Sive Morten
Special Consultant to the FPA
- Messages
- 18,669
Fundamentals
We haven't got too many important events this week, markets mostly were quiet. Last week we've discussed really epic topics, concerning US-China economical and geopolitical confrontation and situation with the US Debt and time that they have until situation might become vital. This week there are few events that also seem important and we take a look at them briefly.
Market overview
The dollar index was on pace to stem the tide of its recent downturn on Tuesday after minutes from the Federal Reserve's most recent policy meeting showed the U.S. central bank was likely to maintain a restrictive stance on interest rates for some time. Fed officials said inflation remained well above their target but noted that rates would only need to be raised if new data showed insufficient progress on reducing price pressures.
Investors are gauging when the Fed may begin to cut rates, pricing in a nearly 60% chance of a cut of at least 25 basis points by May, according to CME's FedWatch Tool, edging up from about 58% on Monday.
U.S. existing home sales dropped to the lowest level in more than 13 years in October as the highest mortgage rates in two decades and a dearth of houses drove buyers from the market. Initial claims for state unemployment benefits dropped by 24,000 to a seasonally adjusted 209,000 for the week ended Nov. 18, the Labor Department said on Wednesday, the lowest level in more than a month. Economists polled by Reuters had forecast 226,000 claims for the latest week.
Other data, however, showed orders for long-lasting U.S. manufactured goods fell more than expected in October.
The greenback extended gains after the University of Michigan's survey of consumer sentiment showed U.S. consumers' inflation expectations rose for a second straight month in November.
European Central Bank (ECB) policymaker Mario Centeno said he expected macroeconomic conditions would lead to a reversal in the bank's recent cycle of rate hikes in the near future while Governing Council member Joachim Nagel said rates in the euro zone are close to their peak in the current cycle or may have already reached it.
Germany's economy shrank slightly in the third quarter from the previous three months. German business morale improved for a third straight month in November, data showed. The single currency is pausing after gaining ground on Thursday on a series of preliminary surveys showing recession in Germany may be shallower than expected, which offset a downbeat reading on French business activity.
And just to complete market overview, I put here few charts, showing that structural crisis is keep going slowly but stubbornly - without slowdown or acceleration and migrating from one sphere to another in all countries across the Globe. Situation mostly has not changed:
Feast of Disobedience
In recent two weeks we see some unexplainable issue - investors totally ignore as Fed's comments as raising inflationary expectations and warnings from economists. They run into risky assets. One more is being added to the basket of reasons for the rally in the American market in recent weeks. Companies have increased the repurchase of their own shares by several times compared to the seasonal trend and volumes since the beginning of the year. This can be done at the current rate only if the company firmly believes that the rate will decrease. Because burdening yourself with debt (or giving away your cash instead of investing it at a comparable interest rate) otherwise is suicide. According to BofA, last week there were the largest weekly buybacks in the entire history of the bank’s data (since 2010). Global equity funds shows the same dynamics.
In addition, according to Goldman, over the past 10 days, CTAs have bought nearly $70 billion worth of US stocks. This is the largest purchase in such a short time.
But not only corporations are believed in a bright tomorrow. An imminent reduction in rates, were some banks that, against the backdrop of another rally (in the bond market), which led to a decrease in yields on long-term treasuries, decided to reduce mortgage rates. Its not too big, just around 0.5%, but still it is, and this means that not only the broad market, but also, let’s say, professional players believe that the Fed, for some unknown reason, will change its policy and turn around. Moreover, cautious investors understand that the only reasonable reason can be a recession, when rates, on the contrary, need to be raised, since the risks of defaults in a recession grow disproportionately. But cautious investors in the market seem to have all been washed out by shorts on S&P.
Finally, Investors are buying up US corporate debt in the hope that the peak rates have passed. Inflows into corporate bond funds reached their highest level since July 2020. According to EPFR, in the month to November 20, corporate bond funds received more than $16 billion: this is more than in any full month since July 2020. This trend is most clearly visible in the junk bond segment—funds investing in low-quality, high-yield bonds received $11.4 billion this month. Another $5 billion went to investment-grade funds holding higher-quality corporate bonds.
So, despite the fact that all the world’s central banks say that they are not going to lower the rate yet, investors are having a holiday of disobedience - they are buying bonds in the hope of a reversal. At the same time, inflation expectations are growing. It seems irrational, unless you take into account the fact that for the most part there is simply nowhere to park bond money. Bond investors are reluctant to invest in stocks, and they simply won’t fit into stocks in full.
