Sive Morten
Special Consultant to the FPA
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Fundamentals
Yesterday guys we saw absolutely wonderful reaction on NFP data. Market rejoice - employment dropped. Rising unemployment is now seen as good news. Hooray! Unemployment is rising! The Fed will no longer raise rates! Let's buy shares! This is of course great, but rising unemployment means that demand will fall, which means that company performance will decline.
It is also absurd that as time goes on, companies' debt servicing costs will continue to increase, since old loans will continue to be refinanced at the current high rates, which means company profits will be under pressure. After all, the Fed is not going to cut rates without a serious reason. Well, yes, a great reason to buy shares.
Market overview
The dollar fell across the board on Thursday, as investors' appetite for riskier currencies grew as they bet the Federal Reserve is done raising interest rates after holding them steady in the previous session. The Fed left interest rates unchanged on Wednesday as policymakers struggled to determine whether financial conditions may be tight enough already to control inflation, or whether an economy that continues to outperform expectations may need still more restraint.
Investors, however, are increasingly convinced a peak in U.S. interest rates has been reached, with Fed funds futures sticking with a sub-20% chance that rates will rise in December. Brad Bechtel, global head of FX at Jefferies in New York, said the Fed is probably finished hiking rates, but he could see the rationale for tightening one more time given the still-resilient U.S. economy.
The yen has been struggling for traction, even as the Bank of Japan on Tuesday made another relaxation of its yield curve control policy. A fall to a one-year low of 151.74 per dollar and 15-year low of 160.83 per euro after the BoJ's announcement had traders on watch for possible intervention to prop up the currency. Kazuo Ueda, the central bank's governor, will continue to dismantle its ultra-loose monetary policy and look to exit the decade-long accommodative regime sometime next year, sources told Reuters.
On Friday data showed the world's largest economy created fewer jobs than expected last month, reinforcing expectations the Federal Reserve is likely to hold interest rates steady again at its December meeting. For the week, the greenback was down 1.4%, on pace for its worst weekly performance since July as well. Data showed nonfarm payrolls increased by 150,000 jobs last month. The numbers for September were revised lower to show 297,000 jobs created instead of 336,000 as previously reported.
Another piece of economic data released on Friday also depicted a slowing economy. The U.S. services sector slowed for a second straight month in October, according to the Institute for Supply Management (ISM). Its non-manufacturing PMI dropped to a five-month low of 51.8 from 53.6 in September. The Services PMI has been declining since August, when it rose to the highest level in six months.
This week's fall was sparked by a combination of the U.S. Treasury Department announcing smaller-than-expected increases in longer-dated Treasury supply, and Fed Chair Jerome Powell seemingly less hawkish than markets expected at his press conference after the Fed's Wednesday meeting. He did, however, leave the door open to a further increase in borrowing costs in a nod to the economy's resilience.
Billionaire investor Stanley Druckenmiller, founder of the Duquesne family office, who said last month that he bought a “massive leveraged position” in two-year U.S. Treasury bonds because of rising concerns about the health of the U.S. economy. Bond bulls argue investors should increase exposure to long-term securities partly because they could appreciate in price if an economic slowdown pushes the Fed to eventually cut rates.
The eventual end of the Federal Reserve’s efforts to reduce its vast bond holdings increasingly appears tied to what happens with the central bank's "reverse repo" operations. That’s because the facility - which allows eligible banks and investment firms to park cash at the Fed and earn interest - is the largest source of easily extinguished liquidity as the Fed seeks to withdraw its pandemic-era stimulus.
