Sive Morten
Special Consultant to the FPA
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Fundamentals
The global situation is changing, forming tight сan of worms that drugs as economical as geopolitical factors. We see how EUR, under the burden of geopolitical problems in EU, shows almost no reaction on key economical statistics, such as recent NFP report. According to our suggestion the problems stay for the longer term, which is impossible to predict by far. Keeping aside a lot of noise, scream in media, we see big money flows effect, initiated by the US to support its economy, using the crisis in the EU. This changes the global economic balance for at least of 6 months, or maybe for longer. With this new environment we suspect that EUR almost impossible to avoid USD parity within few months.
Market overview
Geopolitical worries are clouding the outlook for U.S. stocks, even as military tensions moderate expectations for how aggressively the Federal Reserve will tighten monetary policy in coming months. The see-saw moves come as investor hopes that the Fed may raise rates less severely than anticipated vied with worries about inflation and higher commodity prices, stoked by sanctions against Russia, one of the world’s biggest commodity exporters.
Investors have virtually priced out the chances of a hefty 50 basis point rate hike in March, giving a lift to the technology and growth stocks that had been pummeled in recent weeks by anticipation of harsh Fed tightening. Meanwhile, geopolitical concerns have propelled oil prices, prompting fears of slower growth and higher inflation over the long term. U.S. crude prices topped $115 a barrel this week and hit their highest levels since 2008, while other commodities such as wheat also surged.
Investors next week will be watching data on U.S. inflation, due out Thursday. Consumer prices in January grew at their fastest pace in nearly four decades.
You wouldn't believe if you just had a glimpse over the bund's negative yield (-0.03%) but euro zone inflation actually just hit another record high. Inflation surprisingly jumped to 5.8% in February and with energy prices soaring due to Russia's war in Ukraine, it's unlikely to cool off anytime soon. But despite fast-rising prices, money markets have dramatically scaled back their expectations for an ECB interest rate hike which a first one is now only expected in October.
There's indeed a strong assumption that policy makers need a clearer picture of how much economic damage the war in Ukraine will cause before they can go ahead and tighten. But that doesn't mean inflation isn't a burning concern for the ECB.
As highlighted by Mark Haefele, CIO at UBS GWM, rising oil prices constitute a double whammy in that they both fuel inflation and drag growth down at the same time.
Traders are rushing into currency derivative markets to protect their portfolios against further euro weakness, a sign of broadening stress for European assets. The euro has slipped to the weakest since May 2020 at $1.1059, down 2% since last Thursday. But that decline is modest compared to moves on derivatives, where bearish euro positions have more than doubled in the same period, suggesting investors are preparing for further weakness.
One closely watched gauge of investor demand for options that give traders the right to sell the euro, versus the right to buy it, has slumped to five-year lows, indicating a bias to selling the currency. Three-month risk reversals on Wednesday dropped to March 2017 lows. Currency options charge a premium in the direction deemed most likely, and the outbreak of war on Europe's eastern border has cast a shadow on the regional economy.
Options volumes betting on more euro losses are building too. Refinitiv data showed an outsize $4 billion-plus of euro options expiring at end-March. The single currency has seen deepening inverse correlation with the price of oil and natural gas, a large proportion of which Europe sources from Russia. The price of crude oil in euros has soared to record highs above 100 euros per barrel this week.
Federal Reserve Chair Jerome Powell, balancing high U.S. inflation against the complex new risks of a European land war, said Wednesday the central bank would begin “carefully” raising interest rates at its upcoming March meeting but be ready to move more aggressively if inflation does not cool as quickly as expected.
But he said for now the Fed was proceeding largely as planned to raise the target overnight federal funds rate and reduce the size of its balance sheet in order to tame inflation that is currently the highest it has been since the 1980s. Powell said he will back a quarter point rate increase when the Fed meets March 15-16, effectively putting to rest debate over starting a post-pandemic round of rate hikes with a larger than usual half-point increase.