For the same reason, by the way, real estate is also growing - although buyers are afraid that prices are already too high, they do not see a reasonable alternative. Although each subsequent price “step” makes investing in real estate less and less reasonable. Changing the usual ideas about what is risky and what is not turns out to be the most difficult thing.
Most bright example could be seen in Germany. DAX index stands at high. We have collapse of German economy across the board - GDP is negative, political and budget crisis. Here, just to safe space in report, I bring few links that show situation in details:
Euro-Area Business Weakness Increases the Odds of Recession
Germany financial sector facing dark clouds, Bundesbank warns
Euro zone's shadow banks face risk of margin calls, ECB says
Germany's economy shrinks slightly in third quarter
ECB Warns Weak Economy Heightens Stability Risks From Hikes
The balance sheets of euro zone banks are showing “early signs of stress” after a rise in loan defaults and late repayments from historic lows, the European Central Bank (ECB) has warned. Officials urged lenders to increase provisions to cover rising loan losses and predicted their profits would be hit by a drop in lending volumes and increased funding costs. The ECB has increased interest rates by an unprecedented 4.5 percentage points in the past year.
ECB vice-president Luis de Guindos said that while “risks to financial stability may appear less acute, they remain elevated”, pointing to the impact of weaker economic growth, tighter financing conditions, rising loan defaults and a downturn in property markets. It also points out another interesting point about the fact that over the past years, European banks have supposedly become stronger and have accumulated a margin of safety. We note that the capital-to-asset ratio was about 1.5-2 times lower than that of the American ones. So, if banks in the US have begun to feel unwell, then European banks may also run out of reserves. Especially if some political black swan arrives.
But, in the US situation is not perfect either. FT writes that Investors dump dollar in bet that US rates have peaked. Investors are selling dollars at the fastest rate in a year as they raise their bets that the US Federal Reserve has finished its aggressive campaign of interest rate increases and will deliver multiple cuts next year. Asset managers are on track to sell 1.6 per cent of their open dollar positions this month, the largest monthly outflow since last November, according to State Street, which is custodian to $40 Bln of assets. Managers had made “significant” sales every day since weaker-than-expected US jobs data on November 3, according to the bank.
Geoff Yu, foreign exchange strategist at BNY Mellon, custodian to $46 Bln of assets, said that over the past 20 days the firm’s custody clients “have been selling dollars at the fastest pace this year”, with a preference for buying the Japanese yen, Canadian dollar and a range of Latin American currencies.
US Real Estate market shows awful data:
Second - the US Treasury is not very good at debt managing. They mainly place short-term debt, and 90% of the increase is short-term bills. But this is not because “the issuer decided so,” but because nobody takes long ones. If we remember the early 1990s, then there was exactly the same picture - debt over 1 year simply did not exist, and the demand was for 3-6 month securities.
That is, the US debt market is being reformatted to suit the inflationary scenario. Therefore, speculation around the fact that the rate will soon reverse is most likely necessary for the sale of at least some amount of long-term securities, because if the already gigantic “planned” refinancing is additionally put under pressure by the “new” budget deficit in the amount of $1-1.5 trillion. per year, and even these bills worth $1.6 trillion, all this splendor can break much earlier than in the option of placing long-term debt. That is, almost at any time.
Besides, concerning budget deficit. It is important to understand that the argument “the Fed is reducing its balance sheet” is, of course, an important argument, but the outflow of liquidity is more about the availability of free resources for, let’s say, investment, while income is an income. Approximately the amount of money on your card and your salary are not the same. Somebody borrowed money from you and your liquidity decreased, but your income increased because you began to receive high interest on the loan.
But what was happening in parallel is doubly interesting. In parallel, the Government increased the budget deficit through borrowing and thus began to convert debt into capital. That is, borrow money and spend it. For the state, this is an increase in debt, and for those who receive this money from the state (for example, someone who provides some service for the state and receives revenue) - this becomes their own capital, now it is their money and they do not owe anyone. That is, the state began to inject liquidity into the system, increase income in the system (that is, stimulate GDP growth) simultaneously with pumping up demand.
Oddly enough, taxes are also collected from this additional income. Moreover, this money is circulated in the economy several times and taxes must be collected at each stage. As a result, it turns out that taxes should have increased if the budget deficit grew, but... they did not increase. They even fell in 2023:
It is also noteworthy that if they reduce the budget deficit now, then budget revenues will fall. The relationship is nonlinear, but it exists. And it turns out that in the current situation it is under no circumstances possible to reduce the budget deficit, because demand will decrease, the multiplier effect from these expenses will go away, GDP will decrease, taxes will be collected even less, and so on in a circle.
