Sive Morten
Special Consultant to the FPA
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- 17,453
Fundamentals
This week we see some curious things on the market, guys. It is difficult to combine recent markets' performance, which is extremely bullish, with Fed statement and with recent NFP data. Supposedly something should stand behind it. Maybe this is just technical factors, provided liquidity for "pre-election rally", or investors really start changing their portfolios. But we see rally across the board - stock market is going higher as well as the gold market. It seems that the trust in strong dollar is dented, but why? Either markets feel that Fed pivot indeed somewhere near, because of tight economy conditions, or, maybe they just start losing faith in Fed reputation? Current situation brings more questions rather than answers. Let's try to understand what really has happened on Fed meeting.
FED
First of all, recall that when we just have started discuss current crisis and made initial forecasts, we've said that there are two components of inflation - monetary and structural. Monetary component could be decreased by rising of the interest rate while structural one can't be, as it needs to "re-structure" the whole economy, set the balance, equilibrium between supply and demand. It means that with moving Fed rates higher, the structural inflation will not stop and even could rise more because the major problem is not resolved - disbalances in the economy.
Here we see first fruits of Fed activity - monetary inflation is turning down. Commodity CPI has decreased from 23% to 15%. Economists suggest that it better represents real inflation level. First is because it is not public and hopefully less manipulated. Second - it includes all commodity goods, compares to PPI that has predefined set of goods, used in production chain:
Indeed, it has dropped to 15%. So, 15% is better than 23% but worse that desirable 2% target level. Besides, take a look that in recent two months the pace of decreasing slowed, which means that as stronger Fed rising rate as less effecting it becomes. This is just a hypothesis by far and we will not it only in December when effect of recent rate change makes impact on inflation. Supposedly, based on this chart we could say that monetary inflation indeed close to 2% target and tends to zero, while structural inflation remains at 11-12% and could rise even more. While structural component can't be controlled by monetary tools, such as interest rate we've explained previously.
Now, let's take a look what J. Powell said. This time he was surprisingly definite and transparent. This is drastically contradicts to previous trash-talks. In general, why we pay so much attention to nominal interest rates. For example, in 1980's it was around 19% and everything was functioning more or less normal. The difference, guys, in a size of debt burden. In 1980's it was three times lower, and here we do not speak about corporate and households debt. It has reach astronomical levels. As a result, the higher debt is, the more difficult to serve it. Now the interest rates payments exceed US annual military budget:
Households have two times greater debt than in 80s, while the corporations' position even worse. More rate increase inevitable will lead to defaults and chain of bankruptcies:
Thus, we see decreasing efficiency of rate changing tool on a background of tightening economical conditions in the country. By the way, recent NFP report shows the same. We have positive 261K, rising monthly wage inflation to 0.4%. Unemployment shows only minor tick up to 3.7%. NFP shows that vacancies, demand for employees stands high, but fewer people would like to work for this money, which is also hidden sign of inflation. Participation rate dropped, as you can see. This is the same like to hold prices fix. In this case inflation sign will be an empty shelves in the stores, as nobody would like to produce and sell goods for these prices. This calls as hidden inflation, or goods' deficit. Now we start see it on the US job market.
But, if everything stands so bad, why Fed needs to rise rates at all? Banks feel more or less confident with high rate environment. Banks do, but production is not. It just can't exist with so high interest rates. Production has fundamental operational margin and it can't change it by their own, because it based on physical specific of every industry. Take a look at earnings forecasts of non-energy companies. They are back to January level.
And, based on J. Powell's aggressive rhetoric, it seems that between banks and industry they have chosen industry for saving. Let's see the basic points of his speech. Sorry guys, this time there is more extended list than usual:
Analysts make three major conclusions from recent J. Powell's speech. As we've said it is very different to previous speeches. First conclusion - J.Powell publicly recognizes the mistake. Fed has missed with inflation forecasts (look at last three points in the list above). It seems that real understanding of the nature of current inflation still is absent. Second - J.Powell obviously has made big efforts to recover faith in Fed ability to control and manage situation, its reputation. Because he has given too detailed explanations what Fed is doing and why, and what they intend to do. Neither "Beni-Helicopter" Bernanke, nor A. Greenspan never were giving so detailed explanations. Whether he will be able to resolve the situation - we will see.
