Sive Morten
Special Consultant to the FPA
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Fundamentals
So, guys, now we have so hot mix of news and data that investors have headache trying to find the way in this mess. EUR as you could see, was stunned this week, showing to action at all. Starting from recent Fed comments and following by political events, news, economical statistics we have tough task to decide what to expect and in what direction we should move.
Market overview
The European Central Bank will take action if it sees second-round inflation effects and a de-anchoring of medium-term inflation expectations, European Central Bank Vice President Luis de Guindos told a German newspaper. Earlier this month, the ECB accelerated its exit from unconventional stimulus, and investors have been ramping up their bets on higher ECB rates.
De Guindos told Handelsblatt in an interview published on Sunday that second-round effects and de-anchoring of price expectations would be "deciding factors" for the central bank. Asked about risks to the European financial system due to the war in Ukraine, de Guindos said:
Sales of new U.S. single-family homes unexpectedly fell in February amid rising mortgage rates and higher house prices, which are squeezing out some first-time buyers from the market. Despite the second straight monthly decline reported by the Commerce Department on Wednesday, sales remained above their pre-pandemic level. New home sales decreased 2% to a seasonally adjusted annual rate of 772,000 units last month. January's sales pace was revised down to 788,000 units from the previously reported 801,000 units.
Mortgage rates surged in February and have continued to push higher after the Federal Reserve last week raised its policy interest rate by 25 basis points, the first hike in more than three years, and laid out an aggressive plan to push borrowing costs to restrictive levels by 2023. The 30-year fixed rate vaulted 23 basis points to a three-year high of 4.50% last week, data from the Mortgage Bankers Association showed on Wednesday.
Though, mortgage rates remain low by historical standards, strong house price inflation has combined to significantly increase the typical monthly mortgage payment.
Data last week showed sales of previously owned homes fell sharply in February.
Contracts to buy U.S. previously owned homes dropped to the lowest level in nearly two years in February, weighed down by a persistent shortage of properties, and activity could remain sluggish amid increasing mortgage rates and high house prices. The National Association of Realtors (NAR) said on Friday its Pending Home Sales Index, based on signed contracts, fell 4.1% last month to 104.9, the lowest level since May 2020. It was the fourth straight monthly decline in the index, which leads sales by a month or two.
The University of Michigan's final consumer sentiment index dropped to 59.4 in March, the lowest reading since August 2011. It was slightly revised down from the preliminary reading of 59.7 earlier in the month. The index was at 62.8 in February and it has now declined for three straight months.
The dollar rose for the fourth time in the past five sessions, as economic data on the labor market helped firm expectations the U.S. Federal Reserve will be more aggressive in taking steps to curb inflation. While new durable goods orders unexpectedly fell in February as shipments slowed, demand for goods remained strong. In addition a measure of business activity for March climbed to an eight-month high.
The greenback is poised for a solid gain this week, which would mark its sixth weekly gain in the past seven. The dollar has benefited from its status as a safe haven and the conflict in Ukraine has driven expectations the Fed will hike interest rates.
Bank of America (BofA) and Citi have joined a small but growing number of top investment banks calling for more aggressive interest rate increases from the U.S. Federal Reserve against a backdrop of soaring inflation data and hawkish comments from policymakers. BoFA now expects two hikes of 50 basis points each at the Fed's June and July meetings with "risks" of those expectations being pulled forward into May and June respectively.
Citi, on the other hand, sees 50 basis-point increases in May, June, July, and September. The bank also expects 25 basis-point tightening in October and December. Citi expects the Fed to continue hiking into 2023, reaching a policy rate target range of 3.5-3.75%.
Money markets are assigning an 80% probability of a 50 bps rate hike in May and about 200 basis points in cumulative hikes by the end of 2022 after the Fed raised rates by a quarter point last week.
Goldman Sachs expects as much as seven rate hikes in 2022 and as many as five in 2023.
Morgan Stanley's chief U.S. economist Ellen Zentner on Thursday said the firm now sees 50-basis point hikes at both the Fed's May and June meetings, with 25-basis-point hikes at each meeting after through the rest of the year.