In general, the system is unbalanced and is held together with spit. There is a limit to everything. And the limit lies precisely in the fact that within the system itself the balance begins to deteriorate. Somewhere, gaps arise in both income and liquidity, risks grow and a chain reaction finally works and the system will need to be saved.
So, guys, this is phenomenon - consumers inflation expectations are raising, inflation component in real estate market is raising, Central banks warn about long term high rates... It looks like total loss of survival instinct among all investors?
The Bottom line:
Additionally to issues that we've explained above, we have three fundamental concern. The US banking sector (and EU as well) that has accumulated 650+ Bln of current loss in US bonds. Many of them already could be insolvent. Banks out of top-4 by assets account for 60% of all assets of the banking sector. While the sharp slowdown in bank lending continues.
The second risk factor is commercial real estate, especially office space. Demand for office real estate has decreased significantly. Prices are falling. Defaults are rising. And many banks will end up losing money on their investments in US office real estate. Today, the bank's position in commercial real estate is about $1 trillion.
The third risk factor is the inflating of another derivatives bubble. The hidden problem with derivatives is that it is easy for some institutions to take on too much risk. Today, the US derivatives market is valued at $ 221 trillion . Once this avalanche starts moving, it will be impossible to stop it.
Besides, who said that the Fed can't continue tightening after some break. This happens five times in the history, and breaks were much longer than current 18 weeks:
At the end I would like to mention interesting statement by Francesco Sandrini, head of multi-asset strategies at Amundi heading into 2024 he expected dollar weakness to continue “in part because we anticipate less turbulence between the US and China”, meaning investors had less need of the greenback as a safe haven.
And this week right in time we get exceptional article in FT, dedicated to this subject. Since it relates strongly to geopolitics and Gold market - we consider it tomorrow in Gold report. Here we just say that we wouldn't count on it. All this stuff together is naked, I would say, strategical miss of those who bet on rate cut too early and those who bet on sharp dollar reversal. Thus, Chief currency analyst at Deutsche Bank George Saravelos is confident that the US dollar will strengthen in the coming months, and European currencies will cost less.
It seems that it is a bit early to bury the US Dollar. Especially due to new turn in US-China relationships.
We haven't got too many important events this week, markets mostly were quiet. Last week we've discussed really epic topics, concerning US-China economical and geopolitical confrontation and situation with the US Debt and time that they have until situation might become vital. This week there are few events that also seem important and we take a look at them briefly.
Market overview
The dollar index was on pace to stem the tide of its recent downturn on Tuesday after minutes from the Federal Reserve's most recent policy meeting showed the U.S. central bank was likely to maintain a restrictive stance on interest rates for some time. Fed officials said inflation remained well above their target but noted that rates would only need to be raised if new data showed insufficient progress on reducing price pressures.
Investors are gauging when the Fed may begin to cut rates, pricing in a nearly 60% chance of a cut of at least 25 basis points by May, according to CME's FedWatch Tool, edging up from about 58% on Monday.
U.S. existing home sales dropped to the lowest level in more than 13 years in October as the highest mortgage rates in two decades and a dearth of houses drove buyers from the market. Initial claims for state unemployment benefits dropped by 24,000 to a seasonally adjusted 209,000 for the week ended Nov. 18, the Labor Department said on Wednesday, the lowest level in more than a month. Economists polled by Reuters had forecast 226,000 claims for the latest week.
Other data, however, showed orders for long-lasting U.S. manufactured goods fell more than expected in October.
The greenback extended gains after the University of Michigan's survey of consumer sentiment showed U.S. consumers' inflation expectations rose for a second straight month in November.
European Central Bank (ECB) policymaker Mario Centeno said he expected macroeconomic conditions would lead to a reversal in the bank's recent cycle of rate hikes in the near future while Governing Council member Joachim Nagel said rates in the euro zone are close to their peak in the current cycle or may have already reached it.
Germany's economy shrank slightly in the third quarter from the previous three months. German business morale improved for a third straight month in November, data showed. The single currency is pausing after gaining ground on Thursday on a series of preliminary surveys showing recession in Germany may be shallower than expected, which offset a downbeat reading on French business activity.
