Sive Morten
Special Consultant to the FPA
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Fundamentals
Once again we've got important data form the US - GDP, PCE, Consumption etc. We've got EU inflation data, which lets us to adjust our view on Sep-Oct. Now it becomes clear that we're going on soft scenario with 25 points cut from the Fed and ECB, so impact on EUR/USD will be minimal in September. At the same time, data that we've got looks arguable. Alternative data sources somehow show quite different picture. And on many indicators now we could delete "ex-Covid period" caveat, because situation is deteriorating further. All this stuff makes us keep the same idea, that current artificial prosperity gives the great chance to out of the US assets, which is most advanced investors are doing right now.
Market overview
The U.S. dollar gained due to month-end buying and technical factors after recent declines that pushed it to its weakest in more than a year, as traders awaited data that could dictate the pace of the Federal Reserve's imminent easing cycle. Sharp bouts of volatility hit foreign exchange markets this month as worries around a potential U.S. recession and hawkish signals from the Bank of Japan hammered the dollar and sent other major currencies soaring.
Investors also expect the Fed to begin cutting interest rates next month following Chair Jerome Powell's dovish tilt last week, with the debate now centered on whether or not it will do a super-sized 50-basis point cut, or the standard 25-bp easing. Current pricing indicated a 37% chance of the larger cut, unchanged from late on Tuesday, according to LSEG calculations. Markets also priced in about 105 bps of easing by the end of the year.
Given that markets have been expecting rate cuts from September for weeks now, the downside momentum on the dollar could be waning, with support built around 100.18/30 in the dollar index , said Matt Simpson, senior market analyst at City Index.
Data on Thursday showed the world's largest economy grew a little faster than expected in the second quarter, modestly reducing expectations for a larger 50 basis-point (bp) rate cut next month by the Federal Reserve. The report also added to growing expectations that the United States could avoid recession altogether, or go through just a mild one, analysts said.
Gross domestic product (GDP) grew at a 3.0% annualised rate in the second quarter, according to the Bureau of Economic Analysis' second estimate. That was an upward revision from the 2.8% rate reported last month, and higher than the 1.4% rise seen in the first quarter.
Consumer spending, which accounts for more than two-thirds of U.S. economic activity, rose 0.5% last month after advancing by an unrevised 0.3% in June, the Commerce Department's Bureau of Economic Analysis reported. After adjusting for inflation, consumer spending gained 0.4% after rising 0.3% in June, and implied that spending retained the momentum from the second quarter, when it helped to boost gross domestic product growth to a 3.0% annualized rate.
While the labor market momentum has slowed, it continues to generate decent wage growth that is helping to underpin spending. The slowdown in the labor market is mostly driven by a step down in hiring rather than layoffs. The saving rate dropped to 2.9%, the lowest level since June 2022, from 3.1% in June.
The number of people receiving benefits after an initial week of aid, a proxy for hiring, increased by 13,000 to a seasonally adjusted 1.868 million, near the levels seen in late 2021, suggesting persistent unemployment.
The euro was undermined overall by inflation data from Germany and Spain, which raised bets on the European Central Bank's rate easing outlook. Data showed, inflation fell in six important German states in August, suggesting national inflation could decline noticeably this month. It dropped to the slowest pace in a year in Spain. Money markets priced in 67 bps of ECB cuts in 2024 , from around 63 bps before the data.
On Friday after data showed a key inflation measure came in line with forecasts, while personal spending and income increased, supporting expectations the Federal Reserve will likely cut interest rates by a smaller 25 basis points next month, instead of 50 bps. Data showed the personal consumption expenditures (PCE) price index rose 0.2% last month, in line with expectations, after an unrevised 0.1% advance in June. In the 12 months through July, the PCE price index increased 2.5%, matching June's gain. Consumer spending was also 0.5% higher last month after expanding 0.3% in June.
Separate economic reports showed that the University of Michigan's monthly consumer sentiment index survey edged up to 67.9 in August from July's eight-month low of 66.4, snapping a four-month slide. U.S. consumers see inflation continuing to moderate in the next year, the survey showed, with a gauge of price growth expectations published on Friday at the lowest level in August since late 2020.