Side-by-side declines in U.S. equity and fixed income markets are pushing investors into cash, commodities and dividend-paying stocks as geopolitical uncertainty and worries over a hawkish Federal Reserve rock asset prices. Investors moved $13.2 billion to cash and $2.1 billion to gold over the last week, data from BoFA Global research showed. U.S. stocks saw $3.1 billion in outflows, their largest in nine weeks. The firm’s latest survey showed fund managers’ cash positions earlier this month at their highest since March 2020 . George Young, a portfolio manager at Villere & Co, is raising his portfolio’s cash allocation to nearly 15%, well above the typical 3% of assets he normally holds.
Prices for commodities such as oil and wheat have climbed as tensions in Ukraine have escalated, putting additional upward pressure on already high inflation due to supply chain bottlenecks. Rising inflation has led many central banks, including the U.S. Federal Reserve, to take measures to rein in prices, such as by raising interest rates. Biden has arrived in Brussels later on Wednesday on his first foreign trip since the war in Ukraine began, and met NATO and European leaders in an emergency summit at the Western military alliance's headquarters. Sources said the U.S. package would include measures targeting Russian members of parliament.
A sharp sell-off in U.S. Treasuries has increased concerns about low levels of liquidity in the $23.5 trillion market, potentially amplifying losses for investors which already had a dire start to the year. U.S. government bond yields have spiked this year as the Federal Reserve has sounded more hawkish about how aggressively it will hike interest rates to cool the economy, hitting bond returns. The ICE BofA Treasury Index has recorded its worst start to the year in history, down 6%.
Many investors expect more turmoil in bonds, as soaring consumer prices push the Fed into full inflation-fighting mode. Goldman Sachs on Thursday raised its year-end forecast for the 10-year yield to 2.7% from an earlier projection of 2.25% and predicted a “modest” inversion of the Treasury yield curve, though the bank’s analyst said the phenomenon would not necessarily be indicative of an oncoming recession, as it has in the past
Investors say liquidity concerns this year have not reached the point of threatening market functioning, but concerns have increased for several factors. One is that the Fed has ceased buying U.S. Treasuries, after ending this month a bond-buying programme aimed at supporting the economy during the coronavirus crisis.
For now, the market seems happy enough with the Fed’s policy stance. So far so good, because the Fed is in a tight spot. Tighten too quickly and it risks tipping the economy into recession; tighten too slowly and upward price pressures could become entrenched, requiring an even quicker pace of tightening that could prove more costly in economic terms to bring inflation under control further down the line.
The Fed will be very keen to keep its credibility intact, and keeping a lid on inflation expectations will be key to doing so. The University of Michigan survey shows that US households expect above-target levels of inflation to persist over the next 12 months. Longer-term inflation expectations appear well anchored and are a lot lower than they were in the early 1980s, at least according to this measure. But any further uptick in this metric could put the Fed in an uncomfortable spot, and prompt it either to signal a faster pace of tightening or to risk losing some of its hard-won credibility. Some market-based measures have started drifting higher in recent weeks, raising the stakes.
COT Report
The CFTC data also show that funds made a big bet on the dollar strengthening. They increased their bullish dollar bets against a broad range of currencies by almost $4 billion, the biggest weekly increase since November. A deeper dive into the latest CFTC report shows that the surge in net long dollar positions was driven by a historic wave of euro selling.
Net euro longs were slashed by over 40,000 contracts, the biggest weekly swing against the single currency since 2018 and the fourth largest ever. Drilling even deeper, that was wholly down to funds liquidating long positions rather than opening new short positions. Longs were slashed by 40,643 contracts, the second most since CFTC contracts were launched in 1999.
Even though the European Central Bank is talking tough on inflation and traders are pricing in rate rises later this year, the Russia-NATO confrontation has darkened the euro zone's economic outlook and sentiment towards the euro. But could the dollar be poised to rebound? Analysts at MUFG note that the dollar tends to rise when the yield curve flattens from 50 bps to zero, as it did in March 1997 to January 2000, April 2005 to December 2005, and April 2018 to August 2019.
