Sive Morten
Special Consultant to the FPA
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Fundamentals
Usually we stay focused on the US and EU events as we're dealing mostly with EUR/USD and news from there are obviously become our primary ones. But this week a lot of events have happened, particularly in Japan, that just show how big structural crisis are, and what a tectonic, epic shifts are happening in global finance. In the US situation is taking signs of catastrophe, with coming government shutdown that seems imminence already. Situation with the US statistics and overall economy conditions more and more is getting a political background and becoming a tool for political bargain. This is more the topic for our Gold report tomorrow, but few words we need to say about it as well. Although we will show you few charts as usual, but to be honest, guys, it makes no big sense to do it, because they show the same things - structural crisis continues.
Market overview
The dollar was on track to post its biggest quarterly gain in a year on Friday and gains for the 11th consecutive week as investors priced in the likelihood of a still solid economy and higher rates for longer. The greenback retraced most earlier losses against a basket of currencies to be only slightly lower on the day, following data that showed that U.S. consumer spending increased in August, but underlying inflation moderated, with the year-on-year rise in prices excluding food and energy slowing to less than 4.0%.
The dollar has gained on expectations that the U.S. economy will remain more resilient to higher interest rates and oil prices than other economies, after the Federal Reserve last week warned it may hike rates further and is likely to hold them higher for longer. Despite weaker levels on Thursday and Friday some analysts see the greenback as likely to continue to outperform.
The estimated probability of a Fed rate hike in November has risen to almost 25%:
Meanwhile, a partial government shutdown is looming, which could affect the release of economic data and potentially dent economic growth.
Hardline Republicans in the U.S. House of Representatives on Friday rejected a bill proposed by their leader to temporarily fund the government, making it all but certain that federal agencies will partially shut down beginning Sunday. A government shutdown would "undermine" U.S. economic progress by idling key programs for small businesses and children, and could delay major infrastructure improvements, U.S. Treasury Secretary Janet Yellen said on Friday.
Global bond funds saw their biggest weekly outflows in more than a month on concerns that U.S. and European central banks will keep interest rates higher for longer to curb inflationary pressures. High-yield bond funds booked $3.11 billion of net selling during the week, the biggest outflow in six months. Data showed global equity funds experienced a net $10.7 billion worth of outflow, the biggest in a week since Aug. 23.
Global money market funds also remained out of favour, witnessing outflows to the turn of $22.32 billion, the biggest amount since July 12.
The yen's slide to the cusp of 150 per dollar has put investors on high alert for the risk of intervention. But, Japanese authorities could find propping up their currency both difficult to achieve and hard to justify. BOJ Governor Kazuo Ueda has quashed expectations for a hawkish shift during coming months by repeatedly emphasising a patient approach was needed to tightening the taps on its super loose policy. Spread in JP/US yields has widened to 380 b.p. (3.8%)
Intervention is both financially risky and politically charged. To make even a ripple in the $5 trillion currency market, the BOJ would need to draw down massive amounts of dollar reserves. Considering the major rich democracies commitment to letting markets determine exchange rates, Tokyo could get a grudging response from Washington when it tries explaining why it needed to pour so many dollars into the open market.
Meantime, foreigners dump Japanese stocks. On Japanese bonds we see the party like in 1998 - they are in massive sell-off, despite YCC strategy:
And here we have to ask few questions, concerning "Safety" and "Safe Haven".
Concerning "Safety"
In all economy high schools and Universities, at least of western economical science, teach that credit rating determines the safety. And historically "safe" assets are Gold, JPY and its bonds and safest of course are US Bonds. Let's have a look... if you think that this one is some russian ruble, turkish lira or ukrainian hryvnia -you're wrong. Don’t understand what currency is flying back and forth, then let me remind you of the existence of the yen. So it is the third reserve currency in the world by the way:
It was generally customary to wait out crises there. So this next ultra-reliable instrument has depreciated by 30% since 2021. Moreover, within the framework of 2022-2023 it is twisting and turning as never before. As a result, the Ukrainian hryvnia turned out to be a much more reliable instrument for saving capital. And the Japanese, being the closest friends of the United States, have to sell off the American national debt in order to fish out the dirty green piece of paper and support the exchange rate of their collapsing currency.