At the same time we see that the Fed keeps its QT, as its assets have contracted this week for another 46 Bln:
While US Treasury coin piggy bank stands intact, although we see minor tick down this week:
This tells us important thing - US Banking sector start loosing liquidity and ignores high yield levels, getting cash out of Reverse Repo system. Because now it is the only source of liquidity:
Thus nothing positive happens here. Lending is slowing, especially at smaller banks, funding costs/risk premiums are rising, as is the share of commercial mortgages on the balance sheet, and liquidity is deteriorating. In fact, their situation is now even worse than it was in March, during the collapse of Silicon Valley, Signature and First Republic banks. Well, it’s clear that they also have more external reasons to lash out. Lending is slowing:
LET"S GET SOMETHING FROM THIS MESS
What's going on? It seems that investors see nothing beneath the surface. Here I have selected few data, showing that the US are not alone in terms of unemployment raising and dropping of industrial activity. This week data shows that inflation is slowing in EU as well. This is not surprising, because of drop in consumption. When nobody's buying, price turns down. Huge production deflation, such as in Italy, (but the same we have in all major EU countries) tells that it is distracting, purchasing power is dropping. Pay attention that in Netherlands - this is CPI indicator, not PPI, showing huge drop in population wealth level.
So we not see any reasons to be so happy. We speak about J. Powell statement a bit later, because this week another important event has happened - US Treasury has announced their plans on borrowing. The US Treasury continues to burn out: in order to cope with the growing debt burden , it is necessary to borrow more. On Monday, the department said it would need to borrow $776 billion in the current quarter and $816 billion in the first quarter of calendar 2024.
It is something confusing here... Well, okay, they don’t want to borrow 1.01 trillion. dollars as in the 3rd quarter, and “only” 776 billion dollars. Net, I believe. Just remember that out of the borrowed trillion, $400 billion was borrowed to be deposited in the TGA account of the Ministry of Finance at the Fed (chart is above). At the same time, the Ministry of Finance said that it will not replenish the account anymore, which means all these 776 billion dollars will be successfully spent. And it turns out that this will be more than in the second quarter. Are we expecting new records for GDP growth due to wild fiscal stimulus?
US Treasury has made the choice in favor of shorter-term Notes, which seems logical. There is another ~1 trillion in funds of the reverse repo. Even at the current rate of borrowing, this will be more than enough for another six months. We are, of course, talking about refinancing those short-term bonds that are due to be repaid, but the budget deficit is still needed to support demand in the economy, so a new volume of placement will also be added to the refinancing.
The growth of the US national debt is out of control. The American Ministry of Finance is not able to control its expenses, so it borrows like crazy. Almost a trillion in interest. The United States, with its desire to combat inflation and the enormous spending of the Ministry of Finance, has found itself in an extremely uncomfortable situation. It spends almost a trillion on paying interest on the debt alone. According to the BEA, US Treasury expenses in the third quarter on interest on debt reached $981 billion:
It seems that the Fed and US Treasury accumulate all possible resources to last time until November 2024 and keep economy on surface. Besides, some curious things start to happen. For example, some of the largest United States banks cannot facilitate customer’s deposits after one of the Federal Reserve’s payment systems suffered an outage on Nov. 3. The Federal Reserve said the bug was caused by a “processing issue” in the Automated Clearing House — a payment processing network widely used by banks and employers to deposit wages into employee bank accounts.
Some analysts hint that the Fed is already insolvent for $2.5 Trln. In fact, P. Schiff clearly has explained everything in his Twitter.
At the same time, situation is not better in EU either. EU has two times greater amount of HY and Investment Grade (IG ) bonds in nearest three years. Since rates remain high in both regions, ECB will appear under stronger pressure, because overall situation in EU economy looks worse than in the US:
It means that potentially ECB could start rate easing even earlier than the US and first recession signs also should appear earlier.
Concerning the US and recent J. Powell comments - they were as most diluted as never before. Keeping it simple - "maybe yes, maybe no - maybe rain, maybe snow..."
The window of opportunity for a rate increase has been preserved, but the probability of implementation, as always, has not been determined: "we have not yet made a decision, we do not know what we will do, we will continue to monitor the data." There is no set of factors that will trigger a possible rate hike, i.e. there is no benchmark that will determine that this is the level where the Fed will raise the rate. The Fed will consider a set of factors and their interrelationships in the context of the situation. The Fed is not considering a rate cut in the near future, this issue is not even raised on the current agenda. The only thing that matters is the time during which the restrictive policy will continue until the Fed is sure that the inflation target has been achieved.
