Sive Morten
Special Consultant to the FPA
- Messages
- 18,105
Fundamentals
Well, guys, this week we've got a lot of data, including statistics and multiple speeches from different authorities. Markets were inspiring with the changing situation and shown solid upside performance - stocks, bonds and all currencies against the dollar. The euphoria stands so strong that it starts to spread the opinion that inflation probably tops in September which makes no need to the Fed to rise rate higher. What a delusion... But let's take a look at it step by step.
Market overview
The dollar edged lower on Friday on its way to a second-straight weekly decline as traders pared expectations for U.S. Federal Reserve interest rate hikes and as improving inflation and consumer spending data eased recession fears.
The greenback hit a nearly two-decade peak above 105 earlier this month but has declined along with outlooks for the magnitude of likely Fed rate hikes this year, which have been fueled in part by fears over runaway inflation.
Minutes from the Fed's May meeting this week showed most participants believed 50 basis-point hikes would be appropriate at the June and July policy meetings, but many thought big, early hikes would allow room to pause later in the year to assess whether tighter policy is helping to tame inflation. Officials across the policy spectrum have backed the planned June and July rate hikes, aligning behind Powell's push to make lowering inflation the Fed's top priority. But beyond that, officials have begun laying out a broad range of positions, from a outright pause in rate increases this fall to calls for an aggressive string of half-percentage-point increases at the September, November and December meetings.
Analysts at Citibank said they would be looking "for any discussion of growth versus inflation concerns" as Fed officials try to navigate the economy out of its current inflation dilemma without causing a recession or pushing the unemployment rate substantially higher. Which we suggest impossible to achieve.
Although inflation continued to increase in April, it rose less than in recent months, data showed on Friday. The personal consumption expenditures (PCE) price index rose 0.2%, the smallest gain since November 2020, after shooting up 0.9% in March. For the 12 months through April, the PCE price index advanced 6.3% after jumping 6.6% in March.
Benchmark U.S. Treasury yields were lower on Friday, but briefly bounced off session lows after the April inflation figures, which boosted hopes that the worst of soaring price pressures has passed (!!)
A separate report showed U.S. consumer spending rose more than expected last month as households boosted purchases of goods and services. Next week's key U.S. report will be the nonfarm payrolls numbers for May at the end of the week.
The euro has been the chief beneficiary of the dollar's decline, but that momentum has also stalled as investors believe much of the expected rate hikes from the European Central Bank have been priced into current levels.
Sounds great, right? But what the reason of sudden reversal on the stock market and dropping of the interest rates for the 2nd consecutive week? Are we so wrong in our analysis and situation has improved drastically just after single 0.5% rate change? Watch this:
We already have seen this chart last week, when we've discussed coming liquidity tightening from the Fed. In fact, the QT (quantitative tightening) starts not in June 2022, as it is announced, but first steps already have been done in December. Fed doesn't push liquidity in single direction but tightening mixes with easing. For example, take a look that firs 2022 rally of the S&P after drop has happened right in the period of tactical Fed "easing". And - bingo! What do we see now - the next easing is coming and markets with the glorious screaming "hurrah!" show the pullback.
Indeed, effect is quite comparable to QE, as $ 118 billion was received from the US Treasury by markets in recent 2 weeks, and the net change in liquidity, taking into account the Fed's operations on the open market, stands +109 billion in favor of the market. The previous "easing-tightening steps" from mid-April to mid-May consists of net liquidity decreasing by $400 billion, which was synchronized with the fall of the markets. Approximately the same thing worked from mid-December 2021 to February 2022, when they withdrew almost half a trillion dollars and increased liquidity in the financial system by 200 billion from February 16 to April 13 has led to upside pullback.
But it seems that nobody sees this. Take a look what investors think about current situation, what comments do they give.
The index rose 6.6% this week, snapping a seven-week losing streak, though it is down around 13% for the year to date. Net weekly inflows to U.S. stocks stood at their highest level in 10 weeks, data from BofA Global Research showed Thursday.