But maybe in the US situation is better? Let's see. As we've said in Telegram - currently, investors' expectations for a rate cut are at their highest level on record. From all sides we here banks trash talks that Fed is exhausting and near pivot, and its time to buy to not miss the change to get big yield for long time. Stock implied yield now equals to US yields. And this deadly advertisement makes its dark deed.
Meantime, the US households increased investments in government securities to a maximum in 25 years. By Marketwatch, americans' investment in government bonds rose to about $2.5 trillion, the highest level in the last 25 years, compared to less than $1 trillion before the Federal Reserve began raising borrowing costs, said Thorsten Slok, chief economist at Apollo Global Management.
And now is the most interesting thing - take a look what households money are doing. This is ETF on 20-year US debt. Despite that assets have dropped for 40%, the price of ETF has not changed. Somebody keeps buying it. Could you imagine the amount of households' pain when trap will be clapped?
if something falls, it means someone is selling it. All this stuff is sold by and large to the whole world except Europe, Australia, Canada and Mexico. Some like Japan to support their currency, some anticipating a quick parade of selective technical defaults. A discussion broke out in the United States regarding the issue of allocating money to Ukraine went viral. There the Senator Ron Paul says: “we borrow money from China to send it to Ukraine.”
The guy's information is outdated. China has not provided loans to the states for a long time. In the last year, they have borrowed mostly from their own taxpayers. The situation is completely comical: taxpayers’ money goes to Ukraine, there is not enough of it, so they also borrow it from these same taxpayers. It is not difficult to guess that this wonderful scheme will end with a new surge in inflation. We already went through this in the 1970s. Then money was sent uncontrollably to Vietnam.
But we could say - wait a minute, we have TIPS ETF (inflationary-protected bonds), it should feel much better. Ok, let's take a look - Assets under management of the iShares TIPS ETF are now below pre-COVID levels:
What's going on? They wanted to fight inflation, but they fought their own capital. TIPS is American government debt with interest tied to official inflation.
As a result, inflation has now fallen, but the rate levels are huge. The TIPS yields are calculated as "nominal rate - inflation". Official inflation is dropping as BIS shows to us. It means that difference is raising, pushing price (it moves opposite to yield direction) lower. It means that TIPS are being sold and regular debt is being bought because it is more profitable. Hmmm.... and what maths is?
As a result, investors in the fund that protects against inflation received Biden’s 16% depreciation of the dollar and, in addition, a drop in the price of the fund itself.
The crypto fans have exactly the same story with their Bitcoin. In fact, everyone who tried to use instruments with inflation protection was defrauded by high rates.
Even gold has depreciated, but mostly due technical reasons, which we seem as temporal - investors need cash to compensate other assets devaluation.
Why?
And now it appears that things stand different. Vanguard expects three rate hikes, J. Dimon speaks about 7%,
While L. Fink starts talking about above 5% on 10-year yields. To be honest, this is not some revelation because we suggest that we will see this level in November:
And if everything will keep going as it is now - it might be so that we will have to buyout J. Dimon himself with his JPMorgan Bank all together.
As a result everybody surprisingly starts feeling bad. Germany yields are coming to 3%, while Italian yields silently, to not attract a lot of attention creeping to 5%, and we suspect, not just because of ECB interest rates:
Investors are hurry to change inflation expectations:
Meantime the US yield curve is steepening back, tending to normalize short-to-long term yield levels. If, as it should be, the yield on 10-year bonds becomes 1% higher than the yield on short-term bonds, then this will mean a price drop of another 20 percent. And the problem is not even that the treasures themselves will become cheaper. Following them, as a benchmark, all long-term bonds (mortgage, commercial, etc.) on the market will become cheaper. That is, several more trillions of value will evaporate. Banks have balance sheets as well.
All this stuff means that world are making to be prepared to 6+% rate. By the J. Dimon comments, it seems that the margin of safety somewhere around 6.5-7.0% or this is just the wish of vip-clients.
At same time, we suspect that some forecasts competition could start on who is higher - 5%, 7% or maybe 14%? Market always overreacting on major events. To make such forecasts, we should understand why it is needed to get the rate 7% or 20%. How are the beneficiaries? For some reason, the acceleration of negativity in rates has begun...
