Sive Morten
Special Consultant to the FPA
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Fundamentals
This week the major information comes not from the fresh data and events but from the progress of existed ones. Even J. Powell speech has brought nothing new except 1-2 hints. That's why major market reaction has started later when it has become evident that rates balance is changing - BOJ, SNB, BoE comments. Rates also were cut in Brazil and Mexico. Also we think that L. Summers article is very important, where he speaks on alternative view on the US Inflation, suggesting that it is significantly higher and the US economy is slowing for ~ 5-6% per year, as we've mentioned as well. We also suggest that sharp escalation of conflict in Ukraine and terrorist attack in Moscow are indicators of situation worsening in the US economy, which is becoming difficult to hide. We expect that major fundamental events should come closer to the summer when the US reserves will exhaust.
Market overview
The dollar headed toward a second week of gains on Friday, after a slight rate hike in Japan gave the yen a slight reprieve and a surprise cut in Switzerland highlighted the gap in interest rate policy between the Federal Reserve and other central banks. The week marked a shift in global monetary policy as the Swiss National Bank (SNB) and central banks in developing countries cut rates or indicated their intention to do so, with June the likely moment for the European Central Bank to move.
The dollar rose against all G-10 currencies except the yen, as the relatively strong U.S. economy and high interest rates kept the carry trade alive. But the Swiss rate cut, the first by a major central bank in Europe, marked a definitive shift. The Fed left its overnight rate on hold between 5.25%-5.5% and stuck with projections for three cuts by year's end. But it also said it would not cut until it was confident that inflation was sustainably declining toward its 2% target. About 84 basis points of cuts are priced in for this year - much lower than the 160 or so at the start of the year - but higher than earlier in the week as rate cut bets gained steam.
The BoE revealed a more dovish tilt as two hawkish committee members dropped their prior call for a hike. Data showed UK consumer spending stagnated in February and Bank of England (BoE) Governor Andrew Bailey said rate cuts "were in play" this year. Furthermore, two members of the Monetary Policy Committee that had previously voted to raise rates instead voted to maintain them - a decision many in the market had not expected. Since the BoE's decision on Thursday, market expects three cuts, most likely starting in June, bringing the Bank more in line with the expected timing of rate cuts from the Federal Reserve and the European Central Bank.
The Bank of Japan announced an historic shift out of negative short-term rates and longer-run yield caps, but it was so well telegraphed that the yen fell on the news. Expectations for policy easing in China too have piled pressure on its currency, which dropped sharply in the onshore session, spooking equity investors and prompting state banks to step in.
Among some new statements come from J. Powell was the hint that the Federal Reserve is nearing a decision on slowing the pace of its balance sheet run-off, central bank Chair Jerome Powell said on Wednesday, a tapering move that may allow it to shed more bonds than it once expected.
Thomas Simons, economist at investment bank Jefferies, said in a note that Powell’s comments may have moved forward the start of the tapering process. Ahead of the FOMC meeting, a bare majority of economists in a Reuters poll had been expecting the QT taper process to begin in June and wrap up early next year.
The European Central Bank tried to dampen speculation on a streak of interest rate cuts on Wednesday even as it acknowledged encouraging data about slowing price and wage rises. Many ECB policymakers have expressed support for a first reduction in borrowing costs from their current record highs, most likely in June, with the debate now focused on how many more cuts would follow. But President Christine Lagarde said the ECB could not commit to a certain number of rate cuts even after it starts reducing borrowing costs.
Echoing Lagarde, the ECB's chief economist Philip Lane said he and colleagues will be "calibrating for a long time to come" the appropriate level of rates. And fellow board member Isabel Schnabel even raised the prospect of a new era of structurally higher interest rates.
Money markets are pencilling in three cuts by December with some chance of a fourth, which would lower the 4% rate the ECB pays on bank deposits to 3.25% or 3.0%. And Lagarde hinted that fall of inflation was likely to be "more durable and less beholden to assumptions about commodity prices" than in the past due to an expected fall in underlying inflation, which strip out volatile food and energy prices. She also welcomed ECB data showing annual pay growth had slowed for 4.4% in January to 4.2% in March.
