Sive Morten
Special Consultant to the FPA
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Fundamentals
Despite that this week we've got some important data, investors' focus more and more turns to global shifts in EU and the US economies. Although markets prepare to coming Fed meeting and NFP report, even the brief look over headlines this week, it becomes evident. It means two things. First is, it supports the importance and scale of ongoing processes. Second - confirms our fundamental view.
Market overview
The dollar's race to two-decade highs is leaving a trail of destruction in its wake, exacerbating inflation in other countries and tightening financial conditions just as the world economy confronts the prospect of a slowdown in growth. This year's 8% gain against a basket of currencies is driven partly by bets that the U.S. Federal Reserve will raise interest rates faster and further than other developed countries, and partly by its status as a safe haven in times of turbulence.
It is also supported by Japan's reluctance to ditch its super-easy policies, and fears of recession in Europe. Here are some areas affected by the dollar's muscle-flexing. Except Russian Ruble and Brazil Real that rise against USD:
Source: Spydell finance
Currency weakness normally benefits export-reliant Europe and Japan, but the equation may not hold when inflation is high and rising. Euro zone inflation hit a record 7.5% this month, although so far European Central Bank policymakers blame it mainly on energy prices. Bank of Japan boss Haruhiko Kuroda still views yen weakness as a positive for Japan, but lawmakers fret that the yen, at 20-year lows, will inflict damage via costlier food and fuel. Half of Japanese firms expect higher costs to hurt earnings, a survey found.
A rising U.S. dollar tends to tighten financial conditions, which reflect the availability of funding. Goldman Sachs estimates that a 100 bps tightening in its widely used proprietary Financial Conditions Index (FCI) crimps growth by one percentage point in the following year. The FCI, which factors in the impact of the trade-weighted dollar, shows global conditions at their tightest since 2009. The FCI has tightened by 120 basis points in April alone, as the dollar has strengthened 5%.
The U.S. FCI is at its tightest since July 2020.
The rule of thumb is that a firmer greenback makes dollar-denominated commodities costlier for consumers who use other currencies, eventually subduing demand and prices. This year, however, tight supplies of major commodities have prevented that equation from kicking in as the war has hit exports of oil, grain, metals and fertiliser, keeping prices elevated.
The Fed might welcome a rising greenback that calms imported inflation -- Societe Generale estimates a 10% dollar appreciation causes U.S. consumer inflation to decline by 0.5 percentage points over a year. If dollar gains continue, the Fed won't need to tighten monetary policy as aggressively as anticipated; notably, the dollar surge of the past week has also seen money market bets on Fed rate hikes stabilise.
BMO Markets' analyst Stephen Gallo says if the Fed's trade-weighted dollar index were to break above pandemic-time highs -- it is currently 2% below that level --
The U.S. economy unexpectedly (???) contracted in the first quarter amid a resurgence in COVID-19 cases and drop in pandemic relief money from the government, but the decline in output is misleading as domestic demand remained strong. The first decrease in gross domestic product since the short and sharp pandemic recession nearly two years ago, reported by the Commerce Department on Thursday, was mostly driven by a wider trade deficit as imports surged, and a slowdown in the pace of inventory accumulation.
Gross domestic product fell at a 1.4% annualized rate last quarter, the government said in its advance GDP estimate. The economy also took a hit from supply-chain challenges, worker shortages and rampant inflation. Front-loading by businesses fearful of shortages because of the war contributed to a surge in imports. Exports tumbled, leading to a sharp widening of the trade deficit, which chopped 3.20 percentage points from GDP growth, the most since the third quarter of 2020. Trade has now been a drag on growth for seven straight quarters.
Businesses have turned to imports to satisfy demand, with local manufacturers lacking the capacity to boost production. Business inventories increased at a $158.7 billion pace, slowing from the robust $193.2 billion rate in the October-December quarter. Inventory investment cut 0.84 percentage point from GDP growth.