Concerns over the impact of higher rates at a time when inflation may have peaked will likely mean the central bank will pause its tightening in September, leaving its benchmark overnight interest rate in a range of 1.75% to 2% if financial conditions worsen, BofA strategists said in a note.
Expectations of Fed hawkishness have eased, with investors now pricing in a 35% probability that the Fed funds rate will be between 2.25% and 2.50% after its September meeting, down from a 50% probability a week ago, according to CME. The Fed has already raised rates by 75 basis points this year. Minutes from the central bank’s latest meeting showed officials grappling with how best to navigate the economy toward lower inflation without causing a recession or pushing the unemployment rate substantially higher.
Some investors, however, believe a turning point may be near. Esty Dwek, chief investment officer at FlowBank, is betting the central bank will begin to see signs that inflation and growth are slowing by August, when policymakers hold their annual meeting in Jackson Hole, Wyoming. "The Fed is past peak hawkishness," she said.
But more respectable analysts understand what is going on:
Among those sounding the warning are hedge fund manager Bill Ackman, a member of the Fed’s investor advisory committee on financial markets, who on Twitter this week urged the central bank to quell inflation by raising rates more aggressively. In general, we agree with the position that softer economic growth raises risks of weaker corporate profits, in theory paving the way for softer share prices. Several Wall Street banks have in recent weeks warned that the chances of a U.S. recession are rising, along with an increased likelihood of the low-growth, high-inflation environment known as stagflation. And we agree with them.
Home sales have fallen for a third straight month, while big misses from retail giants such as Target Corp and Walmart Inc shook their share prices last week. The Atlanta Fed's GDPNow estimate of real GDP growth for the second quarter fell to 1.8% on May 25, from 2.4% the previous week.
Now, let's go further...
The U.S. Federal Reserve is carrying $330 billion in unrealized losses on its holdings of U.S. Treasury and mortgage-backed securities as of the end of March, according to newly released financial statements showing the impact of rising interest rates on the market value of the Fed's balance sheet. The losses on the Fed's investments, an $8.5 trillion portfolio that surged higher through asset purchases designed to keep financial markets stable through the pandemic, pose a potentially tough political problem for the central bank. Bill Nelson, chief economist at the Bank Policy Institute, said that adjusting for the appreciation in its assets the Fed had seen through the end of last year, the unrealized losses were an even larger $458 billion.
A New York Fed report earlier this week flagged potentially large losses to the Fed's portfolio, given that interest rates are expected to continue rising. The report also flagged a further issue: As the Fed raises its short term interest rate, it will do so by offering larger payments to banks for the reserves they deposit at the Fed, increasing the central bank's expenses. As its balance sheet shrinks, meanwhile, its interest earnings will decline, potentially pushing the Fed towards operating losses.
New York Fed officials in the report said the Fed would be able to fund its operations and conduct monetary regardless. But it could mean sharp declines in a key metric watched closely by elected official: the profits that the central bank remits to the U.S. Treasury. Those have climbed during the era of "quantitative easing" and hit a record $107 billion last year, but could fall to zero as Fed monetary policy shifts.
U.S. bank profits dropped 6.5% in the first quarter of 2022 to $59.7 billion, as larger firms grew their loan loss provisions in response to heightened economic and geopolitical uncertainty, the Federal Deposit Insurance Corporation reported on Tuesday. Bank profits were down 22.2% compared to the first quarter of 2021, driven by banks with over $10 billion in assets setting aside more funds to guard against loan losses.
New home sales in the United States fell 16.6% month-on-month in April, the largest decline in nine years, and new orders for U.S.-made capital goods rose less than expected in April. And take a look at the prices - hits ATH for the whole history of observation. This is real numbers of inflation, guys... 30%...