But the Fed chief said he was ready if needed to use larger or more frequent rate moves if inflation does not slow, and may over time need to push rates to restrictive levels above 2.5% - slowing economic growth rather than simply stimulating it less robustly.
What Powell described as a collision between strong consumer demand and pandemic constraints on global product supply was "not as transitory as we had hoped...Other mainstream economists and central banks around the world made the same mistake. That doesn’t excuse it, but we thought these things would be resolved long ago.”
The euro extended recent declines and hit its lowest since 2016 against sterling on Thursday as investors worried about the impact of rising oil prices, while the U.S. dollar index rose as Federal Reserve Chairman Jerome Powell reiterated that he supports a 25-basis-point hike this month.
In other U.S. data, new orders for U.S.-made goods increased more than expected in January, pointing to continued strength in manufacturing.
The ballooning euro cost of oil and gas to record highs as war rages in Ukraine has prompted markets to murmur about the chances of a rare, even if unlikely, ECB intervention to bolster the euro against the dollar. And while the euro has slumped against the dollar this week, exaggerating the cost of dollar-priced commodities, it's stable against a broad trade-weighted basket of currencies - still less than 5% from record highs.
There have been few signs of disorderly movements, and it has been more than 20 years since a direct euro-targeted intervention on the markets. But in times of war and crisis, nothing can be ruled out.
The surge in commodity prices, particularly oil and natural gas, is of such a magnitude that further euro depreciation could spin an already toxic inflationary vortex out of control. At least, that's the warning from George Saravelos, head of global currency strategy at Deutsche Bank in a note headlined:
But he argues that surging energy prices are now the single biggest threat to the euro zone economy, which could unleash "a vicious inflationary spiral" that infects broader financial conditions.
A weaker euro may yet pose a headache for the ECB - annual inflation is at a record high 5.8% and likely to rise further - but that seems some way off. As former ECB Vice-President Vitor Constancio points out, the exchange rate is generally not an objective of monetary policy because it is very difficult to reliably identify its drivers.
Constancio also notes that unilateral intervention is rarely effective. In that context, it is difficult to imagine the U.S. Federal Reserve getting on board a policy to weaken the dollar just when it will almost certainly be raising interest rates.
There is a building consensus, however, that the euro is heading lower. Robin Brooks, chief economist at Washington-based Institute of International Finance, reckons parity with the dollar - a 10% depreciation from current levels - could come within three months.
ECB policymakers' consistent position since the euro's launch in 1999 has been that the central bank will intervene in the currency market if it sees disorderly movements or unwarranted volatility. But even if the euro soon trades at parity with the dollar, as the IIF's Brooks predicts, market volatility may not matter to ECB policymakers if they are facing down an oncoming recession.
A slumping euro will aggravate European Central Bank President Christine Lagarde’s already difficult policy predicament. The euro zone economy is more exposed than other regions to the fallout from Russia's invasion of Ukraine and the knock-on effects of sanctions, which is why the single currency is falling. Its broad-based slide will make imports more expensive and exacerbate high inflation.
The euro on Friday fell below $1.10 for the first time in nearly two years and was on track for its biggest daily percentage decline since March 2020, a time of massive demand for dollar funding as Covid-19 hit the West. This time, Europe’s single currency is also displaying independent weakness: It slid to a seven-year low against the Swiss franc and to its weakest since 2016 against the British pound.
In 2021, Russia was the fifth-largest partner for EU exports of goods and the third largest for EU imports of goods, according to the European Commission. Germany, Europe’s biggest economy, was both the largest importer of goods from the country and the largest exporter of goods there. The single currency bloc also depended more heavily on Russian energy than other regions.
A falling currency makes imports pricier at a time when inflation has just hit a record high of 5.8%, nearly three times the ECB’s target. The problem is all the greater because the price of oil, denominated in dollars, is already soaring. Expected efforts to control inflation would come at the expense of economic activity, while changing tack to support the economy would risk prolonged price pressures. She can’t win.