Growth in consumer spending, which accounts for more than two-thirds of U.S. economic activity picked up at a rate of 2.7%. Consumer spending last quarter was driven by services. The shift in demand from goods is likely to help ease pressure on supply chains. Consumer spending accounts for over 70% of US GDP – this is the most important category on which long-term trends in the American economy depend.
Real expenses are seriously slowing down from Q2 2021 - 16.2% YoY, 7.1%, 6.9% and 4.7% by Q1 2022. Relative to the pre-war period, i.e. from Q4 2019, consumer spending increased by only 5% in real terms. And this was supported solely by exorbitant state subsidies and cheap loans. Thus, as mentioned, the trend is that goods are going into negative territory, services are accelerating, so inflationary pressure will transform from a commodity segment into services.
Some investors suggest that the US economy shows healthy grow and stands not near the recession or stagflation:
But if you take a look at the source of consumption spending rising - you'll see that this is very fragile foundation. Personal savings slump drastically. Now, by the recent data, the personal yearly spending stands around $50K per citizen, while in 1947 it was around just $10K. In order to support current consumption, American households are forced to get into savings The savings rate has fallen to lows in 10 years. But this does not help, because the growth rate of consumption expenditures in real terms is radically decreasing. The attraction of fiscal madness is over, inflation is accelerating. There is not the slightest doubt that by the end of 2022, the pace of spending will go into a deep negative.
The personal consumption expenditures (PCE) price index shot up 0.9% in March, the largest increase since September 2005, after climbing 0.5% in February. In the 12 months through March, the PCE price index jumped 6.6%, the largest gain since January 1982, after rising 6.3% in February. The so-called core PCE price index increased 5.2% year-on-year in March.
Even if inflation has peaked, it could remain uncomfortably high for a while. A separate report from the Labor Department on Friday showed its Employment Cost Index, the broadest measure of labor costs, jumped 1.4% in the first quarter after advancing 1.0% in the October-December period. Labor costs soared 4.5% on a year-on-year basis, the biggest gain since 2001, after increasing 4.0% in the fourth quarter.
The ECI is widely viewed by policymakers as one of the better measures of labor market slack and a predictor of core inflation as it adjusts for composition and job quality changes.
But high inflation eroded the gains for employees. Inflation-adjusted wages fell 3.6% year-on-year. Benefits jumped 1.8%, the most in 18 years, after increasing 0.9% in the October-December quarter. With inflation wiping out the compensation gains, consumers are tapping into savings to fund their spending, which some said suggested a slowdown in consumption was looming. The saving rate dropped to 6.2%, the lowest since December 2013, from 6.8% in February. Consumers accumulated more than $2 trillion in excess savings during the pandemic.
After months focusing on central banks' response to raging inflation, financial markets are being jolted into the realisation that a global economic downturn may now loom. Sentiment dampeners include the Ukraine war, huge rises in energy and metals prices, aggressive central bank policy tightening led by the U.S. Federal Reserve, and China's policy of locking down cities to ward off COVID. The International Monetary Fund and World Bank fanned growth fears further last week when they cut 2022 global forecasts by nearly a full percentage point. Financial analysts too are increasingly pessimistic, with Deutsche Bank seeing an "outright" U.S. recession by end-2023. Omens are flying in thick and fast.
On the data front, U.S. new home sales hitting two-year lows, weakening British and German consumer sentiment and new factory orders all point to slowing growth momentum. The average interest rate on the most popular U.S. home loan rose to its highest level since June 2009 last week and demand for mortgages ebbed as the impact of rising costs began to bite, Mortgage Bankers Association (MBA) data showed on Wednesday.
The average contract rate on a 30-year fixed-rate mortgage increased to 5.37% in the week ended April 22 from 5.20% a week earlier, the MBA survey showed. It has risen 220 basis points from 12 months ago, with most of the rise since the turn of the year as financial markets have reacted to the U.S. Federal Reserve's plans to raise interest rates more swiftly to combat high inflation. The MBA said its Purchase Composite Index, a measure of all mortgage loan applications for purchase of a single family home, fell 7.6% on a seasonally adjusted basis, while the refinance index fell 9%.