Speaking shortly on EU data - Inflation in the eurozone rose by 2.2% in August, core inflation by 2.8%, and unemployment by 6.4%. All in line with expectations and likely to force the ECB to cut rates in September.
The European Central Bank should avoid cutting interest rates too fast because it has yet to bring inflation down to 2% even if that goal is now in sight, ECB policymaker Joachim Nagel said on Thursday.
Despite such kind of hawkish statements, it seems that EU data doesn't contradict to September rate cut.
PROBLEMS IN DETAILS
We already in habit that the US statistics become to tricky to treat it literally. Every time we need to dig it to get the truth, so recent data is not an exception. Let's start from Consumer Spending as most easy to explain. So, official data shows 0.5% growth, last month was revisited to record 3% (!). But I like how it was said by Zero Hedge -
"The consumer is done. The saving rate is the 2nd lowest of the post QE era - spending is 0.5%, income is 0.3 and Personal savings craters from 3.1 to 2.9%"
That's it. You can't say it better. As we have clarity from this subject, could explain somebody how GDP could show 3% growth, where 70% comes from Consumption? The only answer is by undervaluing of real inflation. If you keep inflation low, you could overvalue other components and show positive growth. Here we will not speak again about inflation that we've considered many times before. All our readers know that inflation in the US is around 8%+ level. Which means that recent GDP should be ~ -2.5-3%.
Besides, indirect indicators show the same. Dollar General warns that low-income U.S. consumers are running out of money. The nation's largest discount store chain, with more than 20,000 locations in 48 states, painted a bleak financial picture for many of its customers. Low-income families feel more "financially constrained" than six months ago, according to the retail chain.
Second, comments from regional Fed banks tell the opposite. In recent reports from Phil, Dallas and Richmond Feds they stated that consumption is decreasing:
It is interesting that the headlines talk about a decrease in inflation, but in the design and construction sector we have not seen a decrease in prices.
So, in a dry residual we have The index of industrial activity in the area of the Federal Reserve Bank of Texas has been in the red for 28 consecutive months, thereby breaking its anti-record of 2007/09 (27 months). In the service sector of the same region, there are 27 cons in a row, also more than 15 years ago (24). And this is in Texas, where industry and high-tech technologies are fleeing from California! That is, things are worse there than in Germany!
The Richmond Fed index has sunk to the bottom since April 2009 (ex CV19). The assessment of the current state by consumers in the United States (a study by the University of Michigan) is the worst in 2 years. Before that, such values were only in the fall of 2008:
Another example from common life - be my guest:
Now a few words about job market again. Yes, we've spoken last time about big official downward revision etc. But this is not the major problem, this is just a result that comes on surface. The way how this data is gathering shows the total mess. The problem is even bigger, because this mess stands in a period when the Fed has to make crucial decisions for the US economy.
That's why the reasonable question appears - maybe this is intentional mess? It is very comfortable, just choose the data that you want to justify policy change. Here is two examples. On charts below we see unemployment, initial claims and continued claims.
Unemployment shows increase for 1.5 mln people, while both claims stands flat. The question is -Why don't 1.5 million unemployed people apply for benefits? Hypothesis: Some data is incorrect. The unemployment data is from a household survey, which is collected by the Bureau of Labor Statistics, so to speak. The benefit data is from the Employment and Training Administration, so to speak, the Department of Employment and Trade.
The key question is which one is lying. Because historically, when unemployment increases, claims for benefits increase and repeat claims pile up. So now either the BLS, or ETA, or the population they are surveying is lying. The BLS data suggests that the recession has already begun and will only get worse. The ETA data suggests that there is no recession in sight.
The paradox is that according to data from, for example, Apollo, the economy is doing well, there are no signs of a slowdown. According to the Fed's Beige Book, things are not so rosy. And so on. A large number of sources indicate opposite trends.