U.S. job growth accelerated in February, pushing the unemployment rate to a two-year low of 3.8% and raising optimism that the economy could withstand mounting headwinds from geopolitical tensions, inflation and tighter monetary policy. The Labor Department's closely watched employment report on Friday also showed the economy created 92,000 more jobs than initially estimated in December and January.
Though average hourly earnings were flat last month, that was because of the return of workers in lower-paying industries and a calendar bias. Companies are raising wages to attract scarce workers, which is contributing to higher inflation. Economists said absent war in Europe, which has pushed up prices of oil, wheat and other commodities, the strong employment report would have pressured the Federal Reserve to raise interest rates by half of a percentage point later this month.
The survey of establishments showed nonfarm payrolls jumped by 678,000 jobs last month, leaving employment 2.1 million jobs below its pre-pandemic level. Economists expect all the lost jobs will be recouped by the third quarter of this year.
The unchanged reading in average hourly earnings followed a 0.6% increase in January. Data for the employment report is collected during the week that includes the 12th day of the month.
COT Report
Speculators' net long positioning in the U.S. dollar dropped in the latest week to the lowest level since mid-August 2021, according to calculations by Reuters and U.S. Commodity Futures Trading Commission data released on Friday. The value of the net long dollar position fell to $5.12 billion for the week ended March 1, from $5.80 billion the previous week. U.S. dollar net long positioning fell for a seventh consecutive week.
"Data released today showed a decline in U.S. dollar bullish sentiment despite elevated market anxiety owing to the war in Europe," wrote Scotiabank in a research note after the release of the CFTC data.
Speculators also increased net long positioning on the euro to 64,939 contracts, the largest since July 2021.
Scotia, however, said positive drivers are limited for the euro. That should see investors trim net bullish positions on next week's data "particularly ahead of a dovish ECB (European Central Bank) decision on Thursday given the risks posed by the war."
Thus, despite the big collapse on the market, the sentiment data doesn't reflect yet the changes. Thus, CFTC numbers shows increasing of net long position on a background of rising open interest:
To be continued...
The global situation is changing, forming tight сan of worms that drugs as economical as geopolitical factors. We see how EUR, under the burden of geopolitical problems in EU, shows almost no reaction on key economical statistics, such as recent NFP report. According to our suggestion the problems stay for the longer term, which is impossible to predict by far. Keeping aside a lot of noise, scream in media, we see big money flows effect, initiated by the US to support its economy, using the crisis in the EU. This changes the global economic balance for at least of 6 months, or maybe for longer. With this new environment we suspect that EUR almost impossible to avoid USD parity within few months.
Market overview
Geopolitical worries are clouding the outlook for U.S. stocks, even as military tensions moderate expectations for how aggressively the Federal Reserve will tighten monetary policy in coming months. The see-saw moves come as investor hopes that the Fed may raise rates less severely than anticipated vied with worries about inflation and higher commodity prices, stoked by sanctions against Russia, one of the world’s biggest commodity exporters.
Investors have virtually priced out the chances of a hefty 50 basis point rate hike in March, giving a lift to the technology and growth stocks that had been pummeled in recent weeks by anticipation of harsh Fed tightening. Meanwhile, geopolitical concerns have propelled oil prices, prompting fears of slower growth and higher inflation over the long term. U.S. crude prices topped $115 a barrel this week and hit their highest levels since 2008, while other commodities such as wheat also surged.
Investors next week will be watching data on U.S. inflation, due out Thursday. Consumer prices in January grew at their fastest pace in nearly four decades.
"The Fed will be less aggressive now, in the near term, but the problem that the Fed faces has not been ameliorated," Neuman said. "In fact, it has been exacerbated."