European Central Bank policymaker and hawk Robert Holzmann expects an initial interest rate increase this summer or autumn and for rates to rise gradually before settling next year around 1% or 1.5%, he told Austrian broadcaster ORF on Friday.
The euro's drop to a five-year low is rekindling the possibility the currency will reach parity versus the dollar for the first time in two decades, as fears of a euro zone recession encourage investors to pile on the bearish bets. Russia's move to cut off gas supplies to Bulgaria and Poland is the latest blow for the currency, already pressured by the twin headwinds of a surging dollar and sweeping COVID-linked lockdowns in China, a major market for bloc exports. Germany and other European countries could be next in line for restrictions on gas.
Data in the euro zone's biggest economy Germany showed consumer morale at a historic low and the government sharply cut its 2022 growth forecasts. A credit default swap index showed the cost of insuring exposure to lower-rated European debt is at its highest in two years, highlighting risks companies face.
Indeed, one-month euro/dollar risk reversals -- a option market gauge of demand for options on a currency rising or falling -- moved sharply on Wednesday to imply more euro weakness. The ratio of call options on the euro compared to puts almost halved on Wednesday from the previous day to minus 1.8, the lowest since early-April. Call options confer the right to buy an asset while puts enable holders to sell.
The past week may point to a bumpier ride ahead, with analysts noting an unexpected, nearly $500 billion shift in the Fed's balance sheet driven by factors beyond its control and volatility in stock and bond markets as signs the central bank's pivot to tighter monetary policy may not run so smoothly. In particular, a nearly 9% drop in the S&P 500 index over the past month may show a coming hit to household wealth that quickly translates into lower consumer spending, said Steven Blitz, chief U.S. economist at TS Lombard. He noted that changes in asset prices are a key and perhaps increasingly important way monetary policy can influence economic activity and inflation.
COT Report
Recent CFTC data shows clear bearish tendency in sentiment on EUR. Open interest is up for 26K+ contracts while bears have increased positions significantly.
Speculators' net long positioning on the U.S. dollar rose in the latest week as well, according to calculations by Reuters and U.S. Commodity Futures Trading Commission data released on Friday. The value of the net long dollar position climbed to $13.92 billion for the week ended April 26, from $12.91 billion the previous week. This week's U.S. dollar net long positioning was the largest since early April, and the first increase in four weeks.
Next Week to watch
Some big beasts of the central banking world take centre stage over the coming week, with the U.S. Federal Reserve, the Bank of England and the Reserve Bank of Australia holding policy meetings.
#1 the Fed
Increasingly hawkish Fed rhetoric has sparked nasty sell-offs in stock and bond markets, and on Wednesday we will see just how aggressive the central bank plans to get over coming months. The Fed has flagged a 50 basis-point interest rate rise on May 4, and investors expect a hefty 240 bps of monetary tightening in 2022. Many reckon the Fed will continue to surprise on the hawkish side, as it fights to tamp down the worst inflation in four decades.
Markets will also focus on the Fed's plans for its nearly $9 trillion balance sheet, which it could start unwinding as early as May
#2 BoE
The Bank of England's meeting, a day after the Fed, is tipped to lift interest rates for a fourth time in a row, the first time it would have done that since 1997.
BoE boss Andrew Bailey says the bank is treading a "very tight line" between curbing inflation, which at 7% is more than three times its target, and avoiding a recession. A quarter point hike to 1% would meet a precondition for the BoE to start actively selling bonds it holds. A big question for markets is when these sales will start; estimates range from June to well into 2023. Active bond sales would tighten monetary conditions but could hurt a faltering economy and no major central bank has yet started the process.
#3 China and Australia
The yuan, down 4% this month, may have further to fall if weekend data shows Chinese factory activity still weakening. China's slowdown has also applied a discount at the quarry - pushing the Aussie dollar down some 4.5% through April. With recent data showing Australian first-quarter inflation at 20-year highs, anticipation is building that a hiking cycle could begin as soon as Tuesday.