Currently competition starts among G7 central banks who cuts next following SNB. For all banks early rate cut means weaker national currency and raising risks of new inflation increase. By cutting before the Fed, the ECB risks euro weakness that may re-stoke inflation.
There will be no floodgates or fireworks. Instead, banks on opposite sides of the Atlantic are likely to move in the smallest increments with periodic pauses, fearing that ultra-low unemployment could rekindle inflation rates still above their targets. Some emerging market economies, like Brazil, Mexico, Hungary and the Czech Republic have all cut rates already, but financial markets take their cue from the major central banks, so their influence on financial instruments is oversized.
A March 29 U.S. inflation reading is critical for markets after the Federal Reserve stuck with a view for rate cuts this year, even with a stronger economic outlook.
The February Personal Consumption Expenditures Price index is expected to show a 0.4% monthly increase, according to a Reuters poll. January's PCE index rose 0.3%, while the annual increase in inflation was the smallest in three years.
The Fed just upgraded its view on inflation - projecting that the PCE index excluding food and energy would rise at a 2.6% annual rate by year-end, compared with 2.4% in its December projections. It also lifted 2024 economic growth estimates.
Two cents on recent J. Powell Speech
The US Federal Reserve did not dare to start cutting the rate at a meeting held this week, it remained in the range of 5.25-5.5%. Taking into account the data on the state of affairs in the real sector of the economy (see the previous review), it could be assumed that an impetus for monetary policy easing could be given. However, the sharp rise in the stock market most likely scared Fed officials: a rate cut usually sharply supports stock assets, and the acceleration of the inflating of an already obvious bubble cannot please them.
The main thing that Powell said at his press conference: "Jerome Powell Fed: The way forward is not defined." Otherwise, he actually repeated the previous theses
Although they are still penciling in three-quarters-of-a-percentage point of rate cuts this year, officials also raised their longer-run estimate of the fed funds rate to 2.6% from 2.5% in December's forecasts. That breaks above an estimate that had been in place for most of the last five years. But gradually, at least over the last year, views have been shifting. Seven policymakers now figure the long-run neutral rate is at least 2.9%, new projections released on Wednesday showed, versus just three a year ago.
Powell, at a press conference after the rate meeting, said that while he does not anticipate a return to very low rates he was not yet sure that a new higher-rate regime was in the offing.
Tani Fukui, director for global economic and market strategy at MetLife Investment Management, the change in the forecast was quite important.
Among many others, we've chosen a few very interesting points in J. Powell speech. We suggest that these are very important hints:
Our Humble View
Our analysis suggests that inflation in the United States has been growing in recent months. Well, the state of the labor market says nothing about improvement. In other words, Powell is prone to wishful thinking. However, we will find out the exact picture in a month, when all the data for March will be released. Here we need to take a look at some charts that are showing, as we've said in the beginning, the dynamic in indicators. Now personal interest payments (blue line) is exceed wages (red line) for the first time. All are insolvent but they pretend they don’t:
Market now expects raising of PCE numbers next week, as it is shown above. While Atlanta Federal Reserve Bank President Raphael Bostic said he now forecasts just one interest rate cut this year, adding that the cut will likely come later than he previously expected. Meantime, inflation expectations are raising together with deterioration in national economy:
The Fed gently hints that they intend to turn the liquidity tap soon, by slowing the pace of QT or even stopping it. It means that other sources of liquidity are exhausting fast. Which is not surprising with appetites of the US budget.
Credit card debt has become a burden for Americans. Credit card delinquencies have reached their highest level in 13 years, even as banks report record profits from credit card lending, according to Moody's Analytics. But on government bonds, the payment level is outstanding:
Third is, a number of American economists (including such an iconic figure as L. Summers) published an article in which they gave an alternative analysis of inflation in the United States. According to these data, inflation is significantly (at least 4-5%) underestimated. Which suggests that there has been a continuous economic downturn in the United States since 2021.
