Sive Morten
Special Consultant to the FPA
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Fundamentals
It was really long week and we've got a lot of events and many of them are still needed to be analyzed and unclear what consequences they will trigger, but most of them are political ones. On economical front, it almost nothing to discuss - just the US inflation data and recent Fed comments.
Market overview
The euro strengthened as the dollar slid on Tuesday in response to a sharp drop in Treasury yields on the back of further dovish comments by Federal Reserve officials, as well as the prospect of stimulus from China.The benchmark 10-year Treasury note tumbled to a day low of 4.618% from Monday's high of 4.887% after Atlanta Fed President Raphael Bostic said the U.S. central bank does not need to increase interest rates any further.
Bostic, in the latest comments this week by Fed speakers, told the American Bankers Association that Fed policy is sufficiently restrictive and that he sees no recession ahead even as the Fed's rate hikes slow the economy and bring down inflation. U.S. Treasuries rallied, pushing two-year yields to their lowest in a month, as safe-haven demand was driven by the ongoing Mideast bloodshed and dovish Fed comments.
Bloomberg reported that China is weighing the issuance of at least 1 trillion yuan ($137.1 billion) of additional sovereign debt for spending to boost its struggling economy. Analysts said this helped currencies such as the euro, which are more exposed to global growth.
Analysts said the drop in U.S. yields was initially driven by comments from two Fed officials on Monday who said rising long-term yields might negate the need for further hikes. Core reading of U.S. producer prices showed underlying inflation moderated further in September, leading the market to reason the Federal Reserve is done hiking interest rates.
The market later barely reacted to minutes of the Fed's policy meeting last month that showed uncertainty around the path of the U.S. economy pushed Fed officials into a cautious stance as they debated whether more rate hikes were needed. Rising Treasury yields in recent months may be doing some of the U.S. central bank's work for it, Dallas Fed President Lorie Logan and Fed Governor Christopher Waller have argued, preventing any urgent need for another rate hike.
After stripping out food, energy and trade services, the producer price index (PPI) gained 0.2% last month, the same margin as in August. In the 12 months through September, core PPI increased 2.8%, or less than a 2.9% advance in August.
Waller on Wednesday said higher market rates may help the Fed slow inflation and let policymakers "watch and see" if the Fed's policy rate needs to rise again or not as price data seemed to be moving towards its 2% target. Minneapolis Fed President Neel Kashkari said it was "possible" that further hikes might not be needed. But, at the same time, he said that it is necessary to understand the factors that has pushed yields up.
Euro zone households see inflation staying slightly above the European Central Bank's (ECB) 2% target for another three years, an ECB survey on Wednesday showed, as rate-setters struggle to convince the public their plans to tame prices are on track. The ECB has made "important progress" in getting inflation back down to target but there is still a long road ahead and a further rate hike cannot be ruled out, Dutch central bank chief Klaas Knot said on Wednesday.
U.S. consumer prices rose more than expected in September, lifted by an elevated cost of rent that raised the prospect of the Federal Reserve keeping interest rates high for some time. The annual increase in consumer prices last month, excluding the volatile food and energy components, was the smallest in two years, but the surprise surge in rental costs rippled across markets. While many shrugged off the move higher in rental costs, others concluded the Fed's mission to lower inflation to it's 2% target isn't quite there.
The consumer price index increased 0.4% last month, with a 0.6% jump in the cost of shelter accounting for more than half of the rise.
Owners' equivalent rent, a measure of the amount homeowners would pay to rent or would earn from renting their property, rose even though non-official sources show a decline in rental prices.
Thursday's CPI release came after Wednesday's mixed report on U.S. producer prices, and minutes from the Fed's September meeting. Fed officials pointed to uncertainties around the economy, oil prices and financial markets as supporting "the case for proceeding carefully in determining the extent of additional policy firming that may be appropriate," the minutes showed.
Federal Reserve Bank of Philadelphia President Patrick Harker said Friday he believes the central bank is likely done with rate hikes amid an ongoing waning in price pressures, while flagging the uncertainty of how long rates will need to remain elevated.
