Sive Morten
Special Consultant to the FPA
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Fundamentals
This week we've got two major events beyond of NFP report. First is one is the debt ceil decision, whether not the decision itself is important, but mostly its consequences. Second one is political - indirect signs that the US seems to turn to China confrontation, leaving EU deeds on its own. THis topic we keep for Gold report tomorrow. And today consider what steps we should expect from the Fed and US Treasury in nearest few months .
Market overview
The U.S. dollar rose on Friday after May's non-farm payrolls report showed employment numbers surged, while traders weighed the merits of the U.S. Federal Reserve possibly skipping a rate hike in June. The report showed that payrolls in the public and private sector increased by 339,000 in May, far outstripping the 190,000 forecast on average by economists polled by Reuters. May's jump followed a 253,000 rise in April. Despite strong hiring, the unemployment rate rose to 3.7% from a 53-year low of 3.4% in April.
The gain of 339,000 U.S. payroll jobs in May was a blockbuster number, nearly double what was normal before the pandemic and seeming confirmation that key parts of the economy motor along despite aggressive Federal Reserve interest rate increases. But details beneath the headline number may, if sustained, point to some of the first cracks in a labor market that has defied expectations through much of the recovery from the COVID-19 pandemic.
The unemployment rate rose by what is a comparatively large three-tenths of a percentage point, from 3.4% to 3.7%, a level of change not seen, outside the onset of the pandemic, in more than a decade during the sluggish recovery from the 2007-2009 recession. The number of unemployed people jumped by 440,000, the most since November 2010.
Overall, said Rick Rieder, global bond chief at investment giant BlackRock, hiring momentum in industries that remain short of pre-pandemic employment levels, like leisure and hospitality, or that face notable labor shortages, like health and education, may continue to fuel monthly job gains even as other parts of the job market slow.
It's an environment, he said, where the Fed may be right to be cautious.
Money markets are pricing in a roughly 25% chance of a June hike, down from near 70% earlier in the week. Market postpones rate hike to July and September. The breaking moment is suggested in January 2024, where first rate cut should follow, by market view. We still think that rate change in June and July seems more logic, with the following natural pause in August. Just because US Treasury now should come on stage with huge borrowings to full liquidity reserves, and this is easier to do with attractive interest rates levels. It is not too long to wait, we'll see.
Federal Reserve officials, whose hike, skip or pause messaging on interest rates has become a high-stakes word puzzle for investors, seem ready to end the U.S. central bank's run of 10 straight rate increases later this month while leaving the door open to a future rise in borrowing costs. For a central bank that says it is "data-dependent," the decision may be more complex than it wants, with the release on Friday of a May employment report that blew through expectations as employers added 339,000 jobs across a broad set of industries. Key inflation data since the last policy meeting also rose.
Fed policymakers in recent weeks have tried hard to keep their options open, with those inclined towards more hikes acknowledging a case to hold steady, and those worried about higher rates acknowledging stubbornly high inflation may require them to slow the economy even further.
Indeed, Philadelphia Fed President Patrick Harker said on Thursday it was "time to at least hit the stop button for one meeting and see how it goes."
A day earlier, Fed Governor Philip Jefferson said skipping a rate hike "would allow the committee to see more data before making decisions about the extent of additional policy firming."
Fed officials will enter a pre-meeting "blackout" period after Friday, with no formal chance to reshape market or household expectations as the final data reports for the inter-meeting period are released, most notably the Consumer Price Index data for May due out on June 13 as policymakers gather in Washington.
Opinions have been shifting quick. The release of a Labor Department report on Wednesday that showed an unexpected jump in job openings weighed towards a rate increase given the Fed's focus on the strength of the job market; remarks by Fed Governor and vice chair nominee Philip Jefferson later that day tilted towards a pause when he said "skipping a rate hike at a coming meeting would allow the committee to see more data" before deciding if tighter policy was even needed.
For Larry Meyer, a former Fed governor who analyzes monetary policy for his Washington-based consulting firm, the jump in job openings "pushed us over the edge" to believe the central bank will raise rates again in June.
Investors worried about potential losses among banks from office real estate loans after comments from executives, including Wells Fargo & Co Chief Executive Officer Charlie Scharf and Blackstone President Jonathan Gray at a Sanford C Bernstein investor conference. Scharf said on Wednesday there will be losses in the office loan sector and that the bank was proactively managing its portfolio while he looked to reassure investors that it is not "overly concentrated" in that area.