Hedge funds went into the Fed's interest rate lift-off wagering on a stronger dollar and steeper U.S. yield curve, but have so far been wrong-footed as the dollar has since dipped slightly and the curve has flattened dramatically. Futures market data for the week through March 15, the day before the first rise in U.S. interest rates since 2018, showed that speculators increased their net long dollar position by the largest amount this year.
The data also revealed the biggest shift in favor of two-year Treasuries futures in over a year, a reduction in net short positioning that was twice as aggressive as the scaling back of funds' net short position in 10-year bonds. Put together, that was effectively a bet that the two-year yield will fall faster than the 10-year yield, thereby 'steepening' the curve. The opposite happened.
The gap between two- and 10-year Treasury yields shrank by around 13 basis points to just 18 bps after the Fed's rate hike. Inversion of this part of the yield curve, which has preceded every recession in the past 45 years, is close. Funds had successfully bet on a flattening yield curve in the first two months of the year. But in recent weeks they have tried to position for a reversal that has yet to materialize.
The latest Commodity Futures Trading Commission showed that funds slashed their net short two-year Treasuries position by 92,313 contracts, the biggest weekly move since February last year. They cut their 10-year Treasuries net short position by 56,723 contracts.
NEXT WEEK TO WATCH
#1 NFP Release
Is the Federal Reserve's aggressive trajectory for tightening monetary policy too hawkish, or not hawkish enough? Friday's March U.S. jobs report might show.
Economists polled by Reuters expect 450,000 new jobs were created, versus 678,000 in February.
#2 EU Inflation
Inflation is already at a record high 5.9% and could hit 7% in the coming months. Given the ECB target of 2%, it's unsurprising that some officials are urging one or even two rate moves this year.
#3 Ruble payments decision
As pressure grows to announce a ban, there's been a new twist -- President Vladimir Putin's demand that "unfriendly" countries need to pay for gas in roubles is raising yet more concerns about Europe's energy crunch. EU leaders could soon agree to buy gas jointly and secure additional U.S. gas supplies. But in the meantime, the debate is causing unease in all kinds of quarters. Oil producing group OPEC, for one, has warned the move could hurt consumers.
To be continued...
So, guys, now we have so hot mix of news and data that investors have headache trying to find the way in this mess. EUR as you could see, was stunned this week, showing to action at all. Starting from recent Fed comments and following by political events, news, economical statistics we have tough task to decide what to expect and in what direction we should move.
Market overview
The European Central Bank will take action if it sees second-round inflation effects and a de-anchoring of medium-term inflation expectations, European Central Bank Vice President Luis de Guindos told a German newspaper. Earlier this month, the ECB accelerated its exit from unconventional stimulus, and investors have been ramping up their bets on higher ECB rates.
De Guindos told Handelsblatt in an interview published on Sunday that second-round effects and de-anchoring of price expectations would be "deciding factors" for the central bank. Asked about risks to the European financial system due to the war in Ukraine, de Guindos said:
"If we see those, then we will act," he said. There were no liquidity bottlenecks, companies were issuing bonds, and that stocks were volatile but without "dramatic developments".
Sales of new U.S. single-family homes unexpectedly fell in February amid rising mortgage rates and higher house prices, which are squeezing out some first-time buyers from the market. Despite the second straight monthly decline reported by the Commerce Department on Wednesday, sales remained above their pre-pandemic level. New home sales decreased 2% to a seasonally adjusted annual rate of 772,000 units last month. January's sales pace was revised down to 788,000 units from the previously reported 801,000 units.
"With interest rates climbing further because of the negative supply shock emanating from the Russian invasion of Ukraine, home sales are likely to trend lower in coming months," said David Berson, chief economist at Nationwide in Columbus, Ohio. "But unless mortgage rates spike or the economy stalls or worse, the falloff in new home sales should be modest."