Data on Friday showed U.S. consumer sentiment deteriorated in October, with households expecting higher inflation over the next year, but labor market strength was likely to continue supporting consumer spending. Futures pricing suggests traders now see about a 30% chance of another rate hike this year, down from about 45% a week ago. In general, current market expectations on future Fed rate look like this:
U.S. Treasury Secretary Janet Yellen said on Wednesday she continued to expect the U.S. economy would have a soft landing, even though the conflict between Israel and Palestinian Islamist group Hamas brought additional risks.
Yellen said Washington was monitoring the potential economic impact of the escalating conflict, though it was unlikely a major driver of the global outlook.
Yellen said she had nothing to announce yet on whether the United States would tighten sanctions on Iran if evidence emerged that the country was involved in the attack.
European Central Bank policymakers expressed cautious optimism on Thursday that inflation was on its way back to 2% even without more rate hikes and raised pressure on governments to maintain the sort of fiscal discipline needed for a soft landing of the economy. The ECB's models also suggested, according to the accounts, that a deposit rate in the region of 3.75% to 4.00% could bring inflation back to 2%, provided the ECB held this level long enough.
Joining an already long list of policymakers suggesting steady rates for now, French central bank chief Francois Villeroy de Galhau and his Greek counterpart, Yannis Stournaras both planed down the need for further tightening, arguing that policy was already in a setting that could lower inflation.
Hedge funds have entered the final quarter of the year doubling down on two of their biggest macro conviction trades - short U.S. Treasuries and long the dollar.
According to U.S. futures market data, speculators are holding a record short position in two-year Treasuries, and are the most bullish on the dollar in a year.
In currencies, meanwhile, funds ramped up their broad, net long dollar position by $5.4 billion in the week to $8.45 billion. Funds have been turning more bullish on the dollar for seven weeks in a row, the longest streak since April 2021. The net long euro position was cut to 79,000 contracts, the smallest in nearly a year. That equates to a roughly $10 billion bet that the euro will strengthen - still pretty big, but half what it was only a month ago.
A sustained rise in interest rates could not just slow the economy more than Federal Reserve officials feel is needed to lower inflation, but saddle the Biden administration with higher borrowing costs and larger deficits that put top priorities at risk, throw a new wrinkle into the 2024 presidential election, and force the U.S. central bank to recast some long-held plans.
Events like a recent credit downgrade by Fitch Ratings, the repeated flirtations with debt defaults and government shutdowns, and the ouster last week of the Republican speaker of the U.S. House of Representatives are possible reasons investors are demanding more of a return for buying long-term U.S. debt.
That transmits the pressure of rising rates into the world economy's weakest cracks, raising the risk that a key bank or pension fund could fail, or a currency crisis or debt default erupts in one corner of the globe and spills into others.
MARKET SENTIMENT ANALYSIS
In general, from comments above and prospect of the Fed fund rates, it becomes clear that market doesn't expect any rate change this year. Meantime, there are 2-3 special factors that we need to consider. First is, as more higher probability of further rate jump is as more talking will be about Fed pivot. The further prices for treasuries fall (yields raise), the more posts like this there will be: "a reversal is coming!"
But no, not even close, we haven’t even gone a third of the way yet. Although when you are in a position, any puny bump on the chart seems to be a reversal, this is understandable. However, the surest way to preserve the deposit in the current conditions is to cast aside false shame. And for now, do not buy any government debt, at least with a maturity of more than a year.
Second, the US investors carefully start asking the same question - you have too much debt. Wall Street Isn’t Sure It Can Handle All of Washington’s Bonds. Investors long shrugged off U.S. deficits, but a torrent of Treasuries is testing the bond market. Indeed, debt right now is raising for $1 Trln per month. Who could absorb this when everybody is selling - the Fed, US Treasury, China, S. Arabia, Japan? Now the demand mostly is based on the households. Poor US people now under huge brain wash from media, who day by day tell them that this is great interest rate for investing in long-term bonds. But for how long their purchasing power will stay?