From this moment above it should be clear the size of the snowball that could rise as long as fed rate keep moving higher - downside revaluation of the bonds on Fed balance, higher payment to the banks on reserves, finally big expenses to serve national Debt as well. Although it stands upon the Treasury, but what's the difference?
That's being, said here is the modern investors expectations:
The equivalent of a half-point rate hike from the Federal Reserve has been priced out over the last three weeks, putting the peak in rates at 3% next June. That implies cumulative U.S. rate hikes of 210 basis points this cycle, versus 255 bps at the start of May, according to Fed Fund futures that reflect expectations of future interest rate moves. In Britain too, despite expectations of 10% inflation this year, recession signals are forcing a shift, with 120 bps of rate rises priced until June 2023, from 165 bps at the start of May. That would take rates to around 2.4%.
The implied yield on the eurodollar futures June 2023 contract -- essentially where markets see interest rates to be at that point -- is down some 80 basis points this month.
He was referring to the long-held belief that the U.S. central bank will backstop falling stock markets by going easy on rate-tightening.
I would ask only one question - and why Fed is watching on slowing growth but not on 10% inflation, making decision on the pace of hike cycle and terminal rate?
Last time we said - we take the bet that Fed chickens to rise rate until necessary level and pushes the break at first signs of slowdown. And market expects the same now. If it happens - crisis worsens and the core problem will not be resolved.
Goldman Sachs now sees a 35% probability of a U.S. recession during the next two years but expects dividends to fall in any case -- an event that has never happened outside of a recession. Some Fed officials such as Raphael Bostic have urged caution on policy tightening.
Laura Cooper, a senior investment strategist at Blackrock, predicts "a dovish tilt" from the Fed by year-end, as "policymakers become more data-dependent beyond the two 50 bps rate hikes priced in by the market over the next two meetings."
In Britain, where recession is more likely, the Bank of England may find it harder to back off.
A £15 billion government spending package announced this week means "the BoE will need to hike into contractionary territory," Goldman wrote, predicting 25 bps back-to-back rate rises through February 2023, taking the terminal rate to 2.5%.
Finally, for the European Central Bank, tightening bets have ramped up, with 160 bps of rate hikes expected in the coming year, from 123 bps in early-May. ECB boss Christine Lagarde has signalled rates, currently at -0.5%, will be at 0% or above by September. Lagarde's comments implied an increase of at least 50 basis points to the ECB deposit rate and fueled speculation of bigger hikes this summer to fight a surge in inflation tied to rising energy prices caused by the war in Ukraine and massive public-sector stimulus after the onset of the coronavirus pandemic.
Just this week World Bank President David Malpass feared the worst for global output. "It's hard right now to see how we avoid a recession," he said on Wednesday
Commercial banks such as Deutsche Bank and Wells Fargo now forecast a U.S. recession at some point over the next 12-18 months, while many houses see Europe there this year.
International Monetary Fund Managing Director Kristalina Georgieva on Wednesday said she worries less about the risk that the war in Ukraine and a further slowdown in China might trigger a global recession than she does about the strength of the trend toward economic and political fragmentation.
The Guggenheim Partners talk correct things.
The U.S. Federal Reserve may be forced to rethink its hawkish stance as it hikes interest rates in the face of a slowing economy and deteriorating market fundamentals, Guggenheim Partners' Global Chief Investment Officer Scott Minerd said on Tuesday.
In their efforts to bring inflation under control, policymakers have underestimated the impacts of shrinking the central bank's balance sheet while simultaneously hiking rates, he told the Reuters Global Markets Forum, adding that market participants were also underestimating these risks. Guggenheim, which has over $325 billion in assets under management, is overweight corporate credit and prefers current valuations in the investment-grade space over riskier high-yield debt. Minerd sees worsening financial conditions as especially obvious in credit markets. Guggenheim has a bearish stance on equity markets, Minerd said, adding that reducing equity "beta," in his portfolios, or volatility compared to the overall stock market, has become a key priority.
