Sive Morten
Special Consultant to the FPA
- Messages
- 18,655
Fundamentals
Have you signed it, that in recent 2-3 weeks we're getting less financial news and more political ones? And this is not because of Middle East conflict, but because of many financial problems are tried to be resolved by political methods. This week it almost nothing to talk about - J. Powell speech, performance of the US yields, US Banks earnings reports. Although everything seems the same on surface, there are some interesting points that today we pay attention to.
Market overview
Retail sales rose 0.7% last month as households boosted purchases of motor vehicles and spent more at restaurants and bars. Fed funds futures imply a 30% probability the Fed will raise rates in December, down from 39% before Powell's comments, and no chance of a hike in November, according to the CME Group’s FedWatch Tool. Despite the positive sales, Jeffrey Roach, chief economist for LPL Financial, noted that there are some headwinds affecting U.S. consumers.
The dollar rose against the euro and yen on Wednesday as benchmark 10-year Treasury yields hit 16-year highs and as investors watched the war between Hamas and Israel for signs of escalation. Since mid-July, the benchmark 10-year Treasury yield has climbed about 120 basis points and the dollar index has risen around 7%.
Fed Governor Christopher Waller said he wants to "wait, watch and see" if the U.S. economy continues its run of strength or weakens in the face of the Fed's rate hikes to date. ed Bank of New York President John Williams also said interest rates will need to stay high for a while to get inflation back to the central bank's 2% target.
The U.S. central bank's "Beige Book" indicated that U.S. economic activity was little changed over the last month and a half, as labor market tightness continued to ease and prices continued to increase at a modest pace.
On Thursday after Federal Reserve Chair Jerome Powell was interpreted as being generally dovish in comments made at an economic forum, even as he warned that the U.S. central bank could raise interest rates again. The U.S. economy's strength and continued tight labor markets could warrant further rate increases, Powell said. But he also noted that recent market-driven increases in bond yields have helped to "significantly" tighten overall financial conditions.
The rally in the greenback has largely stalled and the currency has consolidated since the index hit a 10-month high on Oct. 3.
The European Central Bank's rate hiking cycle is over, according to all 85 economists polled by Reuters, but it won't be until at least July 2024 before it begins easing as the battle against elevated inflation rattles on. None of the 85 economists polled by Reuters Oct. 12-19 had another lift in their outlook, but the timing of the first cut was more uncertain. The median forecast and 58% majority view among economists, 48 of 83, showed it would be in the third quarter of next year, or later, and that the deposit rate would be at 3.50% by end-September. A slight majority of economists in a separate Reuters poll see a cut by the U.S. Federal Reserve before mid-2024.
While the 20-country euro zone will narrowly dodge a recession, the economy was expected to have only flatlined last quarter and will do the same again in the current one as increased borrowing and living costs force consumers to rein in spending.
Building permits for apartments in Germany fell 28% during the first eight months of the year, the statistics office said on Wednesday, underscoring a downturn in demand in the construction and real estate industry. The nosedive in permits comes as German Chancellor Olaf Scholz faces fresh demands to stem a property crisis in Europe's largest economy. Building permits for apartments were down an even sharper 31.6% in August from a year earlier, according to the statistics office which attributed the decline to higher building costs and worse financing conditions. Companies across the EU are cutting jobs.
Bonds, Rates and the Fed
One of the world's most influential bond market voices has warned that the dollar’s position as the world's reserve currency could be lost unless the United States gets its spending under control. Jeffrey Gundlach, chief executive of DoubleLine Capital and dubbed the "bond king" due to a history of timely market calls, said the risk came as high interest rates continued to ramp up the $33.59 trillion worth of U.S. national debt. Gundlach, whose firm oversees around $150 billion of assets under management, said the interest rate on U.S. debt could rise to 5.5% over time given the current level of Federal Reserve borrowing costs.
Indeed, guys, jokes are ended. As we've mentioned in telegram, recent data on the US bond auctions, as for nominal bonds as for TIPS show explosive jump in inflation. As a result, US 5Y inflation swap, which currently stands at 2.82%, is rising, showing signs of more resilient structural inflation:
10 year Greek bonds already has lower yields that the US once. We consider it as a first sign that market can't absorb such amount of supply. Second - investors demand higher premium for credit risk, as storm clouds around the US debt are gathering. Jerome continues to argue that the rate will still need to be raised. And for the first time he starts talking about the problem of high yields on debt. He voiced its obvious reason: sales of various kinds of holders. Including the Fed itself, which he heads.