Finally, all J. Biden initiatives on Middle East has failed. They dumped Iran with unlocking of $6 Bln, S. Arabia has stopped foreign relations normalization process with Israel. Some tensions starts appearing with Turkey - their NATO ally and 2nd largest NATO army. It is a big question now on Lebanon shelf oil extraction that Turkey and Israel were intended to develop together. Now if we take a look at the structure of CPI data, we see that in recent 2-3 months the energy component was decreasing. Something tells me that next month this trend will change:
Meantime, inflationary expectations are raising. Here is United States Michigan 1-Year Inflation Expectations:
Major UK banks have begun preparing for the possible introduction of Western sanctions against China and have provided the British and American governments with a draft action plan for such an eventuality. This was reported by Reuters with reference to Neil Willey, director of sanctions at the banking and financial association UK Finance. UK Finance organized fortnightly meetings of major British and foreign banks for several months to draw up the project, Willey said. He says the document includes sharing lessons learned from the imposition of Western sanctions, including on Russia, and discussing the consequences that any restrictions on China could entail. The “fun” is yet to come. And by the way, it is difficult to fully imagine the scale and consequences of the initiated disengagement, because it is not very comprehended by the mind. At least I find it difficult.
Israel-Palestine conflict is out of the economical scope and our primary object. The only thing that it is necessary to say - keep an eye on major players in region. Depending on what Iran, Turkey and S. Arabia will do they impact on the shape of the conflict. As the reasons of this confrontation as its consequences, of course, have a pronounced economic meaning.
Returning back to our primary topic of EUR/USD rate, it is difficult to find even single factor that could suggest reversal on the market. Political struggle in Europe is intensifying with far right parties come to power - Hungary, Slovakia, AfD in Germany, just to name some. Best countries in EU show big problems in economy. Now, with Israel war, the US will try to hang Ukraine financing on EU. Tough geopolitical situation should support demand for the US assets. As we hear talks about interest rates ceil from both, the US Dollar should keep status quo of more attractive currency. Besides, US rate still could be raised more, if we will see (I would say when we will see) another jump in inflation. From that standpoint we do not see any reasons to change our long-term view of weaker EUR and downside 0.9 target.
The turning point that we have to carefully watch for is - downside reversal of US Dollar with simultaneous growth of the interest rates. This combination will mean the break of the system.
It was really long week and we've got a lot of events and many of them are still needed to be analyzed and unclear what consequences they will trigger, but most of them are political ones. On economical front, it almost nothing to discuss - just the US inflation data and recent Fed comments.
Market overview
The euro strengthened as the dollar slid on Tuesday in response to a sharp drop in Treasury yields on the back of further dovish comments by Federal Reserve officials, as well as the prospect of stimulus from China.The benchmark 10-year Treasury note tumbled to a day low of 4.618% from Monday's high of 4.887% after Atlanta Fed President Raphael Bostic said the U.S. central bank does not need to increase interest rates any further.
Bostic, in the latest comments this week by Fed speakers, told the American Bankers Association that Fed policy is sufficiently restrictive and that he sees no recession ahead even as the Fed's rate hikes slow the economy and bring down inflation. U.S. Treasuries rallied, pushing two-year yields to their lowest in a month, as safe-haven demand was driven by the ongoing Mideast bloodshed and dovish Fed comments.
Bloomberg reported that China is weighing the issuance of at least 1 trillion yuan ($137.1 billion) of additional sovereign debt for spending to boost its struggling economy. Analysts said this helped currencies such as the euro, which are more exposed to global growth.
Analysts said the drop in U.S. yields was initially driven by comments from two Fed officials on Monday who said rising long-term yields might negate the need for further hikes. Core reading of U.S. producer prices showed underlying inflation moderated further in September, leading the market to reason the Federal Reserve is done hiking interest rates.
The market later barely reacted to minutes of the Fed's policy meeting last month that showed uncertainty around the path of the U.S. economy pushed Fed officials into a cautious stance as they debated whether more rate hikes were needed. Rising Treasury yields in recent months may be doing some of the U.S. central bank's work for it, Dallas Fed President Lorie Logan and Fed Governor Christopher Waller have argued, preventing any urgent need for another rate hike.
After stripping out food, energy and trade services, the producer price index (PPI) gained 0.2% last month, the same margin as in August. In the 12 months through September, core PPI increased 2.8%, or less than a 2.9% advance in August.