U.S. domestic banks reported a widespread tightening of lending standards by the end of the first quarter of 2023 - even before the full impact of the regional banking crisis had been felt. Stricter lending criteria are likely to slow the flow of credit to small businesses and households – amplifying the impact of interest rate increases by the Federal Reserve over the last year. The net percentage of domestic banks tightening standards for commercial and industrial (C&I) loans to small businesses with annual sales below $50 million hit +47% at the end of the first quarter.
The net percentage tightening small business C&I standards has risen to levels usually associated with recession, based on past results from the Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS).
JPMorgan Chase & Co's President and Chief Operating Officer Daniel Pinto said the same - loan demand is declining at a time when regional and small banks are also tightening credit. Consumption remains positive, but there are some indications the economy is slowing, Pinto said. He expected the Federal Reserve to raise rates further.
The market mood was also supported by the U.S. Senate passing bipartisan legislation on Thursday that lifted the federal government's $31.4 trillion debt ceiling and averted what would have been a first-ever default. The bill, which had been passed by the House of Representatives on Wednesday, heads to President Joe Biden, who is expected to sign it.
U.S. Treasury yields were higher (!!!) as investors bet on a possible increase in rates although many believe the Fed is likely to stick with a pause in hikes when it meets later this month. Benchmark 10-year notes were up at 3.695%, while yields on the more rate-sensitive 2-year notes rose to 4.509%.
A wave of debt defaults by companies in the United States and Europe is imminent, due in part to the fastest monetary tightening cycle in 15 years, Deutsche Bank said in its annual default study released on Wednesday. Deutsche expects default rates to peak in the fourth quarter of next year. It forecast peak default rates to reach 9% for U.S. high-yield debt, 11.3% for U.S. loans, 4.4% for European high-yield bonds and 7.3% for European loans.
The estimate for a U.S. loan peak default rate of 11.3% would be a near all-time high, compared to a peak of 12% during the 2007-2008 global financial crisis and 7.7% during the U.S. technology bubble in the late 1990s, Deutsche noted.
The euro zone's top banks may take a hit if their financial clients, such as funds, insurers and clearing houses, withdrew their deposits or otherwise ran into trouble, the European Central Bank warned on Tuesday. This could happen if the shadow banks -- or non-bank financial intermediaries (NBFI) in the regulators' jargon -- were themselves hit by outflows or lost confidence in a bank.
Home prices in the euro zone may be headed for a "disorderly" decline as high mortgage rates make purchases unaffordable for households and unattractive for investors, the European Central Bank (ECB) said on Wednesday. It did not list those countries but ECB data indicates that Portugal, Spain and the Baltic countries are among those where the proportion of mortgages with a floating rate is highest.
The ECB also warned that regions where institutional investors have taken large positions in the residential real estate market could take a bigger hit if capital is withdrawn. These included Berlin, parts of western Germany, and some capitals like Paris, Madrid, Lisbon and Dublin.
So, speaking about structural crisis in general - we do not see any big changes, it is going slowly but stubbornly, without any acceleration or slowdown. Everything is the same in the economy. There is a clear decline in the US and in the European Union, most likely things are not going very well in China and Latin America. But as long as the standard of living of the population in the United States is supported by the provision of cheap Chinese goods, things will be better in China than in the United States. This, by the way, is another argument towards the beginning of a policy of restricting China — in a situation of stimulating private demand, logic requires that these very households buy domestic products, not Chinese ones. Here is few pics for illustration -
Consumption is falling, PPI is following, obviously showing the deflationary processes in economy, based on production sector degradation.
DEBT CEIL FRUITS
Will there be a tightening or easing of monetary policy in the US? As experts mentioned earlier, the last public speeches of Fed Chairman Powell were close to hysteria. Since any decision that the Fed could make takes on a clearly political connotation. And there are no good ways out of the situation anymore.
The format that can be assumed within the framework of the agreements on the national debt limit gives grounds to assume what the policy of the US monetary authorities will be. Since spending cuts of $50 billion with permission to borrow $4 trillion over two years looks pretty wild, we can suggest the following. Only by the end of the year, the Treasury should borrow at least 1.5 trillion. And this is a huge burden on the US monetary system, and in the mode of tightening monetary policy.
Yes, the budget will return this money to the economy, but to the allocated industries, enterprises and municipal farms. In other words, access to money will become more difficult for most of the economy (tightening monetary policy, fighting inflation), but support will be provided for the most needy part, on the contrary. The question is whether this will be enough to reduce inflation, but if it is not enough, then the rate can be raised. But less than it could be. Of course, this scenario will work only if the Treasury takes money from the market.
If it has to deal with the QE of any kind, then inflation will rise for sure. But, as far as we understand, this option is not envisaged yet. Thus, there is reason to believe that answers to both fundamental questions have been found (even if they have not yet been voiced) and in this sense there is no sense in keeping the threat of technical default. That's what we saw.