From a political point of view, this is a very important fact, which suggests that the elites of the United States are preparing to reveal information about the real state of affairs. The time is ticking and they, in fact, has no other options, because the safety margin is melting. Large placements of the US Treasury in medium- and long-term debt are coming, whereas since June 2023 almost the entire volume (80%) has been dumped into bills (2 out of 2.5 trillion net placements).
Since June 2023, almost the entire volume of promissory notes has been intercepted by investment banks and money market funds for excessive liquidity in reverse repos, which decreased from 2.3-2.4 to 0.4-0.5 trillion by this reason. Currently, over 6 trillion bills are suspended on the balance sheet of the Ministry of Finance, which need to be refinanced next year and at least 2 trillion new borrowings will be required.
Even if the Ministry of Finance does not change the debt structure, in any case, preferential placements will be in debt over 5 years, i.e. the demand will grow at least 3 times (from 0.5 to 1.5 trillion) before Dec.24. Here is the most interesting thing. As we've said the entire reserves of sustainability has been exhausted (in June they will scrub the bottom), i.e. there is no extra money, and the placements are huge, which will put pressure on the treasury, raising rates (5% and higher for decades – this is real). This is the reason why Powell starts speaking about QT slowing.
The unrealized loss on dollar bonds in 4Q23 amounted to 3.6 trillion (with a strong rally at the end of the year, when 10-year yields were 3.8%). If the bonds start to decline, the loss will grow to 6-7 trillion, where the treasury is under 3 trillion. BTFP is closed and banks can't get more liquidity, backing bonds with the Fed. In October 2023, when 10 years were under 5%, the system was on the verge, this time it will be repeated with a smaller margin of safety.
Not occasionally among other risks Fathom consulting said to watch over banks:
According to forecasts from the US Budget Office, by the mid-2030s, mandatory government spending will exceed US budget revenues. One solution is to raise revenue through taxes, or to sequester spending - both of which can be painful.
And economists start telling that the US has 8-10 years for budget reform. But, in reality they do not have this time at all. In 2022 it seemed that it would last for 10 years to deny from dollar, but in fact, in two years both the Russian Federation and China de-dollarized 50% of foreign economic activity, so to speak. The dollar holds up mainly due to the fact that it is the main currency in stock trading.
The same is with the budget - even 4 years with current appetites is at least another $7-8 trillion of a new debt., which today simply no one has except the Fed. If you don’t print new money, then there will simply no cash to buy treasures in one year, not even speaking about 4 or 8 years. And there is no mechanism for reducing appetites peacefully. Likewise, transferring investors into treasuries from stocks or crypto will not help much: even if this happens, the departure of some investors to treasuries will be compensated by the exit of others from treasuries, who will buy up cheaper assets. Do not apply water with a leaky bucket. This is why we're skeptic on reducing inflation over the horizon of one, two, or five years.
Besides, budget restructuring with a budget deficit of 8% of GDP and GDP growth of 2.5% is impossible. And it's not about raising taxes. The state, of course, can increase them, redistribute a larger amount through the state budget and get rid of the deficit, but then additional demand in the amount of 8% of GDP multiplied by the multiplier will simply disappear from the economy. Moreover, such a redistribution will also create problems, since this 8% of GDP will leave some industries where the consumer is business or the population and will go to other industries where the consumer is the state. And this will be a really strong imbalance.
It means that until summer, the Fed and US Treasury should keep situation under control without big changes. Statistics data is totally controlled and hardly big changes will be published officially. But later in the year, starting June, we could get sharp change of situation. At the same time, we suggest that SNB acts in advance to ECB. Due to tight relation among European banks, ECB has weaker position in interest rates cut race. Which means that downside EUR/USD tendency should continue in nearest months. Technical picture also supports this view.