And just to complete market overview, I put here few charts, showing that structural crisis is keep going slowly but stubbornly - without slowdown or acceleration and migrating from one sphere to another in all countries across the Globe. Situation mostly has not changed:
Feast of Disobedience
In recent two weeks we see some unexplainable issue - investors totally ignore as Fed's comments as raising inflationary expectations and warnings from economists. They run into risky assets. One more is being added to the basket of reasons for the rally in the American market in recent weeks. Companies have increased the repurchase of their own shares by several times compared to the seasonal trend and volumes since the beginning of the year. This can be done at the current rate only if the company firmly believes that the rate will decrease. Because burdening yourself with debt (or giving away your cash instead of investing it at a comparable interest rate) otherwise is suicide. According to BofA, last week there were the largest weekly buybacks in the entire history of the bank’s data (since 2010). Global equity funds shows the same dynamics.
In addition, according to Goldman, over the past 10 days, CTAs have bought nearly $70 billion worth of US stocks. This is the largest purchase in such a short time.
But not only corporations are believed in a bright tomorrow. An imminent reduction in rates, were some banks that, against the backdrop of another rally (in the bond market), which led to a decrease in yields on long-term treasuries, decided to reduce mortgage rates. Its not too big, just around 0.5%, but still it is, and this means that not only the broad market, but also, let’s say, professional players believe that the Fed, for some unknown reason, will change its policy and turn around. Moreover, cautious investors understand that the only reasonable reason can be a recession, when rates, on the contrary, need to be raised, since the risks of defaults in a recession grow disproportionately. But cautious investors in the market seem to have all been washed out by shorts on S&P.
Finally, Investors are buying up US corporate debt in the hope that the peak rates have passed. Inflows into corporate bond funds reached their highest level since July 2020. According to EPFR, in the month to November 20, corporate bond funds received more than $16 billion: this is more than in any full month since July 2020. This trend is most clearly visible in the junk bond segment—funds investing in low-quality, high-yield bonds received $11.4 billion this month. Another $5 billion went to investment-grade funds holding higher-quality corporate bonds.
So, despite the fact that all the world’s central banks say that they are not going to lower the rate yet, investors are having a holiday of disobedience - they are buying bonds in the hope of a reversal. At the same time, inflation expectations are growing. It seems irrational, unless you take into account the fact that for the most part there is simply nowhere to park bond money. Bond investors are reluctant to invest in stocks, and they simply won’t fit into stocks in full.
For the same reason, by the way, real estate is also growing - although buyers are afraid that prices are already too high, they do not see a reasonable alternative. Although each subsequent price “step” makes investing in real estate less and less reasonable. Changing the usual ideas about what is risky and what is not turns out to be the most difficult thing.
Most bright example could be seen in Germany. DAX index stands at high. We have collapse of German economy across the board - GDP is negative, political and budget crisis. Here, just to safe space in report, I bring few links that show situation in details:
Euro-Area Business Weakness Increases the Odds of Recession
Germany financial sector facing dark clouds, Bundesbank warns
Euro zone's shadow banks face risk of margin calls, ECB says
Germany's economy shrinks slightly in third quarter
ECB Warns Weak Economy Heightens Stability Risks From Hikes
The balance sheets of euro zone banks are showing “early signs of stress” after a rise in loan defaults and late repayments from historic lows, the European Central Bank (ECB) has warned. Officials urged lenders to increase provisions to cover rising loan losses and predicted their profits would be hit by a drop in lending volumes and increased funding costs. The ECB has increased interest rates by an unprecedented 4.5 percentage points in the past year.
ECB vice-president Luis de Guindos said that while “risks to financial stability may appear less acute, they remain elevated”, pointing to the impact of weaker economic growth, tighter financing conditions, rising loan defaults and a downturn in property markets. It also points out another interesting point about the fact that over the past years, European banks have supposedly become stronger and have accumulated a margin of safety. We note that the capital-to-asset ratio was about 1.5-2 times lower than that of the American ones. So, if banks in the US have begun to feel unwell, then European banks may also run out of reserves. Especially if some political black swan arrives.
But, in the US situation is not perfect either. FT writes that Investors dump dollar in bet that US rates have peaked. Investors are selling dollars at the fastest rate in a year as they raise their bets that the US Federal Reserve has finished its aggressive campaign of interest rate increases and will deliver multiple cuts next year. Asset managers are on track to sell 1.6 per cent of their open dollar positions this month, the largest monthly outflow since last November, according to State Street, which is custodian to $40 Bln of assets. Managers had made “significant” sales every day since weaker-than-expected US jobs data on November 3, according to the bank.