It seems that JPow has long given up on inflation, "retreated to pre-prepared boundaries" and is now just trying to somehow keep the pyramid of public debt.
Actually, all his endless tales about temporary inflation, "soft landing" and so on come from here. By and large, his job for the past 5 years is to feed investors with trash talks. There has been no real compliance with the inflation target for a long time. Consequently, everyone who invests in American debt over and over again receives losses, since Powell's forecasts have not come true all these years:
All Powell does is just fooling investors, putting them in losses for many years. This, in fact, is in his execution the control of the national debt pyramid. On average, inflation should devour it, and the maximum number of investors should buy it so that the real yield does not go into a positive zone. The fact that it temporarily turned out to be there, but, is short-term and very soon we will go back to the negative real yield mode, which somehow burns American debts.
it is not funny, because 58% of the US households have investments in debt and shares. And when everybody has laughed about 7% yields proclaimed by JP Morgan - now it doesn't seem as joke any more. The "funniest" thing now in the national debt pyramid is that it turned out to be an infinite cycle. Powell raises rates in order to "beat inflation", because Biden cannot achieve this by his actions in the real economy.
Everything seems to be logical: at a certain point, credit demand will fall, warehouses will be overloaded, discounts will begin and prices will be reduced. But it works only if you have no budget deficit or at least at the level of GDP growth. In the case of the US, the deficit is daunting. As a result, there is no sense from this fastest rate increase in history. With one hand, demand is being tightened, and with the other, they are insanely increasing government spending through unsecured emission.
In fact, there is only a redistribution tool within the system. Those who work exclusively on a commercial basis suffer and may even close down, but those who sit on government orders thrive and devour commercial competitors.
True, a real perpetual motion machine will not work out of this. With such rates and the speed of debt renewal, the cost of servicing the national debt will very quickly reach up to a third of all tax collections and, like it or not, you will have to start saving. This will happen by the end of next year, if the current dynamics continues.
What do you think they will start saving on in the first place?
Banks already have record floating loss on bond portfolios, although real potential losses are few times higher. For example, BofA has reported this week of 132 Bln of accumulated loss on bonds in portfolio. This is long term bonds - you either have to fix the loss or sit until maturity, which is mostly the same if we take into consideration the inflation level. For Bank of America, $132 billion in unrealized losses is exactly half of all the capital they have.
Reuters writes that there are “at least” $650 billion in unrealized losses in the entire banking system. Although serious scientists, and not scribblers from Reuters, showed at the end of April that at that time the unrealized losses of banks were above 2 trillion dollars. Since then, the price of bonds has fallen significantly.
The further you go, the more traders will appear who have accumulated treasures in anticipation of a reversal, and there will be “insiders” from them too. Self-hypnosis is a great thing, but not in this case. As Powell decides, so it will be. I still continue to believe that we haven’t even gone through half of this sad journey yet. We already hear it from Morgan Stanley and PIMCO. But something tells me that it is not time yet. Besides, own balances as of Morgan Stanley as of Pimco are far from good.
The yield curve is just started to take correct shape, but we are not even on half way to normal situation (when long-term rates have to be higher than the short-term), even to parity with short-term rates. It is at least ~ 1% of yield action, which makes overall loss on global bond market unacceptable.
The default season officially is started, as well as situation on job market is turning negative, despite you don't see it yet in official NFP reports.
By the way, another factor behind the recession is the decline in real household incomes by 4.7%.
Meanwhile, GDP is not falling. Why? Probably due to excess government spending, which creates a deficit of 6-7% of GDP at the end of the year. This luxury is permissible as long as there are buyers for government debt at rates with a relatively small premium to the Fed rate using funds in reverse repo. There are not many of them left, only 1.15 trillion. dollars and they will run out in about six months. If at the same time BTFP also ceases to operate (03/31/24), then it is unclear who, in principle, will be able to buy new treasuries. Then, apparently, the recession will appear in all its glory.
Republicans are now “fighting,” at least verbally, to reduce the budget deficit. Let's assume that now some new speaker will be agreed upon, in a couple of weeks the whole process of agreeing on a new budget will continue (if anyone doesn’t remember, it stopped for a month because a temporary budget was adopted) and expenses will be reduced as a result of the compromise.
Although the Treasury will still have its $700+ billion accumulated in the TGA account at the Fed and, for example, will continue to spend it to temporarily cover the deficit. Just 150+ billion dollars per month. Well, in theory.
