Sive Morten
Special Consultant to the FPA
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Fundamentals
Important statistics has been released this week, but numbers accurately fit to our fundamental view, brought no surprises. As EU inflation jump to 9.1% as the US unemployment increase from 3.5 to 3.7% is not unexpected. We've shown you direct numbers from big companies, that they contract labour force, so it was just a question of time, when reality finds the way to statistics. And here is another episode - Snap intends to fire 20% employees
Market overview
A rally in world stocks flagged on Friday, while the U.S. dollar retreated from a 24-year high on the yen, after data that showed the U.S. labor market is starting to loosen failed to allay investor fears about aggressive interest rate hikes from the Federal Reserve.
News that Russia has scrapped a Saturday deadline to resume flows via a major gas supply route to Germany, deepening Europe's difficulties in securing winter fuel, further soured sentiment in the United States ahead of the long Labor Day weekend. Data showed on Friday that U.S. employers hired more workers than expected in August, but moderate wage growth and a rise in the unemployment rate to 3.7% suggested there could be less pressure on the Federal Reserve to deliver a third 75-basis-point interest rate hike this month.
The dollar eased from a 20-year high on Friday after data showed the pace of U.S. hiring rose more than expected in August, but wage growth moderated and unemployment ticked higher, giving the Federal Reserve some wiggle room when it raises interest rates later this month. The U.S. economy added 315,000 jobs in August, data showed, topping the consensus forecast of 300,000 jobs by economists polled by Reuters, and marking the 20th straight month of job growth.
Softer data is seen as alleviating the need for the Fed to raise rates to aggressively curb inflation, moves which the market worries could bring on a recession. Indeed, some analysts said the latest jobs data kept alive the debate about whether the Fed will raise interest rates by 50 basis points later this month, or 75 basis points. Fed funds futures were unchanged after the jobs report and are pricing a 75% chance that the Fed hikes rates by 75 basis points this month, according to Refinitiv data.
Data from the Institute for Supply Management (ISM) showed U.S. manufacturing grew steadily in August as employment and new orders rebounded, while a further easing in price pressures strengthened views that inflation has likely peaked.
But hawkish remarks from Secretary of Treasury Janet Yellen on Friday after the jobs data, where she was quoted as saying that U.S. inflation remained too high and that it is the Fed's job to bring it down, dampened the initial euphoria. Fresh lockdowns in China had earlier fueled concerns about global growth, and high energy costs as a result of the war in Ukraine are weighing on Europe.
Equity funds recorded the fourth largest weekly outflow of 2022, while bond funds saw investors pull out money for a second straight week, BofA said in a note. Here is our another 'magic" chart, showing real-time comparison current S&P dynamic with 2006-2008 subprime crisis.
In Europe, fears of a recession are increasing, with a survey showing on Thursday that manufacturing activity across the euro zone declined again last month, as consumers feeling the pinch from a deepening cost of living crisis cut spending. The European Central Bank is due to meet next week, with money markets betting on an unprecedented 75 basis point hike.
Manufacturing activity across the euro zone shrank for a second month in August, according to a survey, and while European energy costs have softened slightly this week, they remain at highly elevated levels.
Goldman Sachs expects the European Central Bank to raise interest rates by 75 basis points at its policy meeting next week after data on Wednesday showed euro zone inflation hitting a new record high. The bank's economists also raised where they expect rates to peak, to 1.75% in February 2023, from 1.50% previously.
Other banks including Nordea and Danske Bank have also said they expect a 75 basis-point hike.
The U.S. Federal Reserve will not back away from "talking tough" on the markets until there is significant progress on inflation, which will perpetuate volatility into mid-2023, UBS Global Wealth Management's chief investment officer said on Monday. Haefele expected the Fed to hike an additional 100 basis points this year, but did not see major recession in the United States.
US Crisis update
Another dam has burst, with the two-year U.S. Treasury yield's rise to a 15-year high just shy of 3.50% flooding global markets with extra uncertainty and fear. The scale of the two-year U.S. bond yield rise is truly remarkable - a year ago it was as low as 16 basis points, today it nudged 350 bps. With the Fed likely to continue tightening, few would bet against it rising further.
Bloomberg Global Bond index falls for 20% since 2021 - the first in generation bear bond trend starts:
US Bond index falls for 11.5%, which is also poor result:
While Mortage rates are running into the sky while real estate market is falling apart
A storm is brewing in the housing market. - Home sales have fallen by 20% - Mortgage demand has fallen to a 22-year low - Even Blackstone has stopped buying homes! Lawrence Yun, chief economist at the National Association of Realtors, said we are in a "housing recession."
While households' mortgage expenses rises to new top:
What's in the EU?
As usual we stay focused on the US situation and use it as starting point to make a comparison of other economies. Now lets take a look at EU situation directly. Charts below obviously could show why we suggest that ECB and EU economy in general lagging behind the US and have significantly lower power reserve.
The Dutch September gas delivery contract dropped as much as 11% as Germany's economy minister said he expected prices to fall soon as Germany is making progress on its storage targets, with facilities nearly 83% full and set to hit its 85% Oct. 1 goal in early September. Supply fears pushed natural gas futures in Europe 38% higher last week, adding further fuel to the inflation bonfire as a three-day halt to Russian natural gas supplies through its main pipeline to Europe will start on Wednesday.
German benchmark power prices, meanwhile, breached 1,000 euros per megawatt hour for the first time on Monday.
This processes make direct impact on people's wealth, destroying real income. Just to explain you the scale of the crisis, the drop in real incomes of the population in Russia at the "bottom" of 2008 was just 7%. Such a drop literally has brought down the automotive industry, the real estate market, and the banking industry.