To be continued in the next post...
Despite that this week we've got some important data, investors' focus more and more turns to global shifts in EU and the US economies. Although markets prepare to coming Fed meeting and NFP report, even the brief look over headlines this week, it becomes evident. It means two things. First is, it supports the importance and scale of ongoing processes. Second - confirms our fundamental view.
Market overview
The dollar's race to two-decade highs is leaving a trail of destruction in its wake, exacerbating inflation in other countries and tightening financial conditions just as the world economy confronts the prospect of a slowdown in growth. This year's 8% gain against a basket of currencies is driven partly by bets that the U.S. Federal Reserve will raise interest rates faster and further than other developed countries, and partly by its status as a safe haven in times of turbulence.
It is also supported by Japan's reluctance to ditch its super-easy policies, and fears of recession in Europe. Here are some areas affected by the dollar's muscle-flexing. Except Russian Ruble and Brazil Real that rise against USD:
Source: Spydell finance
Currency weakness normally benefits export-reliant Europe and Japan, but the equation may not hold when inflation is high and rising. Euro zone inflation hit a record 7.5% this month, although so far European Central Bank policymakers blame it mainly on energy prices. Bank of Japan boss Haruhiko Kuroda still views yen weakness as a positive for Japan, but lawmakers fret that the yen, at 20-year lows, will inflict damage via costlier food and fuel. Half of Japanese firms expect higher costs to hurt earnings, a survey found.
A rising U.S. dollar tends to tighten financial conditions, which reflect the availability of funding. Goldman Sachs estimates that a 100 bps tightening in its widely used proprietary Financial Conditions Index (FCI) crimps growth by one percentage point in the following year. The FCI, which factors in the impact of the trade-weighted dollar, shows global conditions at their tightest since 2009. The FCI has tightened by 120 basis points in April alone, as the dollar has strengthened 5%.
The U.S. FCI is at its tightest since July 2020.
The rule of thumb is that a firmer greenback makes dollar-denominated commodities costlier for consumers who use other currencies, eventually subduing demand and prices. This year, however, tight supplies of major commodities have prevented that equation from kicking in as the war has hit exports of oil, grain, metals and fertiliser, keeping prices elevated.
The Fed might welcome a rising greenback that calms imported inflation -- Societe Generale estimates a 10% dollar appreciation causes U.S. consumer inflation to decline by 0.5 percentage points over a year. If dollar gains continue, the Fed won't need to tighten monetary policy as aggressively as anticipated; notably, the dollar surge of the past week has also seen money market bets on Fed rate hikes stabilise.
BMO Markets' analyst Stephen Gallo says if the Fed's trade-weighted dollar index were to break above pandemic-time highs -- it is currently 2% below that level --
The U.S. economy unexpectedly (???) contracted in the first quarter amid a resurgence in COVID-19 cases and drop in pandemic relief money from the government, but the decline in output is misleading as domestic demand remained strong. The first decrease in gross domestic product since the short and sharp pandemic recession nearly two years ago, reported by the Commerce Department on Thursday, was mostly driven by a wider trade deficit as imports surged, and a slowdown in the pace of inventory accumulation.
Gross domestic product fell at a 1.4% annualized rate last quarter, the government said in its advance GDP estimate. The economy also took a hit from supply-chain challenges, worker shortages and rampant inflation. Front-loading by businesses fearful of shortages because of the war contributed to a surge in imports. Exports tumbled, leading to a sharp widening of the trade deficit, which chopped 3.20 percentage points from GDP growth, the most since the third quarter of 2020. Trade has now been a drag on growth for seven straight quarters.
Businesses have turned to imports to satisfy demand, with local manufacturers lacking the capacity to boost production. Business inventories increased at a $158.7 billion pace, slowing from the robust $193.2 billion rate in the October-December quarter. Inventory investment cut 0.84 percentage point from GDP growth.