If they cut part of the budget deficit, then government spending will fall, that is, support for demand in the economy will weaken. And then, instead of growing, GDP should begin to fall. In terms of timing, everything seems to be beating, but we’ll see how it turns out in reality. Logical?
Now we foresee the hybrid QE, when long-term rate exceeds the Fed fund rate. It will be possible to borrow from the Fed at 5.5% and immediately buy treasuries at, for example, 6%, immediately repay them back at par to the Fed at 5.5% with BTFP programme, and buy new treasuries, and so on all the way. it will be even more interesting for low coupon bonds that are trading now with ~ 50% discount, which increases the leverage level. That could hold yield rally for awhile, until US Banks capitals will be filled and significantly increase BTFP size, let's keep an eye on it.
Thus, the economic situation in the United States is deteriorating. If our hypothesis about the structural crisis is correct (and so far there is not a single fact that would refute it), then the decline of the US economy will continue for several more years, and in the process there will inevitably be a collapse of financial markets. And this will inevitably entail a drop in the capitalization of fictitious assets, with an inevitable sharp decrease in GDP.
For all US partners, the most painful question is: what will happen to the accumulated assets that are denominated in dollars? Some analysts reveals one important circumstance, due to which, in particular, the main recent economic news was the Hamas attack on Israel. The fact is that it was this attack that became the point after which the return of dollar-denominated capital will become impossible. Of course, there will be exceptions: in particular, Iran is likely to receive its money. But in general, the issue is already closed, no one will be able to use their capital.
Conclusion:
Tomorrow in Gold report we will consider some specific issues of Middle East conflict and explain the real background of ongoing events. It will become clear why EU now as no chance to pull the blanket on its favor. The hydrocarbons in near future will not become cheaper. The shipping costs already are raising. This situation is not just spinning up inflation, but will kill EU industrial sector as they vitally depend on LPG delivery by sea. The US have its own reserves and ability to contract export for own needs. EU has no ability to do this. The Middle East turmoil is just started and is far from resolving. The US have big problems, no doubts, but in comparison to EU and perspective of EUR/USD performance they stand at much better shape. So, our downside scenario remains intact by far, and we consider 0.9 area as downside long-term target.
Have you signed it, that in recent 2-3 weeks we're getting less financial news and more political ones? And this is not because of Middle East conflict, but because of many financial problems are tried to be resolved by political methods. This week it almost nothing to talk about - J. Powell speech, performance of the US yields, US Banks earnings reports. Although everything seems the same on surface, there are some interesting points that today we pay attention to.
Market overview
Retail sales rose 0.7% last month as households boosted purchases of motor vehicles and spent more at restaurants and bars. Fed funds futures imply a 30% probability the Fed will raise rates in December, down from 39% before Powell's comments, and no chance of a hike in November, according to the CME Group’s FedWatch Tool. Despite the positive sales, Jeffrey Roach, chief economist for LPL Financial, noted that there are some headwinds affecting U.S. consumers.
Other data on Tuesday showed that production at U.S. factories increased more than expected in September despite strikes in the automobile industry curbing motor vehicle output. Richmond Fed chief Thomas Barkin on Tuesday said that higher long-term borrowing costs are putting downward pressure on demand, but it's unclear how that will affect the central bank's rates decision in two weeks.
The dollar rose against the euro and yen on Wednesday as benchmark 10-year Treasury yields hit 16-year highs and as investors watched the war between Hamas and Israel for signs of escalation. Since mid-July, the benchmark 10-year Treasury yield has climbed about 120 basis points and the dollar index has risen around 7%.
Fed Governor Christopher Waller said he wants to "wait, watch and see" if the U.S. economy continues its run of strength or weakens in the face of the Fed's rate hikes to date. ed Bank of New York President John Williams also said interest rates will need to stay high for a while to get inflation back to the central bank's 2% target.
The U.S. central bank's "Beige Book" indicated that U.S. economic activity was little changed over the last month and a half, as labor market tightness continued to ease and prices continued to increase at a modest pace.
On Thursday after Federal Reserve Chair Jerome Powell was interpreted as being generally dovish in comments made at an economic forum, even as he warned that the U.S. central bank could raise interest rates again. The U.S. economy's strength and continued tight labor markets could warrant further rate increases, Powell said. But he also noted that recent market-driven increases in bond yields have helped to "significantly" tighten overall financial conditions.
The rally in the greenback has largely stalled and the currency has consolidated since the index hit a 10-month high on Oct. 3.