We are not interested with juristic issues here. This is not our subject. The bottom line is that if the BLS data that everyone relies on is wrong, the Fed will begin easing monetary policy in September with a hot labor market and no economic slowdown. This will lead to nothing more than higher inflation. The growth of inflation, in turn, will require another response from the Fed in about a year and a half, that is, another increase in the rate (hello, three waves of inflation and rate increases in the 70s). This means that treasuries, especially long-term ones, which everyone will actively climb into against the backdrop of the rate reduction, will again begin to depreciate, burning in the fire of inflation. In short, central banks are making the right decision by buying gold.
The same problem you could see among JOLTS and unemployment. How can we trust JOLTS if with the decreasing of layoffs and the continued creation of jobs that are several times higher than layoffs, unemployment can grow? It turns out it can.
The fact that there are two contradictory studies is a medical fact. A mess with statistics is bad in itself. But it is doubly bad when this mess occurs during a crisis and it is unclear whether inflation will soar (the official data of which no one believes) or GDP will plummet (which is also drawn as best it can, including by manipulating the deflator).
We see that by many indicators, the crisis phenomena are approaching the lows of the covid times. Which at that time seemed catastrophic and certainly not regular. Macroeconomic data confirms these indicators only partially, but here the question arises about their adequacy. In particular, if we assume that Larry Summers' inflation estimates are adequate (although we think that it is even higher) then the recession in the American economy began in the fall of 2021.
In such a situation, the assessments of regional banks and consumers become completely adequate. And taking into account the admission of falsification misrepresentation of labor statistics, a natural question arises: why, in fact, can't it be that there are serious distortions in the inflation statistics? And if they are, then all the contradictions in the assessment of different statistical agencies disappear. Since we have written about distortions in inflation and labor statistics many times, for us the answer to the question about the dynamics of the global economy in general and the US economy in particular is obvious: since the fall of 2021, they have been in a state of decline. One can argue about its scale, but the trend itself is unambiguous!
EU SITUATION
Shortly about EU situation, because we're focused on coming ECB decision, which now we suggest still will be 25 points cut, although a month ago we thought, that maybe ECB will take the pause. Here are two reasons for our decision adjustment. If you remember we always point on wage inflation as a cornerstone of our view. But particularly inflation, including wages (at least official) was decreasing. Which lets ECB to act. Besides they do know that the Fed will cut the rate as well...
Second reason is very bad situation in manufacturing and industrial sector across the EU, but mostly in Germany. In fact, recent drop of inflation in majority of German lands is the result of industrial degradation. Sentiment remains weak across the EU.
CONCLUSION:
If the Fed would follow to our scenario and cut rate for 25 points in July, now it wouldn't appear in so delicate situation. If we follow to official statistics - everything goes fine, "consumer is strong", economy is growing, we're at the soft landing or even "no landing" at all. So, everything stands in favor of just 25 points cut. We suggest that at 99% the Fed will follow to this scenario. Although, by all means, overall situation demands 50 points cut.
Meantime, ECB has easy choice to be made. They have no headache. Lazy recession that in fact stands across EU triggers slowdown of inflation and 25 points cut now becomes our view as well.
Both decisions are 100% match to market expectations. It means that hardly we will see any big changes in EUR/USD levels because both decisions are totally priced-in already. I would say that even new the US inflation data, that we will get on 2nd week of September will bring no changes, if it will show unexpected jump. Decision is made already. Even very bad NFP numbers next week will trigger only short-term weakness in the USD. Because it will not change the Fed position for 25 points change.
In longer term perspective, until the end of the year slow upside action on EUR/USD is possible by two reasons. First is the pressure on the Fed will grow, as bad signs are only start coming on the surface. And nobody knows what other surprises will come, additionally to jobs revision last week. So, sentiment will change in favor of more dovish policy from the Fed, that should support EUR/USD in a few coming months. Second is - Japan. The December rate hike is still on the table, so next rate change narrowing will make new wave of pressure on the USD, even in a short term.