Mortgage rates surged in February and have continued to push higher after the Federal Reserve last week raised its policy interest rate by 25 basis points, the first hike in more than three years, and laid out an aggressive plan to push borrowing costs to restrictive levels by 2023. The 30-year fixed rate vaulted 23 basis points to a three-year high of 4.50% last week, data from the Mortgage Bankers Association showed on Wednesday.
Though, mortgage rates remain low by historical standards, strong house price inflation has combined to significantly increase the typical monthly mortgage payment.
"Mortgage payments as a share of median family income have risen above 20% for the first time since late 2007," said Matthew Pointon, senior property economist at Capital Economics in New York. "That will act to cool housing market activity. A record low number of existing homes on the market that implies new sales will grind out a small gain over 2022."
Data last week showed sales of previously owned homes fell sharply in February.
"We may be approaching a pivot point when higher home costs and higher mortgage rates cool both sales and price increases, but given the supply-and-demand imbalance, we may not hit that point this year," said Robert Frick, corporate economist at Navy Federal Credit Union in Vienna, Virginia.
Contracts to buy U.S. previously owned homes dropped to the lowest level in nearly two years in February, weighed down by a persistent shortage of properties, and activity could remain sluggish amid increasing mortgage rates and high house prices. The National Association of Realtors (NAR) said on Friday its Pending Home Sales Index, based on signed contracts, fell 4.1% last month to 104.9, the lowest level since May 2020. It was the fourth straight monthly decline in the index, which leads sales by a month or two.
The University of Michigan's final consumer sentiment index dropped to 59.4 in March, the lowest reading since August 2011. It was slightly revised down from the preliminary reading of 59.7 earlier in the month. The index was at 62.8 in February and it has now declined for three straight months.
The dollar rose for the fourth time in the past five sessions, as economic data on the labor market helped firm expectations the U.S. Federal Reserve will be more aggressive in taking steps to curb inflation. While new durable goods orders unexpectedly fell in February as shipments slowed, demand for goods remained strong. In addition a measure of business activity for March climbed to an eight-month high.
The greenback is poised for a solid gain this week, which would mark its sixth weekly gain in the past seven. The dollar has benefited from its status as a safe haven and the conflict in Ukraine has driven expectations the Fed will hike interest rates.
"The one thing everyone can agree upon is inflation is going to be longer-lasting and a lot of that will be sticky and that will complicate what central banks do in the end," said Edward Moya, senior market analyst, at Oanda in New York. "You will probably see the dollar lead the charge with rate hikes, Europe will lag and that interest rate differential should provide some support for the dollar."
Bank of America (BofA) and Citi have joined a small but growing number of top investment banks calling for more aggressive interest rate increases from the U.S. Federal Reserve against a backdrop of soaring inflation data and hawkish comments from policymakers. BoFA now expects two hikes of 50 basis points each at the Fed's June and July meetings with "risks" of those expectations being pulled forward into May and June respectively.
Citi, on the other hand, sees 50 basis-point increases in May, June, July, and September. The bank also expects 25 basis-point tightening in October and December. Citi expects the Fed to continue hiking into 2023, reaching a policy rate target range of 3.5-3.75%.
"Our economists also now expect the Fed to keep hiking each meeting until they reach a 3-3.25% range in May '23," economists at the bank said. "This represents a 25 bps higher terminal rate achieved 7 months earlier vs previously forecast."
Money markets are assigning an 80% probability of a 50 bps rate hike in May and about 200 basis points in cumulative hikes by the end of 2022 after the Fed raised rates by a quarter point last week.
Goldman Sachs expects as much as seven rate hikes in 2022 and as many as five in 2023.
"Recent Fed speak raised our conviction that Chair (Jerome) Powell and the broader committee will support a 50-bp rate hike in May, despite balance sheet reduction announced at the same meeting," Citi said in its latest note. It appears that 50-bp would have been delivered in March if not for acute uncertainty related to geopolitical tensions," Citi said.