Truist Advisory Services this week lowered its rating on the financials sector to "neutral", while upgrading its ratings on two defensive groups, consumer staples to "overweight" and utilities to "neutral. Because of what is happening overseas, it complicates the global picture," said Keith Lerner, Truist's co-chief investment officer. "The global economy will be somewhat slower, capping rates, and by itself that is a negative for financials.”
You wouldn't believe if you just had a glimpse over the bund's negative yield (-0.03%) but euro zone inflation actually just hit another record high. Inflation surprisingly jumped to 5.8% in February and with energy prices soaring due to Russia's war in Ukraine, it's unlikely to cool off anytime soon. But despite fast-rising prices, money markets have dramatically scaled back their expectations for an ECB interest rate hike which a first one is now only expected in October.
There's indeed a strong assumption that policy makers need a clearer picture of how much economic damage the war in Ukraine will cause before they can go ahead and tighten. But that doesn't mean inflation isn't a burning concern for the ECB.
"It's fair to say we have two huge conflicting forces here", Deutsche Bank Jim Reid wrote in his morning note. For this week though the geopolitics are steamrolling over the inflation hawks for which I will put my hand up and say I am one", he said.
As highlighted by Mark Haefele, CIO at UBS GWM, rising oil prices constitute a double whammy in that they both fuel inflation and drag growth down at the same time.
"On our calculations, if oil prices were to rise to USD 125/bbl or higher for two quarters, it would result in roughly half a percentage point lower in global GDP growth, and higher inflation affecting consumer spending power", he argued this morning.
Traders are rushing into currency derivative markets to protect their portfolios against further euro weakness, a sign of broadening stress for European assets. The euro has slipped to the weakest since May 2020 at $1.1059, down 2% since last Thursday. But that decline is modest compared to moves on derivatives, where bearish euro positions have more than doubled in the same period, suggesting investors are preparing for further weakness.
One closely watched gauge of investor demand for options that give traders the right to sell the euro, versus the right to buy it, has slumped to five-year lows, indicating a bias to selling the currency. Three-month risk reversals on Wednesday dropped to March 2017 lows. Currency options charge a premium in the direction deemed most likely, and the outbreak of war on Europe's eastern border has cast a shadow on the regional economy.
"The FX options market in euro/dollar is extraordinary. Risk reversals have never been as extreme," said Richard Benson, co-chief investment officer at Millennium Global Investments.
Options volumes betting on more euro losses are building too. Refinitiv data showed an outsize $4 billion-plus of euro options expiring at end-March. The single currency has seen deepening inverse correlation with the price of oil and natural gas, a large proportion of which Europe sources from Russia. The price of crude oil in euros has soared to record highs above 100 euros per barrel this week.
"The more oil and natural gas push higher, the more the euro drops, pushing commodities priced in euros even higher - a vicious inflationary spiral," Deutsche Bank strategist George Saravelos told clients.
Federal Reserve Chair Jerome Powell, balancing high U.S. inflation against the complex new risks of a European land war, said Wednesday the central bank would begin “carefully” raising interest rates at its upcoming March meeting but be ready to move more aggressively if inflation does not cool as quickly as expected.
Powell called the situation around Ukraine "a game changer" that could have unpredictable consequences. "There are events yet to come and we don't know what the real effect on the U.S. economy will be," Powell told the House Financial Services Committee during a monetary policy hearing overshadowed by the conflict in Europe.
But he said for now the Fed was proceeding largely as planned to raise the target overnight federal funds rate and reduce the size of its balance sheet in order to tame inflation that is currently the highest it has been since the 1980s. Powell said he will back a quarter point rate increase when the Fed meets March 15-16, effectively putting to rest debate over starting a post-pandemic round of rate hikes with a larger than usual half-point increase.
But the Fed chief said he was ready if needed to use larger or more frequent rate moves if inflation does not slow, and may over time need to push rates to restrictive levels above 2.5% - slowing economic growth rather than simply stimulating it less robustly.