Overall situation could drastically change by only some strong external factor, say, some big financial collapse, social turmoil on US elections results, D. Trump imprisoning or some other geopolitical event, which we can't foresee. If everything goes relatively quiet, EUR/USD should remain on current levels with slow upside tendency. It could re-test 1.13-1.14 resistance area by the end of the year as the pace of the Fed cut and public pressure on it will be stronger than on ECB.
Once again we've got important data form the US - GDP, PCE, Consumption etc. We've got EU inflation data, which lets us to adjust our view on Sep-Oct. Now it becomes clear that we're going on soft scenario with 25 points cut from the Fed and ECB, so impact on EUR/USD will be minimal in September. At the same time, data that we've got looks arguable. Alternative data sources somehow show quite different picture. And on many indicators now we could delete "ex-Covid period" caveat, because situation is deteriorating further. All this stuff makes us keep the same idea, that current artificial prosperity gives the great chance to out of the US assets, which is most advanced investors are doing right now.
Market overview
The U.S. dollar gained due to month-end buying and technical factors after recent declines that pushed it to its weakest in more than a year, as traders awaited data that could dictate the pace of the Federal Reserve's imminent easing cycle. Sharp bouts of volatility hit foreign exchange markets this month as worries around a potential U.S. recession and hawkish signals from the Bank of Japan hammered the dollar and sent other major currencies soaring.
Investors also expect the Fed to begin cutting interest rates next month following Chair Jerome Powell's dovish tilt last week, with the debate now centered on whether or not it will do a super-sized 50-basis point cut, or the standard 25-bp easing. Current pricing indicated a 37% chance of the larger cut, unchanged from late on Tuesday, according to LSEG calculations. Markets also priced in about 105 bps of easing by the end of the year.
Given that markets have been expecting rate cuts from September for weeks now, the downside momentum on the dollar could be waning, with support built around 100.18/30 in the dollar index , said Matt Simpson, senior market analyst at City Index.
Data on Thursday showed the world's largest economy grew a little faster than expected in the second quarter, modestly reducing expectations for a larger 50 basis-point (bp) rate cut next month by the Federal Reserve. The report also added to growing expectations that the United States could avoid recession altogether, or go through just a mild one, analysts said.
Gross domestic product (GDP) grew at a 3.0% annualised rate in the second quarter, according to the Bureau of Economic Analysis' second estimate. That was an upward revision from the 2.8% rate reported last month, and higher than the 1.4% rise seen in the first quarter.
Consumer spending, which accounts for more than two-thirds of U.S. economic activity, rose 0.5% last month after advancing by an unrevised 0.3% in June, the Commerce Department's Bureau of Economic Analysis reported. After adjusting for inflation, consumer spending gained 0.4% after rising 0.3% in June, and implied that spending retained the momentum from the second quarter, when it helped to boost gross domestic product growth to a 3.0% annualized rate.
While the labor market momentum has slowed, it continues to generate decent wage growth that is helping to underpin spending. The slowdown in the labor market is mostly driven by a step down in hiring rather than layoffs. The saving rate dropped to 2.9%, the lowest level since June 2022, from 3.1% in June.
The number of people receiving benefits after an initial week of aid, a proxy for hiring, increased by 13,000 to a seasonally adjusted 1.868 million, near the levels seen in late 2021, suggesting persistent unemployment.
The euro was undermined overall by inflation data from Germany and Spain, which raised bets on the European Central Bank's rate easing outlook. Data showed, inflation fell in six important German states in August, suggesting national inflation could decline noticeably this month. It dropped to the slowest pace in a year in Spain. Money markets priced in 67 bps of ECB cuts in 2024 , from around 63 bps before the data.
On Friday after data showed a key inflation measure came in line with forecasts, while personal spending and income increased, supporting expectations the Federal Reserve will likely cut interest rates by a smaller 25 basis points next month, instead of 50 bps. Data showed the personal consumption expenditures (PCE) price index rose 0.2% last month, in line with expectations, after an unrevised 0.1% advance in June. In the 12 months through July, the PCE price index increased 2.5%, matching June's gain. Consumer spending was also 0.5% higher last month after expanding 0.3% in June.