"The dollar continues to be like a steamroller here, pretty much running over anyone that takes a short position against it," said Karl Schamotta, chief market strategist at Cambridge Global Payments in Toronto. The data we are seeing certainly supports the case for multiple 50-basis-point hikes this year, and that is pushing up the front end of the curve and leading the dollar to outperformance against virtually every major as well as the commodity-linked currencies, which is something of a surprise."
Morgan Stanley's chief U.S. economist Ellen Zentner on Thursday said the firm now sees 50-basis point hikes at both the Fed's May and June meetings, with 25-basis-point hikes at each meeting after through the rest of the year.
“The degree of difficulty for Jerome Powell’s Fed to stick a soft landing for the economy is about the same as Captain Sullenberger’s heroic emergency landing on the Hudson River," said Aaron Clark, a portfolio manager at GW&K Investment Management in Boston, referring to the 2009 landing of a US Airways plane after its engines failed. The market remains in a tug of war between a policy error causing a recession and a resilient economy with a strong consumer and corporate sector," Clark wrote in an email.
Side-by-side declines in U.S. equity and fixed income markets are pushing investors into cash, commodities and dividend-paying stocks as geopolitical uncertainty and worries over a hawkish Federal Reserve rock asset prices. Investors moved $13.2 billion to cash and $2.1 billion to gold over the last week, data from BoFA Global research showed. U.S. stocks saw $3.1 billion in outflows, their largest in nine weeks. The firm’s latest survey showed fund managers’ cash positions earlier this month at their highest since March 2020 . George Young, a portfolio manager at Villere & Co, is raising his portfolio’s cash allocation to nearly 15%, well above the typical 3% of assets he normally holds.
Prices for commodities such as oil and wheat have climbed as tensions in Ukraine have escalated, putting additional upward pressure on already high inflation due to supply chain bottlenecks. Rising inflation has led many central banks, including the U.S. Federal Reserve, to take measures to rein in prices, such as by raising interest rates. Biden has arrived in Brussels later on Wednesday on his first foreign trip since the war in Ukraine began, and met NATO and European leaders in an emergency summit at the Western military alliance's headquarters. Sources said the U.S. package would include measures targeting Russian members of parliament.
"The capital flow is going to be I don’t want to be in Europe, it is closer to Ukraine literally in the geographical sense, but also it is the fallout from the sanctions, there is a lot of money rotating back out of Europe and back towards the States," said Huw Roberts, head of analytics at Quant Insight. If we get another round of sanctions, then people therefore say the blowback on the West is going to fall on Europe disproportionately."
A sharp sell-off in U.S. Treasuries has increased concerns about low levels of liquidity in the $23.5 trillion market, potentially amplifying losses for investors which already had a dire start to the year. U.S. government bond yields have spiked this year as the Federal Reserve has sounded more hawkish about how aggressively it will hike interest rates to cool the economy, hitting bond returns. The ICE BofA Treasury Index has recorded its worst start to the year in history, down 6%.
Many investors expect more turmoil in bonds, as soaring consumer prices push the Fed into full inflation-fighting mode. Goldman Sachs on Thursday raised its year-end forecast for the 10-year yield to 2.7% from an earlier projection of 2.25% and predicted a “modest” inversion of the Treasury yield curve, though the bank’s analyst said the phenomenon would not necessarily be indicative of an oncoming recession, as it has in the past
Investors say liquidity concerns this year have not reached the point of threatening market functioning, but concerns have increased for several factors. One is that the Fed has ceased buying U.S. Treasuries, after ending this month a bond-buying programme aimed at supporting the economy during the coronavirus crisis.
For now, the market seems happy enough with the Fed’s policy stance. So far so good, because the Fed is in a tight spot. Tighten too quickly and it risks tipping the economy into recession; tighten too slowly and upward price pressures could become entrenched, requiring an even quicker pace of tightening that could prove more costly in economic terms to bring inflation under control further down the line.