Now let's take a look at few numbers. Next week, a powerful money pump will begin to work, sucking liquidity from the financial system into US Bonds. The last time the debt limit was raised was on December 16, 2021, and the market, by inertia, lasted only two weeks, after which the strongest collapse since 2008 began.This time, US Treasury borrowing could reach up to $2 trillion from June to December 2023, where $1.2 trillion could be spent on current financing of the budget deficit and up to $800 billion to replenish the zeroed cash position.
It should be understood here that withdrawn liquidity from the market in favor of Treasuries is unallocated cash flows into shares or corporate bonds. The situation with large placements of treasuries clearly aggravated the liquidity balance in the system, redistributing flows from stocks and corporate bonds in treasuries. But - 1.5 years ago the disposition was much better.
Firstly, the peak of net placements occurred from December 17 to March 31 with record net placements of 1 trillion and, most importantly, at low rates, then the Fed's key rate was 0.25%.
Secondly, the main liquidity providers (commercial and investment banks) had much more free cash. Just the peak of the cash position of commercial banks fell on December 15, 2021 (4.23 trillion) and shrank by 1.1 trillion by June 2022, and now it is 3.3 trillion.
It could hurt a lot. The Ministry of Finance can allocate 1.5-2 trillion in the next 6 months, and this is against the backdrop of sales from the Fed (80-95 billion per month), prohibitively high rates and liquidity problems for banks , and there will be more and more problems. Treasury placements should go smoothly, but the stress on the system could be the worst in history.
Even if net placements amount to 1.5 trillion, and the sale of assets from the Fed's balance sheet is half of what was planned, this is over 1.75 trillion, which will be the strongest burden on the dollar system in 6 months. As you can see in the charts, when net borrowing exceeded $1 trillion in 6 months, at that moment the Fed always carried out asset buybacks: 2008-2009, the second half of 2020 and Q1 2022, which leveled the load on the system.
Operations of the US Treasury and the Fed in the aggregate exceeded 1 trillion only twice in history - Q4 2008 and Q3 2020, and now they can hit 1.7-2.5 trillion.
This week we've got two major events beyond of NFP report. First is one is the debt ceil decision, whether not the decision itself is important, but mostly its consequences. Second one is political - indirect signs that the US seems to turn to China confrontation, leaving EU deeds on its own. THis topic we keep for Gold report tomorrow. And today consider what steps we should expect from the Fed and US Treasury in nearest few months .
Market overview
The U.S. dollar rose on Friday after May's non-farm payrolls report showed employment numbers surged, while traders weighed the merits of the U.S. Federal Reserve possibly skipping a rate hike in June. The report showed that payrolls in the public and private sector increased by 339,000 in May, far outstripping the 190,000 forecast on average by economists polled by Reuters. May's jump followed a 253,000 rise in April. Despite strong hiring, the unemployment rate rose to 3.7% from a 53-year low of 3.4% in April.
The gain of 339,000 U.S. payroll jobs in May was a blockbuster number, nearly double what was normal before the pandemic and seeming confirmation that key parts of the economy motor along despite aggressive Federal Reserve interest rate increases. But details beneath the headline number may, if sustained, point to some of the first cracks in a labor market that has defied expectations through much of the recovery from the COVID-19 pandemic.
The unemployment rate rose by what is a comparatively large three-tenths of a percentage point, from 3.4% to 3.7%, a level of change not seen, outside the onset of the pandemic, in more than a decade during the sluggish recovery from the 2007-2009 recession. The number of unemployed people jumped by 440,000, the most since November 2010.
Overall, said Rick Rieder, global bond chief at investment giant BlackRock, hiring momentum in industries that remain short of pre-pandemic employment levels, like leisure and hospitality, or that face notable labor shortages, like health and education, may continue to fuel monthly job gains even as other parts of the job market slow.
It's an environment, he said, where the Fed may be right to be cautious.
Money markets are pricing in a roughly 25% chance of a June hike, down from near 70% earlier in the week. Market postpones rate hike to July and September. The breaking moment is suggested in January 2024, where first rate cut should follow, by market view. We still think that rate change in June and July seems more logic, with the following natural pause in August. Just because US Treasury now should come on stage with huge borrowings to full liquidity reserves, and this is easier to do with attractive interest rates levels. It is not too long to wait, we'll see.
