retail sales gaining 0.4%.
While markets still see the Fed as likely to trim rates in March, expectations for a first cut of at least 25 basis points (bps) are down to 53.2%, according to CME's FedWatch Tool, opens new tab, from 65.1% on Tuesday.
The Fed's "Beige Book" of economic activity showed the majority of the 12 districts reported little or no change since the prior period, while nearly all noted a cooling labor market.
Also supporting the dollar was data showing China's economy grew 5.2% in 2023, slightly more than the official target, but it was a far shakier recovery than many expected while its property crisis deepened.
Dutch central bank chief Klaas Knot told CNBC on Wednesday that investor bets for ECB rate cuts were excessive and possibly self-defeating because they could actually hold back monetary easing. ECB President Christine Lagarde told Bloomberg TV in Davos the central bank was on track to get inflation back to its 2% target but victory has not yet been won.
The European Central Bank will reduce interest rates next quarter, according to a Reuters poll, with 45% of respondents saying the reduction in borrowing costs would happen in June. The poll, which was released on Thursday, also showed the first ECB rate cut was more likely to occur earlier than expected than later.
The central bank will cut rates in the second quarter, said 59 of 85 economists in the poll. Three saw a cut happening in March. The more than 70% of respondents in the latest poll calling for rate cuts before July
27 of 43 - said the first cut was more likely to come earlier than they expected.
The Federal Reserve won't start easing policy until May, traders bet on Friday, capping a week during which stronger-than-expected economic data and commentary from central bankers chipped away at financial market confidence in the idea of an earlier start to interest-rate cuts.
On Friday, a widely watched measure of consumer sentiment rose to its highest level in 2-1/2 years, and Chicago Fed President Austan Goolsbee said the U.S. central bank won't commit itself to rate cuts until it is surer that inflation is on track to a healthy 2%.
Economic data showed the University of Michigan's preliminary reading on the overall index of consumer sentiment came in at 78.8 this month, the highest reading since July 2021,
Futures contracts that settle to the Fed's policy rate fell, and now reflect about a 47% chance of a Fed rate cut by March, down from 55% earlier in the day.
New signs of structural crisis
This week, guys we also have got new data across the board. While in the US it was mostly positive as it is mentioned above, other countries couldn't be happy with their own numbers. Thus, in UK the pound sagged and UK government bond prices rose on Friday, after a shock drop in British consumer spending in December raised the risk of recession, putting a stop to the currency's recent gains.
Job opportunities in London's financial sector plummeted nearly 40% last year, recruiter Morgan McKinley said on Monday, as market turbulence and high inflation led employers to tighten their belts on costs. Many banks are cutting jobs.
Big job contraction stands among EU companies as well. At the same time, expectations on EU salary inflationary indexation is raising. The ECB has singled out wages as the single biggest risk to its 1-1/2 year crusade against inflation. It expects salary growth across the euro zone of 4.6% this year, far more than the 3% pace it considers consistent with inflation at its 2% target. Higher wage settlements would be a risk to interest-rate cuts that financial markets are betting will start in April.
The ECB meets on Thursday next week, ECB has halted rate hikes and clarified how it will wind down its pandemic-era bond-buying scheme. Lagarde could be pushed on the impact of supply chain disruptions in the Red Sea on inflation.
The US single-family housing starts, which account for the bulk of homebuilding, fell 8.6% to a seasonally adjusted annual rate of 1.027 million units last month, the Commerce Department's Census Bureau said on Thursday. Data for November was revised lower to show single-family starts rising to a rate of 1.124 million units instead of the previously reported 1.143 million units.
Defaults by U.S. companies with low junk credit ratings are likely to rise further in the first quarter of 2024, according to a Thursday report by credit rating agency Moody's Investors Service.
Moody's counts 238 corporate borrowers on its "B3 Negative and Lower" list in the fourth quarter of 2023, compared to 218 a year ago. Moody's believes these companies have a higher probability of defaulting on debt. This accounts for 16% of U.S. speculative-grade names, the highest share since mid-2021.
British lenders expect the biggest rise since 2009 in defaults by households with unsecured loans, a Bank of England survey showed on Thursday. The BoE's quarterly Credit Conditions Survey showed a reading of +31.7 in an index of lenders' expectations for unsecured household loan defaults for the three months to the end of February.
Here are few additional pics, indicating that situation doesn't turn to better:
Banking sector is on a first stage again
Markets are forgotten about banks for a long time. Since November 2023, it was no big hype in media concerning banking sector. So, it was mutual mass agreement that banking crisis is overcome and stands in the past. But, unpleasantly this week a kind of "soft" article start to appear, recovering this topic from archive. And there are two major reasons for that - new rules of minimal banking capital requirement in the US, ending of BTFP program in March 2024. And we could call also the 3rd probably - eroding of banking safety margin and profitability.
Now take a look at charts below:
Banking sector faces a number of obstacles associated with a 40 percent reduction in prices per sq.m. office space due to higher interest rates and more people working from home, $3 trillion in commercial mortgages and $684 billion in unrealized losses on Treasuries and mortgages. They say the end result of this negativity is a continued decline in weekly bank lending data, which, based on the trend, will soon go into negative territory.