Of course, 5-7% are quite probable to disperse and accelerate crisis processes. It is high time. But, in fact, you can fantasize as much as you like that the rate will be, for example, 10% and the Fed will intensively keep it at this level, but... who needs that?
There is still some level at which the stock market, banks (both because borrowers will begin to default and because the securities on their balance sheets will begin to become much cheaper), the real estate sector and real business will fall into the abyss. And this can be at any level. What is more important here is not even the level of the rate per se, but how long the high rate will last and how quickly the increase will be.
Well, the rate reached this level and held out for a while and everything nosedived down. Everything - this means absolutely everything. Defaults of companies in the real sector, rising unemployment, bankruptcy of banks, bankruptcy of individuals. Who will benefit from this? Future generations? Hardly somebody things about them. If we talk about the economic elites, then there is unlikely to be any group of beneficiaries of such a fall. Well, except for those who are completely aware of the whole situation.
As long as there is an opportunity to keep the rate high, of course, they keep it. Otherwise the debt market will simply die. No one will invest money in debt if they know that it will definitely result in a loss in real terms. But what next? For whose sake is it necessary to fight inflation if the conditional beneficiaries of real positive rates are hurt not by inflation, but by the fact that all their other assets are depreciating much faster?
All such provoked collapses are needed, in order to actively and quickly redistribute capital. From the population towards certain sectors, for example. Or from one sector to another. Because if you deal with the “common good” with a serious face, then no one will benefit from it. But this imminently is accompanied with 30-40% GDP drop and halving of the value of financial markets. Because the normal level of the P/E is somewhere right there. This is actually what we've talked about in the beginning of 2022 when we've mentioned "Structural crisis" for the first time. Although the crisis has started in the US in the end of 2021...
Obviously such an epic shifts in capital and policy can't happen occasionally and without any control. Definitely this is the tool in the hands of political elites, but in whom hands - democrats, republicans? Crisis hits on financial sector - banking margin, profits, stock markets. The power of Democrats are based on bankers, and Powell with J. Yellen have initialized multiple support programmes - TARP, Revere Repos etc. So, whether this process is controlled by Republicans? Also not quite, because crisis hits production and manufacturing sector, increasing bankruptcies, contraction in industrial sector, overall slowdown an deflation. Thus, it is difficult to answer definitely. Maybe for us it is not very important, we just are moving with the events and our tast is to correctly identify of the process, but not to dig to its core. Still, it seems that we coming to some culmination.
Here is, I've mentioned in the beginning few charts that perfectly describes current situation. EU charts shows that there situation is not just bad, it is awful. It is not necessary any more to show some individual indicators to understand the scale and width of the crisis processes.
We could show you outstanding deflation charts of PPI in Germany, Italy, France etc, but they look absolutely the same as in the US - industrial sector is contracting across the world.
Conclusion
Hopefully, we're interested only with currencies, and do not need to harassing brain with about performance of particular assets such as stocks. Everybody finally starts to understand where wind blows and changing the forecasts fast. We do not need change forecasts, because current long term tendency is our major scenario. Tomorrow in Gold market research we take a bit different look on J. Powell comments and why officials are so stubborn in denying of recession. But this is different, and mostly a political story.
Situation slowly but stubbornly are getting out of control - budget deficit, government shutdown, huge debt and interest expenses, raising of crude oil prices, together with dropping of SPR, high yields and big potential losses on the balances of banks and funds, inflation once again... And this is without external factors and political tensions.
All in all it comes to big political game, as we're entering 2024 Election year in the US. Democrats vitally need to avoid officially acknowledge recession to pretend on victory. But, situation comes so that they will have to search compromise on foreign political arena, as with China as with Russia. Otherwise, they will not survive until November 2024 with $100+ crude oil prices and massive US Treasuries sell-off by China, Middle East countries and now also from Japan. Whether they are ready for that - I don't know.
It makes no sense to prepare far going forecasts. In current situation, it is important for us that current tendencies will last for some time more. We have 1-2 months at least, where overall sentiment and dollar strength should remain intact. That's enough for now and later we will see where the way will turn.