To be continued...
Well, guys, this week we've got a lot of data, including statistics and multiple speeches from different authorities. Markets were inspiring with the changing situation and shown solid upside performance - stocks, bonds and all currencies against the dollar. The euphoria stands so strong that it starts to spread the opinion that inflation probably tops in September which makes no need to the Fed to rise rate higher. What a delusion... But let's take a look at it step by step.
Market overview
The dollar edged lower on Friday on its way to a second-straight weekly decline as traders pared expectations for U.S. Federal Reserve interest rate hikes and as improving inflation and consumer spending data eased recession fears.
The greenback hit a nearly two-decade peak above 105 earlier this month but has declined along with outlooks for the magnitude of likely Fed rate hikes this year, which have been fueled in part by fears over runaway inflation.
Minutes from the Fed's May meeting this week showed most participants believed 50 basis-point hikes would be appropriate at the June and July policy meetings, but many thought big, early hikes would allow room to pause later in the year to assess whether tighter policy is helping to tame inflation. Officials across the policy spectrum have backed the planned June and July rate hikes, aligning behind Powell's push to make lowering inflation the Fed's top priority. But beyond that, officials have begun laying out a broad range of positions, from a outright pause in rate increases this fall to calls for an aggressive string of half-percentage-point increases at the September, November and December meetings.
Analysts at Citibank said they would be looking "for any discussion of growth versus inflation concerns" as Fed officials try to navigate the economy out of its current inflation dilemma without causing a recession or pushing the unemployment rate substantially higher. Which we suggest impossible to achieve.
Although inflation continued to increase in April, it rose less than in recent months, data showed on Friday. The personal consumption expenditures (PCE) price index rose 0.2%, the smallest gain since November 2020, after shooting up 0.9% in March. For the 12 months through April, the PCE price index advanced 6.3% after jumping 6.6% in March.
Benchmark U.S. Treasury yields were lower on Friday, but briefly bounced off session lows after the April inflation figures, which boosted hopes that the worst of soaring price pressures has passed (!!)
A separate report showed U.S. consumer spending rose more than expected last month as households boosted purchases of goods and services. Next week's key U.S. report will be the nonfarm payrolls numbers for May at the end of the week.
The euro has been the chief beneficiary of the dollar's decline, but that momentum has also stalled as investors believe much of the expected rate hikes from the European Central Bank have been priced into current levels.
Sounds great, right? But what the reason of sudden reversal on the stock market and dropping of the interest rates for the 2nd consecutive week? Are we so wrong in our analysis and situation has improved drastically just after single 0.5% rate change? Watch this:
We already have seen this chart last week, when we've discussed coming liquidity tightening from the Fed. In fact, the QT (quantitative tightening) starts not in June 2022, as it is announced, but first steps already have been done in December. Fed doesn't push liquidity in single direction but tightening mixes with easing. For example, take a look that firs 2022 rally of the S&P after drop has happened right in the period of tactical Fed "easing". And - bingo! What do we see now - the next easing is coming and markets with the glorious screaming "hurrah!" show the pullback.
Indeed, effect is quite comparable to QE, as $ 118 billion was received from the US Treasury by markets in recent 2 weeks, and the net change in liquidity, taking into account the Fed's operations on the open market, stands +109 billion in favor of the market. The previous "easing-tightening steps" from mid-April to mid-May consists of net liquidity decreasing by $400 billion, which was synchronized with the fall of the markets. Approximately the same thing worked from mid-December 2021 to February 2022, when they withdrew almost half a trillion dollars and increased liquidity in the financial system by 200 billion from February 16 to April 13 has led to upside pullback.
But it seems that nobody sees this. Take a look what investors think about current situation, what comments do they give.
The index rose 6.6% this week, snapping a seven-week losing streak, though it is down around 13% for the year to date. Net weekly inflows to U.S. stocks stood at their highest level in 10 weeks, data from BofA Global Research showed Thursday.