Finally, here we hear some political notes. Between two scenarios of either to save Bretton-Woods by the rest of US real production sector or, to save the rest of US production sector by victim of Bretton-Wood system, it seems that they have chosen the latter, although with big delay.
The speech clearly shows that that the control is lost. The whole structure of the speech was built around one thing – to maintain confidence in the Fed at any cost. Powell didn't say it directly, but that was the point. They were really scared of losing control and losing trust. If they will lose markets' trust, they will lose control of the markets and the dollar – the game will be over.
They hope that inflation will turn around, otherwise, they will have to start printing money again, and Powell indirectly talked about this. But by printing money without defeating the inflation, they will destroy confidence in the Fed and the dollar system. So, how far they could go with the rate? Some economists suggest that we may not see 5%. Now it is 4% already, and the system stands at the edge. Hence, the most likely scenario is 0.5% in December and 0.25% in February. That 's it ...
On Thursday, it's time for U.S. inflation numbers - a data set that's proven to be an important turning point for markets this year as consumer prices surged to decades high peaks.Investors will once again be looking for signs that price pressures are slowing after a barrage of rate hikes. Yet the world's foremost central bank just said the ultimate benchmark policy rate level will likely be higher than previously estimated to tame inflation, underlining the threat that rising prices pose to the economy.
A stronger-than-expected reading will likely weigh on stocks and bonds, potentially ramping up expectations that policymakers will need to get even more hawkish. A Reuters poll showed analysts expecting inflation to rise by 0.7% month-on-month.
In EU we see that as CPI as PPI hit the new records. Recent CPI EU data shows 10.7% annual level, according to Eurostat:
While PPI level stands at 41.4%:
Conclusion:
Guys, I do not know how to comment this. Fed meets unprecedented problems, and public acknowledgement tells that it is impossible to hide any more. And this is in the US, that has pumped out $1.5-2 Trln. out of the EU, destroyed its industry sector. What we could tell about EU at all? Big times ahead. Now a lot of things depend on elections result. EU political elites mostly were flowing in farwater of US liberal globalist policy. If Democrats will be able to hold the country under management, the trend should remain, so Europe slowly but stubbornly will keep its way to destruction. Republicans victory will change the direction drastically, that could lead to political turmoil in EU and they somehow will have to change the policy which seems impossible after all things been done there. In fact, recent attempt of O. Scholz to talk to China is an example that they start moving and want to insure some political risks. But hardly it helps, based on a tone of audience and how Mr. Xi meets the Chancellor. But this topic is for Gold market report tomorrow.
Besides Fed tights all possible and impossible reserves to drive the US economy out of the crisis. Hardly they will think about EU. EU economy stands now at risk to drop it chaos and out of ECB control. Political and social unrest just exacerbate this process. Fundamentally currently it is few reasons to suggest EUR strength.
Technical analysis is below...
This week we see some curious things on the market, guys. It is difficult to combine recent markets' performance, which is extremely bullish, with Fed statement and with recent NFP data. Supposedly something should stand behind it. Maybe this is just technical factors, provided liquidity for "pre-election rally", or investors really start changing their portfolios. But we see rally across the board - stock market is going higher as well as the gold market. It seems that the trust in strong dollar is dented, but why? Either markets feel that Fed pivot indeed somewhere near, because of tight economy conditions, or, maybe they just start losing faith in Fed reputation? Current situation brings more questions rather than answers. Let's try to understand what really has happened on Fed meeting.
FED
First of all, recall that when we just have started discuss current crisis and made initial forecasts, we've said that there are two components of inflation - monetary and structural. Monetary component could be decreased by rising of the interest rate while structural one can't be, as it needs to "re-structure" the whole economy, set the balance, equilibrium between supply and demand. It means that with moving Fed rates higher, the structural inflation will not stop and even could rise more because the major problem is not resolved - disbalances in the economy.
Here we see first fruits of Fed activity - monetary inflation is turning down. Commodity CPI has decreased from 23% to 15%. Economists suggest that it better represents real inflation level. First is because it is not public and hopefully less manipulated. Second - it includes all commodity goods, compares to PPI that has predefined set of goods, used in production chain:
Indeed, it has dropped to 15%. So, 15% is better than 23% but worse that desirable 2% target level. Besides, take a look that in recent two months the pace of decreasing slowed, which means that as stronger Fed rising rate as less effecting it becomes. This is just a hypothesis by far and we will not it only in December when effect of recent rate change makes impact on inflation. Supposedly, based on this chart we could say that monetary inflation indeed close to 2% target and tends to zero, while structural inflation remains at 11-12% and could rise even more. While structural component can't be controlled by monetary tools, such as interest rate we've explained previously.