Usually we stay focused on the US and EU events as we're dealing mostly with EUR/USD and news from there are obviously become our primary ones. But this week a lot of events have happened, particularly in Japan, that just show how big structural crisis are, and what a tectonic, epic shifts are happening in global finance. In the US situation is taking signs of catastrophe, with coming government shutdown that seems imminence already. Situation with the US statistics and overall economy conditions more and more is getting a political background and becoming a tool for political bargain. This is more the topic for our Gold report tomorrow, but few words we need to say about it as well. Although we will show you few charts as usual, but to be honest, guys, it makes no big sense to do it, because they show the same things - structural crisis continues.
Market overview
The dollar was on track to post its biggest quarterly gain in a year on Friday and gains for the 11th consecutive week as investors priced in the likelihood of a still solid economy and higher rates for longer. The greenback retraced most earlier losses against a basket of currencies to be only slightly lower on the day, following data that showed that U.S. consumer spending increased in August, but underlying inflation moderated, with the year-on-year rise in prices excluding food and energy slowing to less than 4.0%.
The dollar has gained on expectations that the U.S. economy will remain more resilient to higher interest rates and oil prices than other economies, after the Federal Reserve last week warned it may hike rates further and is likely to hold them higher for longer. Despite weaker levels on Thursday and Friday some analysts see the greenback as likely to continue to outperform.
The estimated probability of a Fed rate hike in November has risen to almost 25%:
Meanwhile, a partial government shutdown is looming, which could affect the release of economic data and potentially dent economic growth.
Hardline Republicans in the U.S. House of Representatives on Friday rejected a bill proposed by their leader to temporarily fund the government, making it all but certain that federal agencies will partially shut down beginning Sunday. A government shutdown would "undermine" U.S. economic progress by idling key programs for small businesses and children, and could delay major infrastructure improvements, U.S. Treasury Secretary Janet Yellen said on Friday.
Global bond funds saw their biggest weekly outflows in more than a month on concerns that U.S. and European central banks will keep interest rates higher for longer to curb inflationary pressures. High-yield bond funds booked $3.11 billion of net selling during the week, the biggest outflow in six months. Data showed global equity funds experienced a net $10.7 billion worth of outflow, the biggest in a week since Aug. 23.
Global money market funds also remained out of favour, witnessing outflows to the turn of $22.32 billion, the biggest amount since July 12.
The yen's slide to the cusp of 150 per dollar has put investors on high alert for the risk of intervention. But, Japanese authorities could find propping up their currency both difficult to achieve and hard to justify. BOJ Governor Kazuo Ueda has quashed expectations for a hawkish shift during coming months by repeatedly emphasising a patient approach was needed to tightening the taps on its super loose policy. Spread in JP/US yields has widened to 380 b.p. (3.8%)
Intervention is both financially risky and politically charged. To make even a ripple in the $5 trillion currency market, the BOJ would need to draw down massive amounts of dollar reserves. Considering the major rich democracies commitment to letting markets determine exchange rates, Tokyo could get a grudging response from Washington when it tries explaining why it needed to pour so many dollars into the open market.
Meantime, foreigners dump Japanese stocks. On Japanese bonds we see the party like in 1998 - they are in massive sell-off, despite YCC strategy:
And here we have to ask few questions, concerning "Safety" and "Safe Haven".
Concerning "Safety"
In all economy high schools and Universities, at least of western economical science, teach that credit rating determines the safety. And historically "safe" assets are Gold, JPY and its bonds and safest of course are US Bonds. Let's have a look... if you think that this one is some russian ruble, turkish lira or ukrainian hryvnia -you're wrong. Don’t understand what currency is flying back and forth, then let me remind you of the existence of the yen. So it is the third reserve currency in the world by the way:
It was generally customary to wait out crises there. So this next ultra-reliable instrument has depreciated by 30% since 2021. Moreover, within the framework of 2022-2023 it is twisting and turning as never before. As a result, the Ukrainian hryvnia turned out to be a much more reliable instrument for saving capital. And the Japanese, being the closest friends of the United States, have to sell off the American national debt in order to fish out the dirty green piece of paper and support the exchange rate of their collapsing currency.