Growth in consumer spending, which accounts for more than two-thirds of U.S. economic activity picked up at a rate of 2.7%. Consumer spending last quarter was driven by services. The shift in demand from goods is likely to help ease pressure on supply chains. Consumer spending accounts for over 70% of US GDP – this is the most important category on which long-term trends in the American economy depend.
Real expenses are seriously slowing down from Q2 2021 - 16.2% YoY, 7.1%, 6.9% and 4.7% by Q1 2022. Relative to the pre-war period, i.e. from Q4 2019, consumer spending increased by only 5% in real terms. And this was supported solely by exorbitant state subsidies and cheap loans. Thus, as mentioned, the trend is that goods are going into negative territory, services are accelerating, so inflationary pressure will transform from a commodity segment into services.
Some investors suggest that the US economy shows healthy grow and stands not near the recession or stagflation:
But if you take a look at the source of consumption spending rising - you'll see that this is very fragile foundation. Personal savings slump drastically. Now, by the recent data, the personal yearly spending stands around $50K per citizen, while in 1947 it was around just $10K. In order to support current consumption, American households are forced to get into savings The savings rate has fallen to lows in 10 years. But this does not help, because the growth rate of consumption expenditures in real terms is radically decreasing. The attraction of fiscal madness is over, inflation is accelerating. There is not the slightest doubt that by the end of 2022, the pace of spending will go into a deep negative.
The personal consumption expenditures (PCE) price index shot up 0.9% in March, the largest increase since September 2005, after climbing 0.5% in February. In the 12 months through March, the PCE price index jumped 6.6%, the largest gain since January 1982, after rising 6.3% in February. The so-called core PCE price index increased 5.2% year-on-year in March.
Even if inflation has peaked, it could remain uncomfortably high for a while. A separate report from the Labor Department on Friday showed its Employment Cost Index, the broadest measure of labor costs, jumped 1.4% in the first quarter after advancing 1.0% in the October-December period. Labor costs soared 4.5% on a year-on-year basis, the biggest gain since 2001, after increasing 4.0% in the fourth quarter.
The ECI is widely viewed by policymakers as one of the better measures of labor market slack and a predictor of core inflation as it adjusts for composition and job quality changes.
But high inflation eroded the gains for employees. Inflation-adjusted wages fell 3.6% year-on-year. Benefits jumped 1.8%, the most in 18 years, after increasing 0.9% in the October-December quarter. With inflation wiping out the compensation gains, consumers are tapping into savings to fund their spending, which some said suggested a slowdown in consumption was looming. The saving rate dropped to 6.2%, the lowest since December 2013, from 6.8% in February. Consumers accumulated more than $2 trillion in excess savings during the pandemic.
After months focusing on central banks' response to raging inflation, financial markets are being jolted into the realisation that a global economic downturn may now loom. Sentiment dampeners include the Ukraine war, huge rises in energy and metals prices, aggressive central bank policy tightening led by the U.S. Federal Reserve, and China's policy of locking down cities to ward off COVID. The International Monetary Fund and World Bank fanned growth fears further last week when they cut 2022 global forecasts by nearly a full percentage point. Financial analysts too are increasingly pessimistic, with Deutsche Bank seeing an "outright" U.S. recession by end-2023. Omens are flying in thick and fast.
On the data front, U.S. new home sales hitting two-year lows, weakening British and German consumer sentiment and new factory orders all point to slowing growth momentum. The average interest rate on the most popular U.S. home loan rose to its highest level since June 2009 last week and demand for mortgages ebbed as the impact of rising costs began to bite, Mortgage Bankers Association (MBA) data showed on Wednesday.
The average contract rate on a 30-year fixed-rate mortgage increased to 5.37% in the week ended April 22 from 5.20% a week earlier, the MBA survey showed. It has risen 220 basis points from 12 months ago, with most of the rise since the turn of the year as financial markets have reacted to the U.S. Federal Reserve's plans to raise interest rates more swiftly to combat high inflation. The MBA said its Purchase Composite Index, a measure of all mortgage loan applications for purchase of a single family home, fell 7.6% on a seasonally adjusted basis, while the refinance index fell 9%.