Experts tell that the essence of the Fed's problems is that the rate level has become too high. And for the US budget (see above), and for the American economy. The latter can be seen in all our reports over the past 1-1.5 years. Theoretically, it would be necessary to lower the rate in order to reduce the burden on the refinancing of the budget and give a boost to the industry, but … But inflation has not dropped to 2% and, apparently, is ready to jump up again.
At the same time, deflation is in the industry (a sign of a recession). We will find out the figure for October next week, but in the world, as we have shown above, industrial deflation is raging in full force. And in this situation, it would be necessary to soften monetary policy, especially since the election campaign requires maintaining the standard of living of the population. But very scary …
In general, the fluctuations of the Fed's leadership suggests that it is unable to offer a more or less coherent strategy of action. Even if it's a crisis. Powell cannot even recognize the economic downturn that has been going on for two years (which is masked by underestimating inflation and increasing monetization of fictitious assets, such as growth of financial assets, stocks etc.), since the elections. And then it's easy to say, "the economy will fall by 3%," and if it continues to fall further? And it continued …
And if we also take into account at least two wars that are hanging on the nose, with Iran and/or China, not counting support for Ukraine … Ukraine, however, cannot be abandoned, since the question of testimony against Biden regarding corruption charges will immediately arise. However, this question has already arisen and how it will affect the financial markets is a big question. In general, the Fed leadership has complex problems, more or less a clear solution to which is simply not visible.
Finally recall, that we have only "temporary Government financing", that ends in the middle of the month. Thus, it seems November is becoming some kind of vital moment to test the US on strength (as politically as economically). If we pass November without big fun, then probably the year should be closed without big troubles and all hot points will pass into 2024.
From long-term perspective, relief in US Dollar rally seems temporal but it could last for awhile until investors understand that their "rejoice" on the end of Fed's hiking cycle seems untimely.
Yesterday guys we saw absolutely wonderful reaction on NFP data. Market rejoice - employment dropped. Rising unemployment is now seen as good news. Hooray! Unemployment is rising! The Fed will no longer raise rates! Let's buy shares! This is of course great, but rising unemployment means that demand will fall, which means that company performance will decline.
It is also absurd that as time goes on, companies' debt servicing costs will continue to increase, since old loans will continue to be refinanced at the current high rates, which means company profits will be under pressure. After all, the Fed is not going to cut rates without a serious reason. Well, yes, a great reason to buy shares.
Market overview
The dollar fell across the board on Thursday, as investors' appetite for riskier currencies grew as they bet the Federal Reserve is done raising interest rates after holding them steady in the previous session. The Fed left interest rates unchanged on Wednesday as policymakers struggled to determine whether financial conditions may be tight enough already to control inflation, or whether an economy that continues to outperform expectations may need still more restraint.
Investors, however, are increasingly convinced a peak in U.S. interest rates has been reached, with Fed funds futures sticking with a sub-20% chance that rates will rise in December. Brad Bechtel, global head of FX at Jefferies in New York, said the Fed is probably finished hiking rates, but he could see the rationale for tightening one more time given the still-resilient U.S. economy.
The yen has been struggling for traction, even as the Bank of Japan on Tuesday made another relaxation of its yield curve control policy. A fall to a one-year low of 151.74 per dollar and 15-year low of 160.83 per euro after the BoJ's announcement had traders on watch for possible intervention to prop up the currency. Kazuo Ueda, the central bank's governor, will continue to dismantle its ultra-loose monetary policy and look to exit the decade-long accommodative regime sometime next year, sources told Reuters.
On Friday data showed the world's largest economy created fewer jobs than expected last month, reinforcing expectations the Federal Reserve is likely to hold interest rates steady again at its December meeting. For the week, the greenback was down 1.4%, on pace for its worst weekly performance since July as well. Data showed nonfarm payrolls increased by 150,000 jobs last month. The numbers for September were revised lower to show 297,000 jobs created instead of 336,000 as previously reported.