But maybe in the US situation is better? Let's see. As we've said in Telegram - currently, investors' expectations for a rate cut are at their highest level on record. From all sides we here banks trash talks that Fed is exhausting and near pivot, and its time to buy to not miss the change to get big yield for long time. Stock implied yield now equals to US yields. And this deadly advertisement makes its dark deed.
Meantime, the US households increased investments in government securities to a maximum in 25 years. By Marketwatch, americans' investment in government bonds rose to about $2.5 trillion, the highest level in the last 25 years, compared to less than $1 trillion before the Federal Reserve began raising borrowing costs, said Thorsten Slok, chief economist at Apollo Global Management.
And now is the most interesting thing - take a look what households money are doing. This is ETF on 20-year US debt. Despite that assets have dropped for 40%, the price of ETF has not changed. Somebody keeps buying it. Could you imagine the amount of households' pain when trap will be clapped?
if something falls, it means someone is selling it. All this stuff is sold by and large to the whole world except Europe, Australia, Canada and Mexico. Some like Japan to support their currency, some anticipating a quick parade of selective technical defaults. A discussion broke out in the United States regarding the issue of allocating money to Ukraine went viral. There the Senator Ron Paul says: “we borrow money from China to send it to Ukraine.”
The guy's information is outdated. China has not provided loans to the states for a long time. In the last year, they have borrowed mostly from their own taxpayers. The situation is completely comical: taxpayers’ money goes to Ukraine, there is not enough of it, so they also borrow it from these same taxpayers. It is not difficult to guess that this wonderful scheme will end with a new surge in inflation. We already went through this in the 1970s. Then money was sent uncontrollably to Vietnam.
But we could say - wait a minute, we have TIPS ETF (inflationary-protected bonds), it should feel much better. Ok, let's take a look - Assets under management of the iShares TIPS ETF are now below pre-COVID levels:
What's going on? They wanted to fight inflation, but they fought their own capital. TIPS is American government debt with interest tied to official inflation.
As a result, inflation has now fallen, but the rate levels are huge. The TIPS yields are calculated as "nominal rate - inflation". Official inflation is dropping as BIS shows to us. It means that difference is raising, pushing price (it moves opposite to yield direction) lower. It means that TIPS are being sold and regular debt is being bought because it is more profitable. Hmmm.... and what maths is?
As a result, investors in the fund that protects against inflation received Biden’s 16% depreciation of the dollar and, in addition, a drop in the price of the fund itself.
The crypto fans have exactly the same story with their Bitcoin. In fact, everyone who tried to use instruments with inflation protection was defrauded by high rates.
Even gold has depreciated, but mostly due technical reasons, which we seem as temporal - investors need cash to compensate other assets devaluation.
Why?
And now it appears that things stand different. Vanguard expects three rate hikes, J. Dimon speaks about 7%,
While L. Fink starts talking about above 5% on 10-year yields. To be honest, this is not some revelation because we suggest that we will see this level in November:
And if everything will keep going as it is now - it might be so that we will have to buyout J. Dimon himself with his JPMorgan Bank all together.
As a result everybody surprisingly starts feeling bad. Germany yields are coming to 3%, while Italian yields silently, to not attract a lot of attention creeping to 5%, and we suspect, not just because of ECB interest rates:
Investors are hurry to change inflation expectations:
Meantime the US yield curve is steepening back, tending to normalize short-to-long term yield levels. If, as it should be, the yield on 10-year bonds becomes 1% higher than the yield on short-term bonds, then this will mean a price drop of another 20 percent. And the problem is not even that the treasures themselves will become cheaper. Following them, as a benchmark, all long-term bonds (mortgage, commercial, etc.) on the market will become cheaper. That is, several more trillions of value will evaporate. Banks have balance sheets as well.
All this stuff means that world are making to be prepared to 6+% rate. By the J. Dimon comments, it seems that the margin of safety somewhere around 6.5-7.0% or this is just the wish of vip-clients.
At same time, we suspect that some forecasts competition could start on who is higher - 5%, 7% or maybe 14%? Market always overreacting on major events. To make such forecasts, we should understand why it is needed to get the rate 7% or 20%. How are the beneficiaries? For some reason, the acceleration of negativity in rates has begun...