The Fed will be very keen to keep its credibility intact, and keeping a lid on inflation expectations will be key to doing so. The University of Michigan survey shows that US households expect above-target levels of inflation to persist over the next 12 months. Longer-term inflation expectations appear well anchored and are a lot lower than they were in the early 1980s, at least according to this measure. But any further uptick in this metric could put the Fed in an uncomfortable spot, and prompt it either to signal a faster pace of tightening or to risk losing some of its hard-won credibility. Some market-based measures have started drifting higher in recent weeks, raising the stakes.
COT Report
The CFTC data also show that funds made a big bet on the dollar strengthening. They increased their bullish dollar bets against a broad range of currencies by almost $4 billion, the biggest weekly increase since November. A deeper dive into the latest CFTC report shows that the surge in net long dollar positions was driven by a historic wave of euro selling.
Net euro longs were slashed by over 40,000 contracts, the biggest weekly swing against the single currency since 2018 and the fourth largest ever. Drilling even deeper, that was wholly down to funds liquidating long positions rather than opening new short positions. Longs were slashed by 40,643 contracts, the second most since CFTC contracts were launched in 1999.
Even though the European Central Bank is talking tough on inflation and traders are pricing in rate rises later this year, the Russia-NATO confrontation has darkened the euro zone's economic outlook and sentiment towards the euro. But could the dollar be poised to rebound? Analysts at MUFG note that the dollar tends to rise when the yield curve flattens from 50 bps to zero, as it did in March 1997 to January 2000, April 2005 to December 2005, and April 2018 to August 2019.
"The history for the dollar is pretty good at this juncture for the 2s/10s curve spread. We wouldn't expect the same extent of gains ... but dollar strength looks likely," they wrote on Friday.
Hedge funds went into the Fed's interest rate lift-off wagering on a stronger dollar and steeper U.S. yield curve, but have so far been wrong-footed as the dollar has since dipped slightly and the curve has flattened dramatically. Futures market data for the week through March 15, the day before the first rise in U.S. interest rates since 2018, showed that speculators increased their net long dollar position by the largest amount this year.
The data also revealed the biggest shift in favor of two-year Treasuries futures in over a year, a reduction in net short positioning that was twice as aggressive as the scaling back of funds' net short position in 10-year bonds. Put together, that was effectively a bet that the two-year yield will fall faster than the 10-year yield, thereby 'steepening' the curve. The opposite happened.
The gap between two- and 10-year Treasury yields shrank by around 13 basis points to just 18 bps after the Fed's rate hike. Inversion of this part of the yield curve, which has preceded every recession in the past 45 years, is close. Funds had successfully bet on a flattening yield curve in the first two months of the year. But in recent weeks they have tried to position for a reversal that has yet to materialize.
The latest Commodity Futures Trading Commission showed that funds slashed their net short two-year Treasuries position by 92,313 contracts, the biggest weekly move since February last year. They cut their 10-year Treasuries net short position by 56,723 contracts.
"The March FOMC meeting surprised with its hawkish tilt and now reflects a Fed that has caught up to the curve, recognizing the severity of the inflation/employment mismatch," Bank of America's U.S. rates strategists wrote on Friday. This supports a higher terminal rate and overall level of interest rates, and a flatter curve, they added.
NEXT WEEK TO WATCH
#1 NFP Release
Is the Federal Reserve's aggressive trajectory for tightening monetary policy too hawkish, or not hawkish enough? Friday's March U.S. jobs report might show.
Economists polled by Reuters expect 450,000 new jobs were created, versus 678,000 in February.
#2 EU Inflation
Inflation is already at a record high 5.9% and could hit 7% in the coming months. Given the ECB target of 2%, it's unsurprising that some officials are urging one or even two rate moves this year.
#3 Ruble payments decision
As pressure grows to announce a ban, there's been a new twist -- President Vladimir Putin's demand that "unfriendly" countries need to pay for gas in roubles is raising yet more concerns about Europe's energy crunch. EU leaders could soon agree to buy gas jointly and secure additional U.S. gas supplies. But in the meantime, the debate is causing unease in all kinds of quarters. Oil producing group OPEC, for one, has warned the move could hurt consumers.
To be continued...