This week the major information comes not from the fresh data and events but from the progress of existed ones. Even J. Powell speech has brought nothing new except 1-2 hints. That's why major market reaction has started later when it has become evident that rates balance is changing - BOJ, SNB, BoE comments. Rates also were cut in Brazil and Mexico. Also we think that L. Summers article is very important, where he speaks on alternative view on the US Inflation, suggesting that it is significantly higher and the US economy is slowing for ~ 5-6% per year, as we've mentioned as well. We also suggest that sharp escalation of conflict in Ukraine and terrorist attack in Moscow are indicators of situation worsening in the US economy, which is becoming difficult to hide. We expect that major fundamental events should come closer to the summer when the US reserves will exhaust.
Market overview
The dollar headed toward a second week of gains on Friday, after a slight rate hike in Japan gave the yen a slight reprieve and a surprise cut in Switzerland highlighted the gap in interest rate policy between the Federal Reserve and other central banks. The week marked a shift in global monetary policy as the Swiss National Bank (SNB) and central banks in developing countries cut rates or indicated their intention to do so, with June the likely moment for the European Central Bank to move.
The dollar rose against all G-10 currencies except the yen, as the relatively strong U.S. economy and high interest rates kept the carry trade alive. But the Swiss rate cut, the first by a major central bank in Europe, marked a definitive shift. The Fed left its overnight rate on hold between 5.25%-5.5% and stuck with projections for three cuts by year's end. But it also said it would not cut until it was confident that inflation was sustainably declining toward its 2% target. About 84 basis points of cuts are priced in for this year - much lower than the 160 or so at the start of the year - but higher than earlier in the week as rate cut bets gained steam.
The BoE revealed a more dovish tilt as two hawkish committee members dropped their prior call for a hike. Data showed UK consumer spending stagnated in February and Bank of England (BoE) Governor Andrew Bailey said rate cuts "were in play" this year. Furthermore, two members of the Monetary Policy Committee that had previously voted to raise rates instead voted to maintain them - a decision many in the market had not expected. Since the BoE's decision on Thursday, market expects three cuts, most likely starting in June, bringing the Bank more in line with the expected timing of rate cuts from the Federal Reserve and the European Central Bank.
The Bank of Japan announced an historic shift out of negative short-term rates and longer-run yield caps, but it was so well telegraphed that the yen fell on the news. Expectations for policy easing in China too have piled pressure on its currency, which dropped sharply in the onshore session, spooking equity investors and prompting state banks to step in.
Among some new statements come from J. Powell was the hint that the Federal Reserve is nearing a decision on slowing the pace of its balance sheet run-off, central bank Chair Jerome Powell said on Wednesday, a tapering move that may allow it to shed more bonds than it once expected.
Thomas Simons, economist at investment bank Jefferies, said in a note that Powell’s comments may have moved forward the start of the tapering process. Ahead of the FOMC meeting, a bare majority of economists in a Reuters poll had been expecting the QT taper process to begin in June and wrap up early next year.
The European Central Bank tried to dampen speculation on a streak of interest rate cuts on Wednesday even as it acknowledged encouraging data about slowing price and wage rises. Many ECB policymakers have expressed support for a first reduction in borrowing costs from their current record highs, most likely in June, with the debate now focused on how many more cuts would follow. But President Christine Lagarde said the ECB could not commit to a certain number of rate cuts even after it starts reducing borrowing costs.
Echoing Lagarde, the ECB's chief economist Philip Lane said he and colleagues will be "calibrating for a long time to come" the appropriate level of rates. And fellow board member Isabel Schnabel even raised the prospect of a new era of structurally higher interest rates.
Money markets are pencilling in three cuts by December with some chance of a fourth, which would lower the 4% rate the ECB pays on bank deposits to 3.25% or 3.0%. And Lagarde hinted that fall of inflation was likely to be "more durable and less beholden to assumptions about commodity prices" than in the past due to an expected fall in underlying inflation, which strip out volatile food and energy prices. She also welcomed ECB data showing annual pay growth had slowed for 4.4% in January to 4.2% in March.
Currently competition starts among G7 central banks who cuts next following SNB. For all banks early rate cut means weaker national currency and raising risks of new inflation increase. By cutting before the Fed, the ECB risks euro weakness that may re-stoke inflation.