Of course, 5-7% are quite probable to disperse and accelerate crisis processes. It is high time. But, in fact, you can fantasize as much as you like that the rate will be, for example, 10% and the Fed will intensively keep it at this level, but... who needs that?
There is still some level at which the stock market, banks (both because borrowers will begin to default and because the securities on their balance sheets will begin to become much cheaper), the real estate sector and real business will fall into the abyss. And this can be at any level. What is more important here is not even the level of the rate per se, but how long the high rate will last and how quickly the increase will be.
Well, the rate reached this level and held out for a while and everything nosedived down. Everything - this means absolutely everything. Defaults of companies in the real sector, rising unemployment, bankruptcy of banks, bankruptcy of individuals. Who will benefit from this? Future generations? Hardly somebody things about them. If we talk about the economic elites, then there is unlikely to be any group of beneficiaries of such a fall. Well, except for those who are completely aware of the whole situation.
As long as there is an opportunity to keep the rate high, of course, they keep it. Otherwise the debt market will simply die. No one will invest money in debt if they know that it will definitely result in a loss in real terms. But what next? For whose sake is it necessary to fight inflation if the conditional beneficiaries of real positive rates are hurt not by inflation, but by the fact that all their other assets are depreciating much faster?
All such provoked collapses are needed, in order to actively and quickly redistribute capital. From the population towards certain sectors, for example. Or from one sector to another. Because if you deal with the “common good” with a serious face, then no one will benefit from it. But this imminently is accompanied with 30-40% GDP drop and halving of the value of financial markets. Because the normal level of the P/E is somewhere right there. This is actually what we've talked about in the beginning of 2022 when we've mentioned "Structural crisis" for the first time. Although the crisis has started in the US in the end of 2021...
Obviously such an epic shifts in capital and policy can't happen occasionally and without any control. Definitely this is the tool in the hands of political elites, but in whom hands - democrats, republicans? Crisis hits on financial sector - banking margin, profits, stock markets. The power of Democrats are based on bankers, and Powell with J. Yellen have initialized multiple support programmes - TARP, Revere Repos etc. So, whether this process is controlled by Republicans? Also not quite, because crisis hits production and manufacturing sector, increasing bankruptcies, contraction in industrial sector, overall slowdown an deflation. Thus, it is difficult to answer definitely. Maybe for us it is not very important, we just are moving with the events and our tast is to correctly identify of the process, but not to dig to its core. Still, it seems that we coming to some culmination.
Here is, I've mentioned in the beginning few charts that perfectly describes current situation. EU charts shows that there situation is not just bad, it is awful. It is not necessary any more to show some individual indicators to understand the scale and width of the crisis processes.
We could show you outstanding deflation charts of PPI in Germany, Italy, France etc, but they look absolutely the same as in the US - industrial sector is contracting across the world.
Conclusion
Hopefully, we're interested only with currencies, and do not need to harassing brain with about performance of particular assets such as stocks. Everybody finally starts to understand where wind blows and changing the forecasts fast. We do not need change forecasts, because current long term tendency is our major scenario. Tomorrow in Gold market research we take a bit different look on J. Powell comments and why officials are so stubborn in denying of recession. But this is different, and mostly a political story.
Situation slowly but stubbornly are getting out of control - budget deficit, government shutdown, huge debt and interest expenses, raising of crude oil prices, together with dropping of SPR, high yields and big potential losses on the balances of banks and funds, inflation once again... And this is without external factors and political tensions.
All in all it comes to big political game, as we're entering 2024 Election year in the US. Democrats vitally need to avoid officially acknowledge recession to pretend on victory. But, situation comes so that they will have to search compromise on foreign political arena, as with China as with Russia. Otherwise, they will not survive until November 2024 with $100+ crude oil prices and massive US Treasuries sell-off by China, Middle East countries and now also from Japan. Whether they are ready for that - I don't know.
It makes no sense to prepare far going forecasts. In current situation, it is important for us that current tendencies will last for some time more. We have 1-2 months at least, where overall sentiment and dollar strength should remain intact. That's enough for now and later we will see where the way will turn.