Separate economic reports showed that the University of Michigan's monthly consumer sentiment index survey edged up to 67.9 in August from July's eight-month low of 66.4, snapping a four-month slide. U.S. consumers see inflation continuing to moderate in the next year, the survey showed, with a gauge of price growth expectations published on Friday at the lowest level in August since late 2020.
Speaking shortly on EU data - Inflation in the eurozone rose by 2.2% in August, core inflation by 2.8%, and unemployment by 6.4%. All in line with expectations and likely to force the ECB to cut rates in September.
The European Central Bank should avoid cutting interest rates too fast because it has yet to bring inflation down to 2% even if that goal is now in sight, ECB policymaker Joachim Nagel said on Thursday.
Despite such kind of hawkish statements, it seems that EU data doesn't contradict to September rate cut.
PROBLEMS IN DETAILS
We already in habit that the US statistics become to tricky to treat it literally. Every time we need to dig it to get the truth, so recent data is not an exception. Let's start from Consumer Spending as most easy to explain. So, official data shows 0.5% growth, last month was revisited to record 3% (!). But I like how it was said by Zero Hedge -
"The consumer is done. The saving rate is the 2nd lowest of the post QE era - spending is 0.5%, income is 0.3 and Personal savings craters from 3.1 to 2.9%"
That's it. You can't say it better. As we have clarity from this subject, could explain somebody how GDP could show 3% growth, where 70% comes from Consumption? The only answer is by undervaluing of real inflation. If you keep inflation low, you could overvalue other components and show positive growth. Here we will not speak again about inflation that we've considered many times before. All our readers know that inflation in the US is around 8%+ level. Which means that recent GDP should be ~ -2.5-3%.
Besides, indirect indicators show the same. Dollar General warns that low-income U.S. consumers are running out of money. The nation's largest discount store chain, with more than 20,000 locations in 48 states, painted a bleak financial picture for many of its customers. Low-income families feel more "financially constrained" than six months ago, according to the retail chain.
Second, comments from regional Fed banks tell the opposite. In recent reports from Phil, Dallas and Richmond Feds they stated that consumption is decreasing:
It is interesting that the headlines talk about a decrease in inflation, but in the design and construction sector we have not seen a decrease in prices.
So, in a dry residual we have The index of industrial activity in the area of the Federal Reserve Bank of Texas has been in the red for 28 consecutive months, thereby breaking its anti-record of 2007/09 (27 months). In the service sector of the same region, there are 27 cons in a row, also more than 15 years ago (24). And this is in Texas, where industry and high-tech technologies are fleeing from California! That is, things are worse there than in Germany!
The Richmond Fed index has sunk to the bottom since April 2009 (ex CV19). The assessment of the current state by consumers in the United States (a study by the University of Michigan) is the worst in 2 years. Before that, such values were only in the fall of 2008:
Another example from common life - be my guest:
Now a few words about job market again. Yes, we've spoken last time about big official downward revision etc. But this is not the major problem, this is just a result that comes on surface. The way how this data is gathering shows the total mess. The problem is even bigger, because this mess stands in a period when the Fed has to make crucial decisions for the US economy.
That's why the reasonable question appears - maybe this is intentional mess? It is very comfortable, just choose the data that you want to justify policy change. Here is two examples. On charts below we see unemployment, initial claims and continued claims.
Unemployment shows increase for 1.5 mln people, while both claims stands flat. The question is -Why don't 1.5 million unemployed people apply for benefits? Hypothesis: Some data is incorrect. The unemployment data is from a household survey, which is collected by the Bureau of Labor Statistics, so to speak. The benefit data is from the Employment and Training Administration, so to speak, the Department of Employment and Trade.
The key question is which one is lying. Because historically, when unemployment increases, claims for benefits increase and repeat claims pile up. So now either the BLS, or ETA, or the population they are surveying is lying. The BLS data suggests that the recession has already begun and will only get worse. The ETA data suggests that there is no recession in sight.