There will be no floodgates or fireworks. Instead, banks on opposite sides of the Atlantic are likely to move in the smallest increments with periodic pauses, fearing that ultra-low unemployment could rekindle inflation rates still above their targets. Some emerging market economies, like Brazil, Mexico, Hungary and the Czech Republic have all cut rates already, but financial markets take their cue from the major central banks, so their influence on financial instruments is oversized.
A March 29 U.S. inflation reading is critical for markets after the Federal Reserve stuck with a view for rate cuts this year, even with a stronger economic outlook.
The February Personal Consumption Expenditures Price index is expected to show a 0.4% monthly increase, according to a Reuters poll. January's PCE index rose 0.3%, while the annual increase in inflation was the smallest in three years.
The Fed just upgraded its view on inflation - projecting that the PCE index excluding food and energy would rise at a 2.6% annual rate by year-end, compared with 2.4% in its December projections. It also lifted 2024 economic growth estimates.
Two cents on recent J. Powell Speech
The US Federal Reserve did not dare to start cutting the rate at a meeting held this week, it remained in the range of 5.25-5.5%. Taking into account the data on the state of affairs in the real sector of the economy (see the previous review), it could be assumed that an impetus for monetary policy easing could be given. However, the sharp rise in the stock market most likely scared Fed officials: a rate cut usually sharply supports stock assets, and the acceleration of the inflating of an already obvious bubble cannot please them.
The main thing that Powell said at his press conference: "Jerome Powell Fed: The way forward is not defined." Otherwise, he actually repeated the previous theses
Although they are still penciling in three-quarters-of-a-percentage point of rate cuts this year, officials also raised their longer-run estimate of the fed funds rate to 2.6% from 2.5% in December's forecasts. That breaks above an estimate that had been in place for most of the last five years. But gradually, at least over the last year, views have been shifting. Seven policymakers now figure the long-run neutral rate is at least 2.9%, new projections released on Wednesday showed, versus just three a year ago.
Powell, at a press conference after the rate meeting, said that while he does not anticipate a return to very low rates he was not yet sure that a new higher-rate regime was in the offing.
Tani Fukui, director for global economic and market strategy at MetLife Investment Management, the change in the forecast was quite important.
Among many others, we've chosen a few very interesting points in J. Powell speech. We suggest that these are very important hints:
- Perhaps at some point, we will lower the rate this year, but the prospects are uncertain. The rate has probably reached its peak.
- We discussed with the chairmen the SLOWDOWN in the reduction of the Fed's balance sheet (QT)
- Inflationary spikes in January and February are seasonal adjustments. It's nothing terrible!
- we want to avoid turbulence. This is the main reason for the decrease in the rate of balance reduction (QT).
- my intuition tells me that the Fed rate will not decrease to the levels that we have seen in previous years.
- No one knows if the rate will be even higher in the long run.
- A HIGH level of uncertainty remains around all this.
- Most believe that the Fed will cut the rate this year, but EVERYTHING will depend on the data.
- IT is NORMAL if there is more stable inflation in the USA in the 1st half of the year.
Our Humble View
Our analysis suggests that inflation in the United States has been growing in recent months. Well, the state of the labor market says nothing about improvement. In other words, Powell is prone to wishful thinking. However, we will find out the exact picture in a month, when all the data for March will be released. Here we need to take a look at some charts that are showing, as we've said in the beginning, the dynamic in indicators. Now personal interest payments (blue line) is exceed wages (red line) for the first time. All are insolvent but they pretend they don’t:
Market now expects raising of PCE numbers next week, as it is shown above. While Atlanta Federal Reserve Bank President Raphael Bostic said he now forecasts just one interest rate cut this year, adding that the cut will likely come later than he previously expected. Meantime, inflation expectations are raising together with deterioration in national economy:
The Fed gently hints that they intend to turn the liquidity tap soon, by slowing the pace of QT or even stopping it. It means that other sources of liquidity are exhausting fast. Which is not surprising with appetites of the US budget.