The European Central Bank's rate hiking cycle is over, according to all 85 economists polled by Reuters, but it won't be until at least July 2024 before it begins easing as the battle against elevated inflation rattles on. None of the 85 economists polled by Reuters Oct. 12-19 had another lift in their outlook, but the timing of the first cut was more uncertain. The median forecast and 58% majority view among economists, 48 of 83, showed it would be in the third quarter of next year, or later, and that the deposit rate would be at 3.50% by end-September. A slight majority of economists in a separate Reuters poll see a cut by the U.S. Federal Reserve before mid-2024.
While the 20-country euro zone will narrowly dodge a recession, the economy was expected to have only flatlined last quarter and will do the same again in the current one as increased borrowing and living costs force consumers to rein in spending.
Building permits for apartments in Germany fell 28% during the first eight months of the year, the statistics office said on Wednesday, underscoring a downturn in demand in the construction and real estate industry. The nosedive in permits comes as German Chancellor Olaf Scholz faces fresh demands to stem a property crisis in Europe's largest economy. Building permits for apartments were down an even sharper 31.6% in August from a year earlier, according to the statistics office which attributed the decline to higher building costs and worse financing conditions. Companies across the EU are cutting jobs.
Bonds, Rates and the Fed
One of the world's most influential bond market voices has warned that the dollar’s position as the world's reserve currency could be lost unless the United States gets its spending under control. Jeffrey Gundlach, chief executive of DoubleLine Capital and dubbed the "bond king" due to a history of timely market calls, said the risk came as high interest rates continued to ramp up the $33.59 trillion worth of U.S. national debt. Gundlach, whose firm oversees around $150 billion of assets under management, said the interest rate on U.S. debt could rise to 5.5% over time given the current level of Federal Reserve borrowing costs.
Indeed, guys, jokes are ended. As we've mentioned in telegram, recent data on the US bond auctions, as for nominal bonds as for TIPS show explosive jump in inflation. As a result, US 5Y inflation swap, which currently stands at 2.82%, is rising, showing signs of more resilient structural inflation:
10 year Greek bonds already has lower yields that the US once. We consider it as a first sign that market can't absorb such amount of supply. Second - investors demand higher premium for credit risk, as storm clouds around the US debt are gathering. Jerome continues to argue that the rate will still need to be raised. And for the first time he starts talking about the problem of high yields on debt. He voiced its obvious reason: sales of various kinds of holders. Including the Fed itself, which he heads.
It seems that JPow has long given up on inflation, "retreated to pre-prepared boundaries" and is now just trying to somehow keep the pyramid of public debt.
Actually, all his endless tales about temporary inflation, "soft landing" and so on come from here. By and large, his job for the past 5 years is to feed investors with trash talks. There has been no real compliance with the inflation target for a long time. Consequently, everyone who invests in American debt over and over again receives losses, since Powell's forecasts have not come true all these years:
All Powell does is just fooling investors, putting them in losses for many years. This, in fact, is in his execution the control of the national debt pyramid. On average, inflation should devour it, and the maximum number of investors should buy it so that the real yield does not go into a positive zone. The fact that it temporarily turned out to be there, but, is short-term and very soon we will go back to the negative real yield mode, which somehow burns American debts.
it is not funny, because 58% of the US households have investments in debt and shares. And when everybody has laughed about 7% yields proclaimed by JP Morgan - now it doesn't seem as joke any more. The "funniest" thing now in the national debt pyramid is that it turned out to be an infinite cycle. Powell raises rates in order to "beat inflation", because Biden cannot achieve this by his actions in the real economy.
Everything seems to be logical: at a certain point, credit demand will fall, warehouses will be overloaded, discounts will begin and prices will be reduced. But it works only if you have no budget deficit or at least at the level of GDP growth. In the case of the US, the deficit is daunting. As a result, there is no sense from this fastest rate increase in history. With one hand, demand is being tightened, and with the other, they are insanely increasing government spending through unsecured emission.
In fact, there is only a redistribution tool within the system. Those who work exclusively on a commercial basis suffer and may even close down, but those who sit on government orders thrive and devour commercial competitors.
True, a real perpetual motion machine will not work out of this. With such rates and the speed of debt renewal, the cost of servicing the national debt will very quickly reach up to a third of all tax collections and, like it or not, you will have to start saving. This will happen by the end of next year, if the current dynamics continues.
What do you think they will start saving on in the first place?