Federal Reserve officials, whose hike, skip or pause messaging on interest rates has become a high-stakes word puzzle for investors, seem ready to end the U.S. central bank's run of 10 straight rate increases later this month while leaving the door open to a future rise in borrowing costs. For a central bank that says it is "data-dependent," the decision may be more complex than it wants, with the release on Friday of a May employment report that blew through expectations as employers added 339,000 jobs across a broad set of industries. Key inflation data since the last policy meeting also rose.
Fed policymakers in recent weeks have tried hard to keep their options open, with those inclined towards more hikes acknowledging a case to hold steady, and those worried about higher rates acknowledging stubbornly high inflation may require them to slow the economy even further.
Indeed, Philadelphia Fed President Patrick Harker said on Thursday it was "time to at least hit the stop button for one meeting and see how it goes."
A day earlier, Fed Governor Philip Jefferson said skipping a rate hike "would allow the committee to see more data before making decisions about the extent of additional policy firming."
Fed officials will enter a pre-meeting "blackout" period after Friday, with no formal chance to reshape market or household expectations as the final data reports for the inter-meeting period are released, most notably the Consumer Price Index data for May due out on June 13 as policymakers gather in Washington.
Opinions have been shifting quick. The release of a Labor Department report on Wednesday that showed an unexpected jump in job openings weighed towards a rate increase given the Fed's focus on the strength of the job market; remarks by Fed Governor and vice chair nominee Philip Jefferson later that day tilted towards a pause when he said "skipping a rate hike at a coming meeting would allow the committee to see more data" before deciding if tighter policy was even needed.
For Larry Meyer, a former Fed governor who analyzes monetary policy for his Washington-based consulting firm, the jump in job openings "pushed us over the edge" to believe the central bank will raise rates again in June.
Investors worried about potential losses among banks from office real estate loans after comments from executives, including Wells Fargo & Co Chief Executive Officer Charlie Scharf and Blackstone President Jonathan Gray at a Sanford C Bernstein investor conference. Scharf said on Wednesday there will be losses in the office loan sector and that the bank was proactively managing its portfolio while he looked to reassure investors that it is not "overly concentrated" in that area.
U.S. domestic banks reported a widespread tightening of lending standards by the end of the first quarter of 2023 - even before the full impact of the regional banking crisis had been felt. Stricter lending criteria are likely to slow the flow of credit to small businesses and households – amplifying the impact of interest rate increases by the Federal Reserve over the last year. The net percentage of domestic banks tightening standards for commercial and industrial (C&I) loans to small businesses with annual sales below $50 million hit +47% at the end of the first quarter.
The net percentage tightening small business C&I standards has risen to levels usually associated with recession, based on past results from the Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS).
JPMorgan Chase & Co's President and Chief Operating Officer Daniel Pinto said the same - loan demand is declining at a time when regional and small banks are also tightening credit. Consumption remains positive, but there are some indications the economy is slowing, Pinto said. He expected the Federal Reserve to raise rates further.
The market mood was also supported by the U.S. Senate passing bipartisan legislation on Thursday that lifted the federal government's $31.4 trillion debt ceiling and averted what would have been a first-ever default. The bill, which had been passed by the House of Representatives on Wednesday, heads to President Joe Biden, who is expected to sign it.
U.S. Treasury yields were higher (!!!) as investors bet on a possible increase in rates although many believe the Fed is likely to stick with a pause in hikes when it meets later this month. Benchmark 10-year notes were up at 3.695%, while yields on the more rate-sensitive 2-year notes rose to 4.509%.
A wave of debt defaults by companies in the United States and Europe is imminent, due in part to the fastest monetary tightening cycle in 15 years, Deutsche Bank said in its annual default study released on Wednesday. Deutsche expects default rates to peak in the fourth quarter of next year. It forecast peak default rates to reach 9% for U.S. high-yield debt, 11.3% for U.S. loans, 4.4% for European high-yield bonds and 7.3% for European loans.
The estimate for a U.S. loan peak default rate of 11.3% would be a near all-time high, compared to a peak of 12% during the 2007-2008 global financial crisis and 7.7% during the U.S. technology bubble in the late 1990s, Deutsche noted.
The euro zone's top banks may take a hit if their financial clients, such as funds, insurers and clearing houses, withdrew their deposits or otherwise ran into trouble, the European Central Bank warned on Tuesday. This could happen if the shadow banks -- or non-bank financial intermediaries (NBFI) in the regulators' jargon -- were themselves hit by outflows or lost confidence in a bank.
Home prices in the euro zone may be headed for a "disorderly" decline as high mortgage rates make purchases unaffordable for households and unattractive for investors, the European Central Bank (ECB) said on Wednesday. It did not list those countries but ECB data indicates that Portugal, Spain and the Baltic countries are among those where the proportion of mortgages with a floating rate is highest.