Credit card debt has become a burden for Americans. Credit card delinquencies have reached their highest level in 13 years, even as banks report record profits from credit card lending, according to Moody's Analytics. But on government bonds, the payment level is outstanding:
Third is, a number of American economists (including such an iconic figure as L. Summers) published an article in which they gave an alternative analysis of inflation in the United States. According to these data, inflation is significantly (at least 4-5%) underestimated. Which suggests that there has been a continuous economic downturn in the United States since 2021.
From a political point of view, this is a very important fact, which suggests that the elites of the United States are preparing to reveal information about the real state of affairs. The time is ticking and they, in fact, has no other options, because the safety margin is melting. Large placements of the US Treasury in medium- and long-term debt are coming, whereas since June 2023 almost the entire volume (80%) has been dumped into bills (2 out of 2.5 trillion net placements).
Since June 2023, almost the entire volume of promissory notes has been intercepted by investment banks and money market funds for excessive liquidity in reverse repos, which decreased from 2.3-2.4 to 0.4-0.5 trillion by this reason. Currently, over 6 trillion bills are suspended on the balance sheet of the Ministry of Finance, which need to be refinanced next year and at least 2 trillion new borrowings will be required.
Even if the Ministry of Finance does not change the debt structure, in any case, preferential placements will be in debt over 5 years, i.e. the demand will grow at least 3 times (from 0.5 to 1.5 trillion) before Dec.24. Here is the most interesting thing. As we've said the entire reserves of sustainability has been exhausted (in June they will scrub the bottom), i.e. there is no extra money, and the placements are huge, which will put pressure on the treasury, raising rates (5% and higher for decades – this is real). This is the reason why Powell starts speaking about QT slowing.
The unrealized loss on dollar bonds in 4Q23 amounted to 3.6 trillion (with a strong rally at the end of the year, when 10-year yields were 3.8%). If the bonds start to decline, the loss will grow to 6-7 trillion, where the treasury is under 3 trillion. BTFP is closed and banks can't get more liquidity, backing bonds with the Fed. In October 2023, when 10 years were under 5%, the system was on the verge, this time it will be repeated with a smaller margin of safety.
Not occasionally among other risks Fathom consulting said to watch over banks:
According to forecasts from the US Budget Office, by the mid-2030s, mandatory government spending will exceed US budget revenues. One solution is to raise revenue through taxes, or to sequester spending - both of which can be painful.
And economists start telling that the US has 8-10 years for budget reform. But, in reality they do not have this time at all. In 2022 it seemed that it would last for 10 years to deny from dollar, but in fact, in two years both the Russian Federation and China de-dollarized 50% of foreign economic activity, so to speak. The dollar holds up mainly due to the fact that it is the main currency in stock trading.
The same is with the budget - even 4 years with current appetites is at least another $7-8 trillion of a new debt., which today simply no one has except the Fed. If you don’t print new money, then there will simply no cash to buy treasures in one year, not even speaking about 4 or 8 years. And there is no mechanism for reducing appetites peacefully. Likewise, transferring investors into treasuries from stocks or crypto will not help much: even if this happens, the departure of some investors to treasuries will be compensated by the exit of others from treasuries, who will buy up cheaper assets. Do not apply water with a leaky bucket. This is why we're skeptic on reducing inflation over the horizon of one, two, or five years.
Besides, budget restructuring with a budget deficit of 8% of GDP and GDP growth of 2.5% is impossible. And it's not about raising taxes. The state, of course, can increase them, redistribute a larger amount through the state budget and get rid of the deficit, but then additional demand in the amount of 8% of GDP multiplied by the multiplier will simply disappear from the economy. Moreover, such a redistribution will also create problems, since this 8% of GDP will leave some industries where the consumer is business or the population and will go to other industries where the consumer is the state. And this will be a really strong imbalance.
It means that until summer, the Fed and US Treasury should keep situation under control without big changes. Statistics data is totally controlled and hardly big changes will be published officially. But later in the year, starting June, we could get sharp change of situation. At the same time, we suggest that SNB acts in advance to ECB. Due to tight relation among European banks, ECB has weaker position in interest rates cut race. Which means that downside EUR/USD tendency should continue in nearest months. Technical picture also supports this view.