The paradox is that according to data from, for example, Apollo, the economy is doing well, there are no signs of a slowdown. According to the Fed's Beige Book, things are not so rosy. And so on. A large number of sources indicate opposite trends.
We are not interested with juristic issues here. This is not our subject. The bottom line is that if the BLS data that everyone relies on is wrong, the Fed will begin easing monetary policy in September with a hot labor market and no economic slowdown. This will lead to nothing more than higher inflation. The growth of inflation, in turn, will require another response from the Fed in about a year and a half, that is, another increase in the rate (hello, three waves of inflation and rate increases in the 70s). This means that treasuries, especially long-term ones, which everyone will actively climb into against the backdrop of the rate reduction, will again begin to depreciate, burning in the fire of inflation. In short, central banks are making the right decision by buying gold.
The same problem you could see among JOLTS and unemployment. How can we trust JOLTS if with the decreasing of layoffs and the continued creation of jobs that are several times higher than layoffs, unemployment can grow? It turns out it can.
The fact that there are two contradictory studies is a medical fact. A mess with statistics is bad in itself. But it is doubly bad when this mess occurs during a crisis and it is unclear whether inflation will soar (the official data of which no one believes) or GDP will plummet (which is also drawn as best it can, including by manipulating the deflator).
We see that by many indicators, the crisis phenomena are approaching the lows of the covid times. Which at that time seemed catastrophic and certainly not regular. Macroeconomic data confirms these indicators only partially, but here the question arises about their adequacy. In particular, if we assume that Larry Summers' inflation estimates are adequate (although we think that it is even higher) then the recession in the American economy began in the fall of 2021.
In such a situation, the assessments of regional banks and consumers become completely adequate. And taking into account the admission of
EU SITUATION
Shortly about EU situation, because we're focused on coming ECB decision, which now we suggest still will be 25 points cut, although a month ago we thought, that maybe ECB will take the pause. Here are two reasons for our decision adjustment. If you remember we always point on wage inflation as a cornerstone of our view. But particularly inflation, including wages (at least official) was decreasing. Which lets ECB to act. Besides they do know that the Fed will cut the rate as well...
Second reason is very bad situation in manufacturing and industrial sector across the EU, but mostly in Germany. In fact, recent drop of inflation in majority of German lands is the result of industrial degradation. Sentiment remains weak across the EU.
CONCLUSION:
If the Fed would follow to our scenario and cut rate for 25 points in July, now it wouldn't appear in so delicate situation. If we follow to official statistics - everything goes fine, "consumer is strong", economy is growing, we're at the soft landing or even "no landing" at all. So, everything stands in favor of just 25 points cut. We suggest that at 99% the Fed will follow to this scenario. Although, by all means, overall situation demands 50 points cut.
Meantime, ECB has easy choice to be made. They have no headache. Lazy recession that in fact stands across EU triggers slowdown of inflation and 25 points cut now becomes our view as well.
Both decisions are 100% match to market expectations. It means that hardly we will see any big changes in EUR/USD levels because both decisions are totally priced-in already. I would say that even new the US inflation data, that we will get on 2nd week of September will bring no changes, if it will show unexpected jump. Decision is made already. Even very bad NFP numbers next week will trigger only short-term weakness in the USD. Because it will not change the Fed position for 25 points change.
In longer term perspective, until the end of the year slow upside action on EUR/USD is possible by two reasons. First is the pressure on the Fed will grow, as bad signs are only start coming on the surface. And nobody knows what other surprises will come, additionally to jobs revision last week. So, sentiment will change in favor of more dovish policy from the Fed, that should support EUR/USD in a few coming months. Second is - Japan. The December rate hike is still on the table, so next rate change narrowing will make new wave of pressure on the USD, even in a short term.
Overall situation could drastically change by only some strong external factor, say, some big financial collapse, social turmoil on US elections results, D. Trump imprisoning or some other geopolitical event, which we can't foresee. If everything goes relatively quiet, EUR/USD should remain on current levels with slow upside tendency. It could re-test 1.13-1.14 resistance area by the end of the year as the pace of the Fed cut and public pressure on it will be stronger than on ECB.