Concerns over the impact of higher rates at a time when inflation may have peaked will likely mean the central bank will pause its tightening in September, leaving its benchmark overnight interest rate in a range of 1.75% to 2% if financial conditions worsen, BofA strategists said in a note.
Expectations of Fed hawkishness have eased, with investors now pricing in a 35% probability that the Fed funds rate will be between 2.25% and 2.50% after its September meeting, down from a 50% probability a week ago, according to CME. The Fed has already raised rates by 75 basis points this year. Minutes from the central bank’s latest meeting showed officials grappling with how best to navigate the economy toward lower inflation without causing a recession or pushing the unemployment rate substantially higher.
Some investors, however, believe a turning point may be near. Esty Dwek, chief investment officer at FlowBank, is betting the central bank will begin to see signs that inflation and growth are slowing by August, when policymakers hold their annual meeting in Jackson Hole, Wyoming. "The Fed is past peak hawkishness," she said.
But more respectable analysts understand what is going on:
Among those sounding the warning are hedge fund manager Bill Ackman, a member of the Fed’s investor advisory committee on financial markets, who on Twitter this week urged the central bank to quell inflation by raising rates more aggressively. In general, we agree with the position that softer economic growth raises risks of weaker corporate profits, in theory paving the way for softer share prices. Several Wall Street banks have in recent weeks warned that the chances of a U.S. recession are rising, along with an increased likelihood of the low-growth, high-inflation environment known as stagflation. And we agree with them.
Home sales have fallen for a third straight month, while big misses from retail giants such as Target Corp and Walmart Inc shook their share prices last week. The Atlanta Fed's GDPNow estimate of real GDP growth for the second quarter fell to 1.8% on May 25, from 2.4% the previous week.
Now, let's go further...
The U.S. Federal Reserve is carrying $330 billion in unrealized losses on its holdings of U.S. Treasury and mortgage-backed securities as of the end of March, according to newly released financial statements showing the impact of rising interest rates on the market value of the Fed's balance sheet. The losses on the Fed's investments, an $8.5 trillion portfolio that surged higher through asset purchases designed to keep financial markets stable through the pandemic, pose a potentially tough political problem for the central bank. Bill Nelson, chief economist at the Bank Policy Institute, said that adjusting for the appreciation in its assets the Fed had seen through the end of last year, the unrealized losses were an even larger $458 billion.
A New York Fed report earlier this week flagged potentially large losses to the Fed's portfolio, given that interest rates are expected to continue rising. The report also flagged a further issue: As the Fed raises its short term interest rate, it will do so by offering larger payments to banks for the reserves they deposit at the Fed, increasing the central bank's expenses. As its balance sheet shrinks, meanwhile, its interest earnings will decline, potentially pushing the Fed towards operating losses.
New York Fed officials in the report said the Fed would be able to fund its operations and conduct monetary regardless. But it could mean sharp declines in a key metric watched closely by elected official: the profits that the central bank remits to the U.S. Treasury. Those have climbed during the era of "quantitative easing" and hit a record $107 billion last year, but could fall to zero as Fed monetary policy shifts.
U.S. bank profits dropped 6.5% in the first quarter of 2022 to $59.7 billion, as larger firms grew their loan loss provisions in response to heightened economic and geopolitical uncertainty, the Federal Deposit Insurance Corporation reported on Tuesday. Bank profits were down 22.2% compared to the first quarter of 2021, driven by banks with over $10 billion in assets setting aside more funds to guard against loan losses.
New home sales in the United States fell 16.6% month-on-month in April, the largest decline in nine years, and new orders for U.S.-made capital goods rose less than expected in April. And take a look at the prices - hits ATH for the whole history of observation. This is real numbers of inflation, guys... 30%...