Another piece of economic data released on Friday also depicted a slowing economy. The U.S. services sector slowed for a second straight month in October, according to the Institute for Supply Management (ISM). Its non-manufacturing PMI dropped to a five-month low of 51.8 from 53.6 in September. The Services PMI has been declining since August, when it rose to the highest level in six months.
This week's fall was sparked by a combination of the U.S. Treasury Department announcing smaller-than-expected increases in longer-dated Treasury supply, and Fed Chair Jerome Powell seemingly less hawkish than markets expected at his press conference after the Fed's Wednesday meeting. He did, however, leave the door open to a further increase in borrowing costs in a nod to the economy's resilience.
Billionaire investor Stanley Druckenmiller, founder of the Duquesne family office, who said last month that he bought a “massive leveraged position” in two-year U.S. Treasury bonds because of rising concerns about the health of the U.S. economy. Bond bulls argue investors should increase exposure to long-term securities partly because they could appreciate in price if an economic slowdown pushes the Fed to eventually cut rates.
The eventual end of the Federal Reserve’s efforts to reduce its vast bond holdings increasingly appears tied to what happens with the central bank's "reverse repo" operations. That’s because the facility - which allows eligible banks and investment firms to park cash at the Fed and earn interest - is the largest source of easily extinguished liquidity as the Fed seeks to withdraw its pandemic-era stimulus.
At the same time we see that the Fed keeps its QT, as its assets have contracted this week for another 46 Bln:
While US Treasury coin piggy bank stands intact, although we see minor tick down this week:
This tells us important thing - US Banking sector start loosing liquidity and ignores high yield levels, getting cash out of Reverse Repo system. Because now it is the only source of liquidity:
Thus nothing positive happens here. Lending is slowing, especially at smaller banks, funding costs/risk premiums are rising, as is the share of commercial mortgages on the balance sheet, and liquidity is deteriorating. In fact, their situation is now even worse than it was in March, during the collapse of Silicon Valley, Signature and First Republic banks. Well, it’s clear that they also have more external reasons to lash out. Lending is slowing:
LET"S GET SOMETHING FROM THIS MESS
What's going on? It seems that investors see nothing beneath the surface. Here I have selected few data, showing that the US are not alone in terms of unemployment raising and dropping of industrial activity. This week data shows that inflation is slowing in EU as well. This is not surprising, because of drop in consumption. When nobody's buying, price turns down. Huge production deflation, such as in Italy, (but the same we have in all major EU countries) tells that it is distracting, purchasing power is dropping. Pay attention that in Netherlands - this is CPI indicator, not PPI, showing huge drop in population wealth level.
So we not see any reasons to be so happy. We speak about J. Powell statement a bit later, because this week another important event has happened - US Treasury has announced their plans on borrowing. The US Treasury continues to burn out: in order to cope with the growing debt burden , it is necessary to borrow more. On Monday, the department said it would need to borrow $776 billion in the current quarter and $816 billion in the first quarter of calendar 2024.
It is something confusing here... Well, okay, they don’t want to borrow 1.01 trillion. dollars as in the 3rd quarter, and “only” 776 billion dollars. Net, I believe. Just remember that out of the borrowed trillion, $400 billion was borrowed to be deposited in the TGA account of the Ministry of Finance at the Fed (chart is above). At the same time, the Ministry of Finance said that it will not replenish the account anymore, which means all these 776 billion dollars will be successfully spent. And it turns out that this will be more than in the second quarter. Are we expecting new records for GDP growth due to wild fiscal stimulus?
US Treasury has made the choice in favor of shorter-term Notes, which seems logical. There is another ~1 trillion in funds of the reverse repo. Even at the current rate of borrowing, this will be more than enough for another six months. We are, of course, talking about refinancing those short-term bonds that are due to be repaid, but the budget deficit is still needed to support demand in the economy, so a new volume of placement will also be added to the refinancing.