Waller on Wednesday said higher market rates may help the Fed slow inflation and let policymakers "watch and see" if the Fed's policy rate needs to rise again or not as price data seemed to be moving towards its 2% target. Minneapolis Fed President Neel Kashkari said it was "possible" that further hikes might not be needed. But, at the same time, he said that it is necessary to understand the factors that has pushed yields up.
Euro zone households see inflation staying slightly above the European Central Bank's (ECB) 2% target for another three years, an ECB survey on Wednesday showed, as rate-setters struggle to convince the public their plans to tame prices are on track. The ECB has made "important progress" in getting inflation back down to target but there is still a long road ahead and a further rate hike cannot be ruled out, Dutch central bank chief Klaas Knot said on Wednesday.
U.S. consumer prices rose more than expected in September, lifted by an elevated cost of rent that raised the prospect of the Federal Reserve keeping interest rates high for some time. The annual increase in consumer prices last month, excluding the volatile food and energy components, was the smallest in two years, but the surprise surge in rental costs rippled across markets. While many shrugged off the move higher in rental costs, others concluded the Fed's mission to lower inflation to it's 2% target isn't quite there.
The consumer price index increased 0.4% last month, with a 0.6% jump in the cost of shelter accounting for more than half of the rise.
Owners' equivalent rent, a measure of the amount homeowners would pay to rent or would earn from renting their property, rose even though non-official sources show a decline in rental prices.
Thursday's CPI release came after Wednesday's mixed report on U.S. producer prices, and minutes from the Fed's September meeting. Fed officials pointed to uncertainties around the economy, oil prices and financial markets as supporting "the case for proceeding carefully in determining the extent of additional policy firming that may be appropriate," the minutes showed.
Federal Reserve Bank of Philadelphia President Patrick Harker said Friday he believes the central bank is likely done with rate hikes amid an ongoing waning in price pressures, while flagging the uncertainty of how long rates will need to remain elevated.
Data on Friday showed U.S. consumer sentiment deteriorated in October, with households expecting higher inflation over the next year, but labor market strength was likely to continue supporting consumer spending. Futures pricing suggests traders now see about a 30% chance of another rate hike this year, down from about 45% a week ago. In general, current market expectations on future Fed rate look like this:
U.S. Treasury Secretary Janet Yellen said on Wednesday she continued to expect the U.S. economy would have a soft landing, even though the conflict between Israel and Palestinian Islamist group Hamas brought additional risks.
Yellen said Washington was monitoring the potential economic impact of the escalating conflict, though it was unlikely a major driver of the global outlook.
Yellen said she had nothing to announce yet on whether the United States would tighten sanctions on Iran if evidence emerged that the country was involved in the attack.
European Central Bank policymakers expressed cautious optimism on Thursday that inflation was on its way back to 2% even without more rate hikes and raised pressure on governments to maintain the sort of fiscal discipline needed for a soft landing of the economy. The ECB's models also suggested, according to the accounts, that a deposit rate in the region of 3.75% to 4.00% could bring inflation back to 2%, provided the ECB held this level long enough.
Joining an already long list of policymakers suggesting steady rates for now, French central bank chief Francois Villeroy de Galhau and his Greek counterpart, Yannis Stournaras both planed down the need for further tightening, arguing that policy was already in a setting that could lower inflation.
Hedge funds have entered the final quarter of the year doubling down on two of their biggest macro conviction trades - short U.S. Treasuries and long the dollar.
According to U.S. futures market data, speculators are holding a record short position in two-year Treasuries, and are the most bullish on the dollar in a year.
In currencies, meanwhile, funds ramped up their broad, net long dollar position by $5.4 billion in the week to $8.45 billion. Funds have been turning more bullish on the dollar for seven weeks in a row, the longest streak since April 2021. The net long euro position was cut to 79,000 contracts, the smallest in nearly a year. That equates to a roughly $10 billion bet that the euro will strengthen - still pretty big, but half what it was only a month ago.