From this moment above it should be clear the size of the snowball that could rise as long as fed rate keep moving higher - downside revaluation of the bonds on Fed balance, higher payment to the banks on reserves, finally big expenses to serve national Debt as well. Although it stands upon the Treasury, but what's the difference?
That's being, said here is the modern investors expectations:
The equivalent of a half-point rate hike from the Federal Reserve has been priced out over the last three weeks, putting the peak in rates at 3% next June. That implies cumulative U.S. rate hikes of 210 basis points this cycle, versus 255 bps at the start of May, according to Fed Fund futures that reflect expectations of future interest rate moves. In Britain too, despite expectations of 10% inflation this year, recession signals are forcing a shift, with 120 bps of rate rises priced until June 2023, from 165 bps at the start of May. That would take rates to around 2.4%.
The implied yield on the eurodollar futures June 2023 contract -- essentially where markets see interest rates to be at that point -- is down some 80 basis points this month.
He was referring to the long-held belief that the U.S. central bank will backstop falling stock markets by going easy on rate-tightening.
I would ask only one question - and why Fed is watching on slowing growth but not on 10% inflation, making decision on the pace of hike cycle and terminal rate?
Last time we said - we take the bet that Fed chickens to rise rate until necessary level and pushes the break at first signs of slowdown. And market expects the same now. If it happens - crisis worsens and the core problem will not be resolved.
Goldman Sachs now sees a 35% probability of a U.S. recession during the next two years but expects dividends to fall in any case -- an event that has never happened outside of a recession. Some Fed officials such as Raphael Bostic have urged caution on policy tightening.
Laura Cooper, a senior investment strategist at Blackrock, predicts "a dovish tilt" from the Fed by year-end, as "policymakers become more data-dependent beyond the two 50 bps rate hikes priced in by the market over the next two meetings."
In Britain, where recession is more likely, the Bank of England may find it harder to back off.
A £15 billion government spending package announced this week means "the BoE will need to hike into contractionary territory," Goldman wrote, predicting 25 bps back-to-back rate rises through February 2023, taking the terminal rate to 2.5%.
Finally, for the European Central Bank, tightening bets have ramped up, with 160 bps of rate hikes expected in the coming year, from 123 bps in early-May. ECB boss Christine Lagarde has signalled rates, currently at -0.5%, will be at 0% or above by September. Lagarde's comments implied an increase of at least 50 basis points to the ECB deposit rate and fueled speculation of bigger hikes this summer to fight a surge in inflation tied to rising energy prices caused by the war in Ukraine and massive public-sector stimulus after the onset of the coronavirus pandemic.
Just this week World Bank President David Malpass feared the worst for global output. "It's hard right now to see how we avoid a recession," he said on Wednesday
Commercial banks such as Deutsche Bank and Wells Fargo now forecast a U.S. recession at some point over the next 12-18 months, while many houses see Europe there this year.
International Monetary Fund Managing Director Kristalina Georgieva on Wednesday said she worries less about the risk that the war in Ukraine and a further slowdown in China might trigger a global recession than she does about the strength of the trend toward economic and political fragmentation.
The Guggenheim Partners talk correct things.
The U.S. Federal Reserve may be forced to rethink its hawkish stance as it hikes interest rates in the face of a slowing economy and deteriorating market fundamentals, Guggenheim Partners' Global Chief Investment Officer Scott Minerd said on Tuesday.
In their efforts to bring inflation under control, policymakers have underestimated the impacts of shrinking the central bank's balance sheet while simultaneously hiking rates, he told the Reuters Global Markets Forum, adding that market participants were also underestimating these risks. Guggenheim, which has over $325 billion in assets under management, is overweight corporate credit and prefers current valuations in the investment-grade space over riskier high-yield debt. Minerd sees worsening financial conditions as especially obvious in credit markets. Guggenheim has a bearish stance on equity markets, Minerd said, adding that reducing equity "beta," in his portfolios, or volatility compared to the overall stock market, has become a key priority.
To be continued...