What Powell described as a collision between strong consumer demand and pandemic constraints on global product supply was "not as transitory as we had hoped...Other mainstream economists and central banks around the world made the same mistake. That doesn’t excuse it, but we thought these things would be resolved long ago.”
"We have an expectation that inflation will peak and begin to come down this year. To the extent inflation comes in higher or is more persistently high ... we would be prepared to move more aggressively by raising the federal funds rate by more than 25 basis points at a meeting or meetings."
The euro extended recent declines and hit its lowest since 2016 against sterling on Thursday as investors worried about the impact of rising oil prices, while the U.S. dollar index rose as Federal Reserve Chairman Jerome Powell reiterated that he supports a 25-basis-point hike this month.
"The dollar is in a significant groove right now, benefiting from safe-haven flows and the solid shape of the U.S. economy," said Joe Manimbo, senior market analyst at Western Union Business Solutions in Washington. Certainly the data this week has been really bullish ... so if we see strong job growth coupled with oil exacerbating inflation, we think that would keep big Fed rate hikes in the conversation," he said.
In other U.S. data, new orders for U.S.-made goods increased more than expected in January, pointing to continued strength in manufacturing.
The ballooning euro cost of oil and gas to record highs as war rages in Ukraine has prompted markets to murmur about the chances of a rare, even if unlikely, ECB intervention to bolster the euro against the dollar. And while the euro has slumped against the dollar this week, exaggerating the cost of dollar-priced commodities, it's stable against a broad trade-weighted basket of currencies - still less than 5% from record highs.
There have been few signs of disorderly movements, and it has been more than 20 years since a direct euro-targeted intervention on the markets. But in times of war and crisis, nothing can be ruled out.
The surge in commodity prices, particularly oil and natural gas, is of such a magnitude that further euro depreciation could spin an already toxic inflationary vortex out of control. At least, that's the warning from George Saravelos, head of global currency strategy at Deutsche Bank in a note headlined:
"The ECB should intervene in EUR/USD." To be clear, he says this remains unlikely and that the ECB can support the euro in other ways, like interest rate hikes or verbal intervention. If financial conditions get disorderly, there is precedent for coordinated FX intervention from the G7," Saravelos says, pointing to the G7's action in 2011 to weaken the Japanese yen after the Japanese earthquake, tsunami, and Fukushima nuclear disaster in March that year.
But he argues that surging energy prices are now the single biggest threat to the euro zone economy, which could unleash "a vicious inflationary spiral" that infects broader financial conditions.
A weaker euro may yet pose a headache for the ECB - annual inflation is at a record high 5.8% and likely to rise further - but that seems some way off. As former ECB Vice-President Vitor Constancio points out, the exchange rate is generally not an objective of monetary policy because it is very difficult to reliably identify its drivers.
Constancio also notes that unilateral intervention is rarely effective. In that context, it is difficult to imagine the U.S. Federal Reserve getting on board a policy to weaken the dollar just when it will almost certainly be raising interest rates.
"Right now, the euro is hovering around $1.11, and there is no need or the possibility of organizing a multilateral intervention. It is better, therefore, to forget the issue," he said.
There is a building consensus, however, that the euro is heading lower. Robin Brooks, chief economist at Washington-based Institute of International Finance, reckons parity with the dollar - a 10% depreciation from current levels - could come within three months.
ECB policymakers' consistent position since the euro's launch in 1999 has been that the central bank will intervene in the currency market if it sees disorderly movements or unwarranted volatility. But even if the euro soon trades at parity with the dollar, as the IIF's Brooks predicts, market volatility may not matter to ECB policymakers if they are facing down an oncoming recession.
"The picture in the euro zone has turned on a dime and the whole notion of second-round inflation effects is just fanciful now. ECB intervention to support the euro is counterintuitive. An effective tightening of policy makes no sense," Brooks said.