The ECB also warned that regions where institutional investors have taken large positions in the residential real estate market could take a bigger hit if capital is withdrawn. These included Berlin, parts of western Germany, and some capitals like Paris, Madrid, Lisbon and Dublin.
So, speaking about structural crisis in general - we do not see any big changes, it is going slowly but stubbornly, without any acceleration or slowdown. Everything is the same in the economy. There is a clear decline in the US and in the European Union, most likely things are not going very well in China and Latin America. But as long as the standard of living of the population in the United States is supported by the provision of cheap Chinese goods, things will be better in China than in the United States. This, by the way, is another argument towards the beginning of a policy of restricting China — in a situation of stimulating private demand, logic requires that these very households buy domestic products, not Chinese ones. Here is few pics for illustration -
Consumption is falling, PPI is following, obviously showing the deflationary processes in economy, based on production sector degradation.
DEBT CEIL FRUITS
Will there be a tightening or easing of monetary policy in the US? As experts mentioned earlier, the last public speeches of Fed Chairman Powell were close to hysteria. Since any decision that the Fed could make takes on a clearly political connotation. And there are no good ways out of the situation anymore.
The format that can be assumed within the framework of the agreements on the national debt limit gives grounds to assume what the policy of the US monetary authorities will be. Since spending cuts of $50 billion with permission to borrow $4 trillion over two years looks pretty wild, we can suggest the following. Only by the end of the year, the Treasury should borrow at least 1.5 trillion. And this is a huge burden on the US monetary system, and in the mode of tightening monetary policy.
Yes, the budget will return this money to the economy, but to the allocated industries, enterprises and municipal farms. In other words, access to money will become more difficult for most of the economy (tightening monetary policy, fighting inflation), but support will be provided for the most needy part, on the contrary. The question is whether this will be enough to reduce inflation, but if it is not enough, then the rate can be raised. But less than it could be. Of course, this scenario will work only if the Treasury takes money from the market.
If it has to deal with the QE of any kind, then inflation will rise for sure. But, as far as we understand, this option is not envisaged yet. Thus, there is reason to believe that answers to both fundamental questions have been found (even if they have not yet been voiced) and in this sense there is no sense in keeping the threat of technical default. That's what we saw.
Now let's take a look at few numbers. Next week, a powerful money pump will begin to work, sucking liquidity from the financial system into US Bonds. The last time the debt limit was raised was on December 16, 2021, and the market, by inertia, lasted only two weeks, after which the strongest collapse since 2008 began.This time, US Treasury borrowing could reach up to $2 trillion from June to December 2023, where $1.2 trillion could be spent on current financing of the budget deficit and up to $800 billion to replenish the zeroed cash position.
It should be understood here that withdrawn liquidity from the market in favor of Treasuries is unallocated cash flows into shares or corporate bonds. The situation with large placements of treasuries clearly aggravated the liquidity balance in the system, redistributing flows from stocks and corporate bonds in treasuries. But - 1.5 years ago the disposition was much better.
Firstly, the peak of net placements occurred from December 17 to March 31 with record net placements of 1 trillion and, most importantly, at low rates, then the Fed's key rate was 0.25%.
Secondly, the main liquidity providers (commercial and investment banks) had much more free cash. Just the peak of the cash position of commercial banks fell on December 15, 2021 (4.23 trillion) and shrank by 1.1 trillion by June 2022, and now it is 3.3 trillion.
It could hurt a lot. The Ministry of Finance can allocate 1.5-2 trillion in the next 6 months, and this is against the backdrop of sales from the Fed (80-95 billion per month), prohibitively high rates and liquidity problems for banks , and there will be more and more problems. Treasury placements should go smoothly, but the stress on the system could be the worst in history.
Even if net placements amount to 1.5 trillion, and the sale of assets from the Fed's balance sheet is half of what was planned, this is over 1.75 trillion, which will be the strongest burden on the dollar system in 6 months. As you can see in the charts, when net borrowing exceeded $1 trillion in 6 months, at that moment the Fed always carried out asset buybacks: 2008-2009, the second half of 2020 and Q1 2022, which leveled the load on the system.
Operations of the US Treasury and the Fed in the aggregate exceeded 1 trillion only twice in history - Q4 2008 and Q3 2020, and now they can hit 1.7-2.5 trillion.
Thus, if you still want to take position - try to do it as closer to invalidation point as possible, depending on your direction. Because your stop should be outside of 1.0670-1.0780 range. Thus if you're with downside butterfly - your stop is above 1.0780 and conversely - if you're with upside scenario and potential butterfly, your stop at least has to be under 1.0670 area. 