Now, let's take a look what J. Powell said. This time he was surprisingly definite and transparent. This is drastically contradicts to previous trash-talks. In general, why we pay so much attention to nominal interest rates. For example, in 1980's it was around 19% and everything was functioning more or less normal. The difference, guys, in a size of debt burden. In 1980's it was three times lower, and here we do not speak about corporate and households debt. It has reach astronomical levels. As a result, the higher debt is, the more difficult to serve it. Now the interest rates payments exceed US annual military budget:
Households have two times greater debt than in 80s, while the corporations' position even worse. More rate increase inevitable will lead to defaults and chain of bankruptcies:
Thus, we see decreasing efficiency of rate changing tool on a background of tightening economical conditions in the country. By the way, recent NFP report shows the same. We have positive 261K, rising monthly wage inflation to 0.4%. Unemployment shows only minor tick up to 3.7%. NFP shows that vacancies, demand for employees stands high, but fewer people would like to work for this money, which is also hidden sign of inflation. Participation rate dropped, as you can see. This is the same like to hold prices fix. In this case inflation sign will be an empty shelves in the stores, as nobody would like to produce and sell goods for these prices. This calls as hidden inflation, or goods' deficit. Now we start see it on the US job market.
But, if everything stands so bad, why Fed needs to rise rates at all? Banks feel more or less confident with high rate environment. Banks do, but production is not. It just can't exist with so high interest rates. Production has fundamental operational margin and it can't change it by their own, because it based on physical specific of every industry. Take a look at earnings forecasts of non-energy companies. They are back to January level.
And, based on J. Powell's aggressive rhetoric, it seems that between banks and industry they have chosen industry for saving. Let's see the basic points of his speech. Sorry guys, this time there is more extended list than usual:
- Inflation expectations are under control (they have been trending down for the last three months), but as longer high inflation stands, as more probable that expectations of higher inflation will inhabit .
- The inflation target is unchanged and remains at 2%. The Fed intends to fulfill its obligations to return inflation to the target.
- The Fed will take decisive steps to set demand in line with supply.
- Financial conditions have tightened significantly and this is reflected in the most vulnerable sectors, such as real estate.
- It will take time to fully feel the impact of monetary restrictions (especially on inflation).
- The Fed will take into account the cumulative effect of the tightening including lag in the transmission of monetary policy effect on economic activity and financial stability.
- Fed policy first affects financial conditions, then affects economic activity and financial stability, and finally directly affects inflation itself. This lag may be significant, but it is important to note that financial conditions are acting ahead of the immediate action by the Fed. Thus, the transmission of the policy in modern conditions is faster than in the 80s.
- It would be reasonable to slow down the pace of tightening when the interest rate becomes "restrictive enough" to direct inflation to the 2% target. There is considerable uncertainty around this level of interest rate and the Fed does not have an understanding of where this "restrictive level" is.
- The final level of interest rates will be higher than previously expected (September 21).
- Reducing inflation is likely to require a long period of below-trend economic growth and degradation of labor market conditions.
- Historical data warns against premature weakening of the policy. The Fed will stick to the tightening course until inflation returns to the target.
- There is no universal guideline showing the trigger has come to stop the cycle of tightening the PREP. The decrease in inflation in several inflation reports is not be a reason to revise the policy. The Fed will use a set of financial and macroeconomic indicators to make sure that inflation is on a steady path to target.
- The restrictive level of the rate is uncertain. Strong macro data suggests that the rates may be higher than previously expected.
- The Fed has no decision on when to slow down the rate hike rate. It could be December 14th, or it could be February 1st. The more important question is how much to raise rates and how long to keep them at a high level.
- The Fed intends to focus more on the projected inflation rate rather than current rate. The Fed may consider real positive rates as an intermediate goal.
- Many households and businesses are already taking loans at rates that are near or above inflation, so we can assume that at the moment real rates are already in the positive area.
- The losses from the rapid tightening are less significant than the costs from the loss of control over inflation.