Geoff Yu, foreign exchange strategist at BNY Mellon, custodian to $46 Bln of assets, said that over the past 20 days the firm’s custody clients “have been selling dollars at the fastest pace this year”, with a preference for buying the Japanese yen, Canadian dollar and a range of Latin American currencies.
US Real Estate market shows awful data:
Second - the US Treasury is not very good at debt managing. They mainly place short-term debt, and 90% of the increase is short-term bills. But this is not because “the issuer decided so,” but because nobody takes long ones. If we remember the early 1990s, then there was exactly the same picture - debt over 1 year simply did not exist, and the demand was for 3-6 month securities.
That is, the US debt market is being reformatted to suit the inflationary scenario. Therefore, speculation around the fact that the rate will soon reverse is most likely necessary for the sale of at least some amount of long-term securities, because if the already gigantic “planned” refinancing is additionally put under pressure by the “new” budget deficit in the amount of $1-1.5 trillion. per year, and even these bills worth $1.6 trillion, all this splendor can break much earlier than in the option of placing long-term debt. That is, almost at any time.
Besides, concerning budget deficit. It is important to understand that the argument “the Fed is reducing its balance sheet” is, of course, an important argument, but the outflow of liquidity is more about the availability of free resources for, let’s say, investment, while income is an income. Approximately the amount of money on your card and your salary are not the same. Somebody borrowed money from you and your liquidity decreased, but your income increased because you began to receive high interest on the loan.
But what was happening in parallel is doubly interesting. In parallel, the Government increased the budget deficit through borrowing and thus began to convert debt into capital. That is, borrow money and spend it. For the state, this is an increase in debt, and for those who receive this money from the state (for example, someone who provides some service for the state and receives revenue) - this becomes their own capital, now it is their money and they do not owe anyone. That is, the state began to inject liquidity into the system, increase income in the system (that is, stimulate GDP growth) simultaneously with pumping up demand.
Oddly enough, taxes are also collected from this additional income. Moreover, this money is circulated in the economy several times and taxes must be collected at each stage. As a result, it turns out that taxes should have increased if the budget deficit grew, but... they did not increase. They even fell in 2023:
It is also noteworthy that if they reduce the budget deficit now, then budget revenues will fall. The relationship is nonlinear, but it exists. And it turns out that in the current situation it is under no circumstances possible to reduce the budget deficit, because demand will decrease, the multiplier effect from these expenses will go away, GDP will decrease, taxes will be collected even less, and so on in a circle.
In general, the system is unbalanced and is held together with spit. There is a limit to everything. And the limit lies precisely in the fact that within the system itself the balance begins to deteriorate. Somewhere, gaps arise in both income and liquidity, risks grow and a chain reaction finally works and the system will need to be saved.
So, guys, this is phenomenon - consumers inflation expectations are raising, inflation component in real estate market is raising, Central banks warn about long term high rates... It looks like total loss of survival instinct among all investors?
The Bottom line:
Additionally to issues that we've explained above, we have three fundamental concern. The US banking sector (and EU as well) that has accumulated 650+ Bln of current loss in US bonds. Many of them already could be insolvent. Banks out of top-4 by assets account for 60% of all assets of the banking sector. While the sharp slowdown in bank lending continues.
The second risk factor is commercial real estate, especially office space. Demand for office real estate has decreased significantly. Prices are falling. Defaults are rising. And many banks will end up losing money on their investments in US office real estate. Today, the bank's position in commercial real estate is about $1 trillion.
The third risk factor is the inflating of another derivatives bubble. The hidden problem with derivatives is that it is easy for some institutions to take on too much risk. Today, the US derivatives market is valued at $ 221 trillion . Once this avalanche starts moving, it will be impossible to stop it.
Besides, who said that the Fed can't continue tightening after some break. This happens five times in the history, and breaks were much longer than current 18 weeks:
At the end I would like to mention interesting statement by Francesco Sandrini, head of multi-asset strategies at Amundi heading into 2024 he expected dollar weakness to continue “in part because we anticipate less turbulence between the US and China”, meaning investors had less need of the greenback as a safe haven.
And this week right in time we get exceptional article in FT, dedicated to this subject. Since it relates strongly to geopolitics and Gold market - we consider it tomorrow in Gold report. Here we just say that we wouldn't count on it. All this stuff together is naked, I would say, strategical miss of those who bet on rate cut too early and those who bet on sharp dollar reversal. Thus, Chief currency analyst at Deutsche Bank George Saravelos is confident that the US dollar will strengthen in the coming months, and European currencies will cost less.
It seems that it is a bit early to bury the US Dollar. Especially due to new turn in US-China relationships.