With the potential loss equals to 35% of capital on average, new rules of raising capital just will kill banks totally. Besides, started from March 2024, when BTFP programme will be closed banks will not be able to borrow against full notional value of US Bonds on their balances. Although they have one more year to return already borrowed money.
That is, here additional liquidity based on the difference between the market price and the par value is taken out of thin air. More precisely from the Fed. The market value of the collateral/security does not correspond to the amount raised and does not cover it.
$200 Blns by the end of the month taken through BTFP - these are still flowers. Taking into account the fact that after March 11, it will be impossible to take money from there (and what will be taken on March 11, 2024 will have to be returned before March 11, 2025), banks will take as much as they could from BTFP and put it into reserves in Fed.
If inflation doesn't rise. Because if it jumps, then the yields on long-term treasuries will soar and the holes in the balance sheets of banks will grow.
But this is only the half of the story. Around the same time, by mid-March, funds in the reverse repo with the Fed should run out. These funds are now flowing not somewhere, but into short-term treasuries, for which higher rates are offered.
Therefore, after the money in the reverse repo runs out, one of the sources of demand for short-term treasuries will disappear. All other things being equal, this should lead to an increase in the yield of short-term treasuries, which means that the trend of money outflow from bank deposits ( $2.5 trillion over 16 months) into money market funds will accelerate significantly.
That is, both because one of the powerful sources will dry up, and because the yield on short-term treasuries will become even more attractive than on deposits. And, if BTFP ceases to be available to banks, this may create certain difficulties for them in terms of liquidity.
There may be several solutions to this situation. First, as Logan said, the Fed may stop shrinking its balance sheet. Secondly, the Ministry of Finance may begin to issue more long-term securities, although it will increase in unrealized losses of banks, as in March 2023. And thirdly, the Ministry of Finance may simply start borrowing less and start spending 0.7 trillion dollars that have been accumulated since mid-2023.
Lowering rates in a situation where there is a bubble in the stock market, and all bonds, except short ones, give a very small return above inflation, there is a huge amount of liquidity in the system, lowering rates can have unexpected consequences. Theoretically the Fed could start issuing more long-term debt that will lead to normalization of yield curve and cash inflow in longer-term debt due higher interest rates level. But this could be done only together with some supportive programme to banking sector. Once inflation will jump again - take off the shoes of everyone who buys long-term treasuries. It happened once already 2 years ago.
The financial conditions index shows that stimulation has actually started since the Fall 2023. Financial conditions are relaxing. Rates remain nominally high, yes, but other measures are used, such as BTFP.
The shares immediately went up. Given forecasts for further growth, banks are expecting new liquidity from somewhere. Coupled with geopolitics, transport, energy - this is all a reliable foundation for a new wave of inflation, of course.
In any case, the Fed is on track to end QT and resume QE in the coming months amid an accommodative fiscal policy and a still resilient economy, which opens the door to renewed inflationary pressures that the Fed may have little desire (or ability) to contain. But as it is becoming evident right now - the Fed doesn't use common things, such as "stop QT", "starting QE". In fact, with multiple non official QE tools, such as BTFP they do not need to cut rate at all, because they already provide liquidity to the market. At the same time, they present the vision of struggle against inflation, keeping rates high, avoiding big capital re-distribution out from the US to rival economies.
The IMF publicly announced a paradigm shift in monetary policy:
Well, that is, as expected - no one will reduce anything and feed investors on the stock market too. While JPM and GS are still selling the idea of QE -
JPMorgan expects the Fed to decide on a schedule for tapering the QT (balance sheet reduction) program at its January meeting, which will be confirmed in the minutes of that January FOMC meeting in mid-February. It is expected that a formal agreement on the winding down of QT will be reached in mid-March, and the very beginning of winding down the program will be launched in early April 2024
—————————-
BofA said in early January that it expected the Fed to announce the start of a gradual unwinding of "quantitative tightening" (QT) in March, which would coincide with its first rate cut of 0.25%
And how it relates to EUR/USD (instead of conclusion)?
Very simple. We have shown you very clearly the way how the Fed could manipulate with markets without using evident QE and QT terms. In fact, by March when reverse repo and personal savings will exhaust, it is very probable that the Fed will keep nominal QT but start selling more long-term bonds, buying new issues of short-term bonds from US Treasury. This will lead to normalization of yield curve and higher longer-term yields. So, those who're now buying long-term bonds and idea of soon rate cut will be punished.
Then, in 2nd half of 2024 Fed will start buying longer-term bonds back, releasing
EU in turn, has no same ability and freedom to juggle with different sources of liquidity and redistribute them so fast. Besides, right to March 2024 the impact of Red Sea collapse will catch up with EU statistics. While Fed will keep disguising raising inflation and hidden QE (that already is started) under cover of high interest rates. This should support USD rate in perspective of nearest few months.
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