A sustained rise in interest rates could not just slow the economy more than Federal Reserve officials feel is needed to lower inflation, but saddle the Biden administration with higher borrowing costs and larger deficits that put top priorities at risk, throw a new wrinkle into the 2024 presidential election, and force the U.S. central bank to recast some long-held plans.
Events like a recent credit downgrade by Fitch Ratings, the repeated flirtations with debt defaults and government shutdowns, and the ouster last week of the Republican speaker of the U.S. House of Representatives are possible reasons investors are demanding more of a return for buying long-term U.S. debt.
That transmits the pressure of rising rates into the world economy's weakest cracks, raising the risk that a key bank or pension fund could fail, or a currency crisis or debt default erupts in one corner of the globe and spills into others.
MARKET SENTIMENT ANALYSIS
In general, from comments above and prospect of the Fed fund rates, it becomes clear that market doesn't expect any rate change this year. Meantime, there are 2-3 special factors that we need to consider. First is, as more higher probability of further rate jump is as more talking will be about Fed pivot. The further prices for treasuries fall (yields raise), the more posts like this there will be: "a reversal is coming!"
But no, not even close, we haven’t even gone a third of the way yet. Although when you are in a position, any puny bump on the chart seems to be a reversal, this is understandable. However, the surest way to preserve the deposit in the current conditions is to cast aside false shame. And for now, do not buy any government debt, at least with a maturity of more than a year.
Second, the US investors carefully start asking the same question - you have too much debt. Wall Street Isn’t Sure It Can Handle All of Washington’s Bonds. Investors long shrugged off U.S. deficits, but a torrent of Treasuries is testing the bond market. Indeed, debt right now is raising for $1 Trln per month. Who could absorb this when everybody is selling - the Fed, US Treasury, China, S. Arabia, Japan? Now the demand mostly is based on the households. Poor US people now under huge brain wash from media, who day by day tell them that this is great interest rate for investing in long-term bonds. But for how long their purchasing power will stay?
Finally, all J. Biden initiatives on Middle East has failed. They dumped Iran with unlocking of $6 Bln, S. Arabia has stopped foreign relations normalization process with Israel. Some tensions starts appearing with Turkey - their NATO ally and 2nd largest NATO army. It is a big question now on Lebanon shelf oil extraction that Turkey and Israel were intended to develop together. Now if we take a look at the structure of CPI data, we see that in recent 2-3 months the energy component was decreasing. Something tells me that next month this trend will change:
Meantime, inflationary expectations are raising. Here is United States Michigan 1-Year Inflation Expectations:
Major UK banks have begun preparing for the possible introduction of Western sanctions against China and have provided the British and American governments with a draft action plan for such an eventuality. This was reported by Reuters with reference to Neil Willey, director of sanctions at the banking and financial association UK Finance. UK Finance organized fortnightly meetings of major British and foreign banks for several months to draw up the project, Willey said. He says the document includes sharing lessons learned from the imposition of Western sanctions, including on Russia, and discussing the consequences that any restrictions on China could entail. The “fun” is yet to come. And by the way, it is difficult to fully imagine the scale and consequences of the initiated disengagement, because it is not very comprehended by the mind. At least I find it difficult.
Israel-Palestine conflict is out of the economical scope and our primary object. The only thing that it is necessary to say - keep an eye on major players in region. Depending on what Iran, Turkey and S. Arabia will do they impact on the shape of the conflict. As the reasons of this confrontation as its consequences, of course, have a pronounced economic meaning.
Returning back to our primary topic of EUR/USD rate, it is difficult to find even single factor that could suggest reversal on the market. Political struggle in Europe is intensifying with far right parties come to power - Hungary, Slovakia, AfD in Germany, just to name some. Best countries in EU show big problems in economy. Now, with Israel war, the US will try to hang Ukraine financing on EU. Tough geopolitical situation should support demand for the US assets. As we hear talks about interest rates ceil from both, the US Dollar should keep status quo of more attractive currency. Besides, US rate still could be raised more, if we will see (I would say when we will see) another jump in inflation. From that standpoint we do not see any reasons to change our long-term view of weaker EUR and downside 0.9 target.
The turning point that we have to carefully watch for is - downside reversal of US Dollar with simultaneous growth of the interest rates. This combination will mean the break of the system.