- The housing market is overheated, there was a bubble. Falling prices and falling sales are normal, but there is no bubble in the subprime lending market such as there was in 2007 and in general the situation is controlled from the point of view of the quality of the loan portfolio.
- A strong dollar is a problem for many countries.
- If the Fed is overreacted with tightening, we have the tools to fix it (Powell sarcastically refers to the experience of March 2020 with unlimited money supply).
- It is premature to discuss a pause in tightening, inflation is not where it should be, we have yet to find a "restrictive level" of the interest rate at which supply and demand will normalize.
- Consumers continue to spend actively, which is probably due to accumulated savings in 2020-2021.
- There was a narrowing of the path to a soft landing due to the trajectory of the tightening (the first recognition of a potential crisis from Powell).
- Everything went wrong as the Fed predicted. Inflation is not declining as it should be, the labor market remains strong when it should have already started to decline, and demand is still significant, while supply growth is limited.
- The Fed is commitment to take inflation under control.
Analysts make three major conclusions from recent J. Powell's speech. As we've said it is very different to previous speeches. First conclusion - J.Powell publicly recognizes the mistake. Fed has missed with inflation forecasts (look at last three points in the list above). It seems that real understanding of the nature of current inflation still is absent. Second - J.Powell obviously has made big efforts to recover faith in Fed ability to control and manage situation, its reputation. Because he has given too detailed explanations what Fed is doing and why, and what they intend to do. Neither "Beni-Helicopter" Bernanke, nor A. Greenspan never were giving so detailed explanations. Whether he will be able to resolve the situation - we will see.
Finally, here we hear some political notes. Between two scenarios of either to save Bretton-Woods by the rest of US real production sector or, to save the rest of US production sector by victim of Bretton-Wood system, it seems that they have chosen the latter, although with big delay.
The speech clearly shows that that the control is lost. The whole structure of the speech was built around one thing – to maintain confidence in the Fed at any cost. Powell didn't say it directly, but that was the point. They were really scared of losing control and losing trust. If they will lose markets' trust, they will lose control of the markets and the dollar – the game will be over.
They hope that inflation will turn around, otherwise, they will have to start printing money again, and Powell indirectly talked about this. But by printing money without defeating the inflation, they will destroy confidence in the Fed and the dollar system. So, how far they could go with the rate? Some economists suggest that we may not see 5%. Now it is 4% already, and the system stands at the edge. Hence, the most likely scenario is 0.5% in December and 0.25% in February. That 's it ...
On Thursday, it's time for U.S. inflation numbers - a data set that's proven to be an important turning point for markets this year as consumer prices surged to decades high peaks.Investors will once again be looking for signs that price pressures are slowing after a barrage of rate hikes. Yet the world's foremost central bank just said the ultimate benchmark policy rate level will likely be higher than previously estimated to tame inflation, underlining the threat that rising prices pose to the economy.
A stronger-than-expected reading will likely weigh on stocks and bonds, potentially ramping up expectations that policymakers will need to get even more hawkish. A Reuters poll showed analysts expecting inflation to rise by 0.7% month-on-month.
In EU we see that as CPI as PPI hit the new records. Recent CPI EU data shows 10.7% annual level, according to Eurostat:
While PPI level stands at 41.4%:
Conclusion:
Guys, I do not know how to comment this. Fed meets unprecedented problems, and public acknowledgement tells that it is impossible to hide any more. And this is in the US, that has pumped out $1.5-2 Trln. out of the EU, destroyed its industry sector. What we could tell about EU at all? Big times ahead. Now a lot of things depend on elections result. EU political elites mostly were flowing in farwater of US liberal globalist policy. If Democrats will be able to hold the country under management, the trend should remain, so Europe slowly but stubbornly will keep its way to destruction. Republicans victory will change the direction drastically, that could lead to political turmoil in EU and they somehow will have to change the policy which seems impossible after all things been done there. In fact, recent attempt of O. Scholz to talk to China is an example that they start moving and want to insure some political risks. But hardly it helps, based on a tone of audience and how Mr. Xi meets the Chancellor. But this topic is for Gold market report tomorrow.
Besides Fed tights all possible and impossible reserves to drive the US economy out of the crisis. Hardly they will think about EU. EU economy stands now at risk to drop it chaos and out of ECB control. Political and social unrest just exacerbate this process. Fundamentally currently it is few reasons to suggest EUR strength.
Technical analysis is below...