European Central Bank policymaker and hawk Robert Holzmann expects an initial interest rate increase this summer or autumn and for rates to rise gradually before settling next year around 1% or 1.5%, he told Austrian broadcaster ORF on Friday.
The euro's drop to a five-year low is rekindling the possibility the currency will reach parity versus the dollar for the first time in two decades, as fears of a euro zone recession encourage investors to pile on the bearish bets. Russia's move to cut off gas supplies to Bulgaria and Poland is the latest blow for the currency, already pressured by the twin headwinds of a surging dollar and sweeping COVID-linked lockdowns in China, a major market for bloc exports. Germany and other European countries could be next in line for restrictions on gas.
Data in the euro zone's biggest economy Germany showed consumer morale at a historic low and the government sharply cut its 2022 growth forecasts. A credit default swap index showed the cost of insuring exposure to lower-rated European debt is at its highest in two years, highlighting risks companies face.
Indeed, one-month euro/dollar risk reversals -- a option market gauge of demand for options on a currency rising or falling -- moved sharply on Wednesday to imply more euro weakness. The ratio of call options on the euro compared to puts almost halved on Wednesday from the previous day to minus 1.8, the lowest since early-April. Call options confer the right to buy an asset while puts enable holders to sell.
The past week may point to a bumpier ride ahead, with analysts noting an unexpected, nearly $500 billion shift in the Fed's balance sheet driven by factors beyond its control and volatility in stock and bond markets as signs the central bank's pivot to tighter monetary policy may not run so smoothly. In particular, a nearly 9% drop in the S&P 500 index over the past month may show a coming hit to household wealth that quickly translates into lower consumer spending, said Steven Blitz, chief U.S. economist at TS Lombard. He noted that changes in asset prices are a key and perhaps increasingly important way monetary policy can influence economic activity and inflation.
COT Report
Recent CFTC data shows clear bearish tendency in sentiment on EUR. Open interest is up for 26K+ contracts while bears have increased positions significantly.
Speculators' net long positioning on the U.S. dollar rose in the latest week as well, according to calculations by Reuters and U.S. Commodity Futures Trading Commission data released on Friday. The value of the net long dollar position climbed to $13.92 billion for the week ended April 26, from $12.91 billion the previous week. This week's U.S. dollar net long positioning was the largest since early April, and the first increase in four weeks.
Next Week to watch
Some big beasts of the central banking world take centre stage over the coming week, with the U.S. Federal Reserve, the Bank of England and the Reserve Bank of Australia holding policy meetings.
#1 the Fed
Increasingly hawkish Fed rhetoric has sparked nasty sell-offs in stock and bond markets, and on Wednesday we will see just how aggressive the central bank plans to get over coming months. The Fed has flagged a 50 basis-point interest rate rise on May 4, and investors expect a hefty 240 bps of monetary tightening in 2022. Many reckon the Fed will continue to surprise on the hawkish side, as it fights to tamp down the worst inflation in four decades.
Markets will also focus on the Fed's plans for its nearly $9 trillion balance sheet, which it could start unwinding as early as May
#2 BoE
The Bank of England's meeting, a day after the Fed, is tipped to lift interest rates for a fourth time in a row, the first time it would have done that since 1997.
BoE boss Andrew Bailey says the bank is treading a "very tight line" between curbing inflation, which at 7% is more than three times its target, and avoiding a recession. A quarter point hike to 1% would meet a precondition for the BoE to start actively selling bonds it holds. A big question for markets is when these sales will start; estimates range from June to well into 2023. Active bond sales would tighten monetary conditions but could hurt a faltering economy and no major central bank has yet started the process.
#3 China and Australia
The yuan, down 4% this month, may have further to fall if weekend data shows Chinese factory activity still weakening. China's slowdown has also applied a discount at the quarry - pushing the Aussie dollar down some 4.5% through April. With recent data showing Australian first-quarter inflation at 20-year highs, anticipation is building that a hiking cycle could begin as soon as Tuesday.
To be continued in the next post...