A slumping euro will aggravate European Central Bank President Christine Lagarde’s already difficult policy predicament. The euro zone economy is more exposed than other regions to the fallout from Russia's invasion of Ukraine and the knock-on effects of sanctions, which is why the single currency is falling. Its broad-based slide will make imports more expensive and exacerbate high inflation.
The euro on Friday fell below $1.10 for the first time in nearly two years and was on track for its biggest daily percentage decline since March 2020, a time of massive demand for dollar funding as Covid-19 hit the West. This time, Europe’s single currency is also displaying independent weakness: It slid to a seven-year low against the Swiss franc and to its weakest since 2016 against the British pound.
In 2021, Russia was the fifth-largest partner for EU exports of goods and the third largest for EU imports of goods, according to the European Commission. Germany, Europe’s biggest economy, was both the largest importer of goods from the country and the largest exporter of goods there. The single currency bloc also depended more heavily on Russian energy than other regions.
A falling currency makes imports pricier at a time when inflation has just hit a record high of 5.8%, nearly three times the ECB’s target. The problem is all the greater because the price of oil, denominated in dollars, is already soaring. Expected efforts to control inflation would come at the expense of economic activity, while changing tack to support the economy would risk prolonged price pressures. She can’t win.
U.S. job growth accelerated in February, pushing the unemployment rate to a two-year low of 3.8% and raising optimism that the economy could withstand mounting headwinds from geopolitical tensions, inflation and tighter monetary policy. The Labor Department's closely watched employment report on Friday also showed the economy created 92,000 more jobs than initially estimated in December and January.
Though average hourly earnings were flat last month, that was because of the return of workers in lower-paying industries and a calendar bias. Companies are raising wages to attract scarce workers, which is contributing to higher inflation. Economists said absent war in Europe, which has pushed up prices of oil, wheat and other commodities, the strong employment report would have pressured the Federal Reserve to raise interest rates by half of a percentage point later this month.
"On balance, despite weakness in wages, this is one more in a long line of reports suggesting the Fed should have started raising rates ages ago," said Chris Low, chief economist at FHN Financial in New York. "The Fed has its work cut out if it wants to slow demand enough to stabilize the unemployment rate at 4%."
The survey of establishments showed nonfarm payrolls jumped by 678,000 jobs last month, leaving employment 2.1 million jobs below its pre-pandemic level. Economists expect all the lost jobs will be recouped by the third quarter of this year.
The unchanged reading in average hourly earnings followed a 0.6% increase in January. Data for the employment report is collected during the week that includes the 12th day of the month.
"There's a very well-established pattern when the 15th of the month falls on a Saturday that typically boosts average hourly earnings that month and the following month falls to the downside," said Robert Rosener, a senior economist at Morgan Stanley in New York. "That was the case in January, when the 15th of the month fell on a Saturday ... and February was expected to show some payback that would drag down the figure."
COT Report
Speculators' net long positioning in the U.S. dollar dropped in the latest week to the lowest level since mid-August 2021, according to calculations by Reuters and U.S. Commodity Futures Trading Commission data released on Friday. The value of the net long dollar position fell to $5.12 billion for the week ended March 1, from $5.80 billion the previous week. U.S. dollar net long positioning fell for a seventh consecutive week.
"Data released today showed a decline in U.S. dollar bullish sentiment despite elevated market anxiety owing to the war in Europe," wrote Scotiabank in a research note after the release of the CFTC data.
Speculators also increased net long positioning on the euro to 64,939 contracts, the largest since July 2021.
Scotia, however, said positive drivers are limited for the euro. That should see investors trim net bullish positions on next week's data "particularly ahead of a dovish ECB (European Central Bank) decision on Thursday given the risks posed by the war."
Thus, despite the big collapse on the market, the sentiment data doesn't reflect yet the changes. Thus, CFTC numbers shows increasing of net long position on a background of rising open interest:
To be continued...