The growth of the US national debt is out of control. The American Ministry of Finance is not able to control its expenses, so it borrows like crazy. Almost a trillion in interest. The United States, with its desire to combat inflation and the enormous spending of the Ministry of Finance, has found itself in an extremely uncomfortable situation. It spends almost a trillion on paying interest on the debt alone. According to the BEA, US Treasury expenses in the third quarter on interest on debt reached $981 billion:
It seems that the Fed and US Treasury accumulate all possible resources to last time until November 2024 and keep economy on surface. Besides, some curious things start to happen. For example, some of the largest United States banks cannot facilitate customer’s deposits after one of the Federal Reserve’s payment systems suffered an outage on Nov. 3. The Federal Reserve said the bug was caused by a “processing issue” in the Automated Clearing House — a payment processing network widely used by banks and employers to deposit wages into employee bank accounts.
Some analysts hint that the Fed is already insolvent for $2.5 Trln. In fact, P. Schiff clearly has explained everything in his Twitter.
At the same time, situation is not better in EU either. EU has two times greater amount of HY and Investment Grade (IG ) bonds in nearest three years. Since rates remain high in both regions, ECB will appear under stronger pressure, because overall situation in EU economy looks worse than in the US:
It means that potentially ECB could start rate easing even earlier than the US and first recession signs also should appear earlier.
Concerning the US and recent J. Powell comments - they were as most diluted as never before. Keeping it simple - "maybe yes, maybe no - maybe rain, maybe snow..."
The window of opportunity for a rate increase has been preserved, but the probability of implementation, as always, has not been determined: "we have not yet made a decision, we do not know what we will do, we will continue to monitor the data." There is no set of factors that will trigger a possible rate hike, i.e. there is no benchmark that will determine that this is the level where the Fed will raise the rate. The Fed will consider a set of factors and their interrelationships in the context of the situation. The Fed is not considering a rate cut in the near future, this issue is not even raised on the current agenda. The only thing that matters is the time during which the restrictive policy will continue until the Fed is sure that the inflation target has been achieved.
Experts tell that the essence of the Fed's problems is that the rate level has become too high. And for the US budget (see above), and for the American economy. The latter can be seen in all our reports over the past 1-1.5 years. Theoretically, it would be necessary to lower the rate in order to reduce the burden on the refinancing of the budget and give a boost to the industry, but … But inflation has not dropped to 2% and, apparently, is ready to jump up again.
At the same time, deflation is in the industry (a sign of a recession). We will find out the figure for October next week, but in the world, as we have shown above, industrial deflation is raging in full force. And in this situation, it would be necessary to soften monetary policy, especially since the election campaign requires maintaining the standard of living of the population. But very scary …
In general, the fluctuations of the Fed's leadership suggests that it is unable to offer a more or less coherent strategy of action. Even if it's a crisis. Powell cannot even recognize the economic downturn that has been going on for two years (which is masked by underestimating inflation and increasing monetization of fictitious assets, such as growth of financial assets, stocks etc.), since the elections. And then it's easy to say, "the economy will fall by 3%," and if it continues to fall further? And it continued …
And if we also take into account at least two wars that are hanging on the nose, with Iran and/or China, not counting support for Ukraine … Ukraine, however, cannot be abandoned, since the question of testimony against Biden regarding corruption charges will immediately arise. However, this question has already arisen and how it will affect the financial markets is a big question. In general, the Fed leadership has complex problems, more or less a clear solution to which is simply not visible.
Finally recall, that we have only "temporary Government financing", that ends in the middle of the month. Thus, it seems November is becoming some kind of vital moment to test the US on strength (as politically as economically). If we pass November without big fun, then probably the year should be closed without big troubles and all hot points will pass into 2024.
From long-term perspective, relief in US Dollar rally seems temporal but it could last for awhile until investors understand that their "rejoice" on the end of Fed's hiking cycle seems untimely.