Banks already have record floating loss on bond portfolios, although real potential losses are few times higher. For example, BofA has reported this week of 132 Bln of accumulated loss on bonds in portfolio. This is long term bonds - you either have to fix the loss or sit until maturity, which is mostly the same if we take into consideration the inflation level. For Bank of America, $132 billion in unrealized losses is exactly half of all the capital they have.
Reuters writes that there are “at least” $650 billion in unrealized losses in the entire banking system. Although serious scientists, and not scribblers from Reuters, showed at the end of April that at that time the unrealized losses of banks were above 2 trillion dollars. Since then, the price of bonds has fallen significantly.
The further you go, the more traders will appear who have accumulated treasures in anticipation of a reversal, and there will be “insiders” from them too. Self-hypnosis is a great thing, but not in this case. As Powell decides, so it will be. I still continue to believe that we haven’t even gone through half of this sad journey yet. We already hear it from Morgan Stanley and PIMCO. But something tells me that it is not time yet. Besides, own balances as of Morgan Stanley as of Pimco are far from good.
The yield curve is just started to take correct shape, but we are not even on half way to normal situation (when long-term rates have to be higher than the short-term), even to parity with short-term rates. It is at least ~ 1% of yield action, which makes overall loss on global bond market unacceptable.
The default season officially is started, as well as situation on job market is turning negative, despite you don't see it yet in official NFP reports.
By the way, another factor behind the recession is the decline in real household incomes by 4.7%.
Meanwhile, GDP is not falling. Why? Probably due to excess government spending, which creates a deficit of 6-7% of GDP at the end of the year. This luxury is permissible as long as there are buyers for government debt at rates with a relatively small premium to the Fed rate using funds in reverse repo. There are not many of them left, only 1.15 trillion. dollars and they will run out in about six months. If at the same time BTFP also ceases to operate (03/31/24), then it is unclear who, in principle, will be able to buy new treasuries. Then, apparently, the recession will appear in all its glory.
Republicans are now “fighting,” at least verbally, to reduce the budget deficit. Let's assume that now some new speaker will be agreed upon, in a couple of weeks the whole process of agreeing on a new budget will continue (if anyone doesn’t remember, it stopped for a month because a temporary budget was adopted) and expenses will be reduced as a result of the compromise.
Although the Treasury will still have its $700+ billion accumulated in the TGA account at the Fed and, for example, will continue to spend it to temporarily cover the deficit. Just 150+ billion dollars per month. Well, in theory.
If they cut part of the budget deficit, then government spending will fall, that is, support for demand in the economy will weaken. And then, instead of growing, GDP should begin to fall. In terms of timing, everything seems to be beating, but we’ll see how it turns out in reality. Logical?
Now we foresee the hybrid QE, when long-term rate exceeds the Fed fund rate. It will be possible to borrow from the Fed at 5.5% and immediately buy treasuries at, for example, 6%, immediately repay them back at par to the Fed at 5.5% with BTFP programme, and buy new treasuries, and so on all the way. it will be even more interesting for low coupon bonds that are trading now with ~ 50% discount, which increases the leverage level. That could hold yield rally for awhile, until US Banks capitals will be filled and significantly increase BTFP size, let's keep an eye on it.
Thus, the economic situation in the United States is deteriorating. If our hypothesis about the structural crisis is correct (and so far there is not a single fact that would refute it), then the decline of the US economy will continue for several more years, and in the process there will inevitably be a collapse of financial markets. And this will inevitably entail a drop in the capitalization of fictitious assets, with an inevitable sharp decrease in GDP.
For all US partners, the most painful question is: what will happen to the accumulated assets that are denominated in dollars? Some analysts reveals one important circumstance, due to which, in particular, the main recent economic news was the Hamas attack on Israel. The fact is that it was this attack that became the point after which the return of dollar-denominated capital will become impossible. Of course, there will be exceptions: in particular, Iran is likely to receive its money. But in general, the issue is already closed, no one will be able to use their capital.
Conclusion:
Tomorrow in Gold report we will consider some specific issues of Middle East conflict and explain the real background of ongoing events. It will become clear why EU now as no chance to pull the blanket on its favor. The hydrocarbons in near future will not become cheaper. The shipping costs already are raising. This situation is not just spinning up inflation, but will kill EU industrial sector as they vitally depend on LPG delivery by sea. The US have its own reserves and ability to contract export for own needs. EU has no ability to do this. The Middle East turmoil is just started and is far from resolving. The US have big problems, no doubts, but in comparison to EU and perspective of EUR/USD performance they stand at much better shape. So, our downside scenario remains intact by far, and we consider 0.9 area as downside long-term target.