However, all this is still ahead for Europe, and there is no good way out of the crisis. The traditional recipe is to increase budget spending by borrowing. But the southern countries of Europe are again at the epicenter of the crisis. At current rates, the only investor in the bonds of these countries is the ECB. And this means the continuation of money printing, and inflation heating up, including in the "healthy" economies of the region.
At the same time, people are loosing its savings, keep trust in own government and trying to hold usual consumption level:
While the price for the food is growing right now for 16% (YoY), with two-digits general inflation in majority of EU members. Here is great chart, showing the major difference in inflation in US and EU. Take a look that energy component is much smaller in the US, while fiscal activity is greater. Also the US have much better demand/supply balance. This chart clearly explains the pain points of the EU and why EUR has no chances against the USD in nearest time.
In general, the processes that we see in EU now is coming out of economical common sense. They care clear signs of political hysteria. We do not analyse recent G7 initiatives on gas, oil price limits because they care no economical sense and are purely political.
Speaking on difficult situation of households as in the US we record mortage rates, top consumer loans, as in EU - the drop in savings means that households still has faith to government and authorities and believe that the situation will change for the better. Therefore, they try to keep the same level of consumption. As real income falls, they try to do it by spending savings.
It is obvious that no improvements are likely to happen in coming few years, we can expect that at some point households in Germany (and in EU in general) will dramatically change their behavior, significantly increase savings (above the average, if it will be possible at all ) and drastically cut consumption. This will cause a sharp drop in German GDP, and this drop will be immediately visible in the statistics.
So, a sharp change in consumer behavior of households is called panic. Today, there is no panic in the world, people are annoyed, worried, starting to think — but so far they keep trusting the authorities. But somewhere by spring, the abscess will open and panic will begin. Perhaps it could be caused by a collapse in speculative markets.
Conclusion
So, the first signs of problems are becoming visible on the US Bond market. Data shows real drop in demand that we've warned about few months ago, as toxic negative yields destroy any interest among investors to buy it. The negative process should accelerate. At the same time, the destructive processes are spreading across all economy spheres, particularly real estate. Rising unemployment has not become a surprise as well, because we've expected this change even last month, but it has happened only in July. As vacation time is coming to an end, the problems should become sharper. Recent dynamic just confirms our major long-term view.
We suggest that Fed stands strongly focused on inflation. J. Powell has spoken about coming employment drop a month ago, so it should not become a surprise for them either. Thus, we think that unemployment, drop in business sentiment should not stop them from radical steps in rate change. We agree with UBS position and think that September change should be at 0.75%, which is mostly priced-in.
The only temptation to change just for 0.5% is the stock market. Changing rate just for 0.5% Fed could provide support to the stock market without spending a single cent. If they decide to save some existing reserves and to go in this way... maybe it could be 0.5% but, our suggestion that they could follow this measure closer to November elections, on the next meeting. Whatever decision will be made - existed Fed reserves let them to feel more or less come and confident, at least within 6-9 months. Using the reserves easily could support stock market and even keep common practice of new debt auctions and QT programme.
EU cares the major burden of energy crisis, EU step for the same 0.75% looks like a pie to the elephant and can't significantly change the situation, when CPI, PPI numbers stand above 30% and average inflation is about 10%. EU is hopelessly behind the US with no chances to change EUR/USD trend any time soon. So, we keep our mid term 0.98 target valid. With the stop of Nord Stream I, big deficit of alternative energy sources and starting of cold time the tension will keep rising. And, social unrest, tensions likely to come, additionally to economical and political problems.
Important statistics has been released this week, but numbers accurately fit to our fundamental view, brought no surprises. As EU inflation jump to 9.1% as the US unemployment increase from 3.5 to 3.7% is not unexpected. We've shown you direct numbers from big companies, that they contract labour force, so it was just a question of time, when reality finds the way to statistics. And here is another episode - Snap intends to fire 20% employees
Market overview
A rally in world stocks flagged on Friday, while the U.S. dollar retreated from a 24-year high on the yen, after data that showed the U.S. labor market is starting to loosen failed to allay investor fears about aggressive interest rate hikes from the Federal Reserve.
News that Russia has scrapped a Saturday deadline to resume flows via a major gas supply route to Germany, deepening Europe's difficulties in securing winter fuel, further soured sentiment in the United States ahead of the long Labor Day weekend. Data showed on Friday that U.S. employers hired more workers than expected in August, but moderate wage growth and a rise in the unemployment rate to 3.7% suggested there could be less pressure on the Federal Reserve to deliver a third 75-basis-point interest rate hike this month.
The dollar eased from a 20-year high on Friday after data showed the pace of U.S. hiring rose more than expected in August, but wage growth moderated and unemployment ticked higher, giving the Federal Reserve some wiggle room when it raises interest rates later this month. The U.S. economy added 315,000 jobs in August, data showed, topping the consensus forecast of 300,000 jobs by economists polled by Reuters, and marking the 20th straight month of job growth.
Softer data is seen as alleviating the need for the Fed to raise rates to aggressively curb inflation, moves which the market worries could bring on a recession. Indeed, some analysts said the latest jobs data kept alive the debate about whether the Fed will raise interest rates by 50 basis points later this month, or 75 basis points. Fed funds futures were unchanged after the jobs report and are pricing a 75% chance that the Fed hikes rates by 75 basis points this month, according to Refinitiv data.
Data from the Institute for Supply Management (ISM) showed U.S. manufacturing grew steadily in August as employment and new orders rebounded, while a further easing in price pressures strengthened views that inflation has likely peaked.
"It comes as no surprise that the dollar hit a fresh record high on both safe-haven flows from global economic weakness and as a resilient U.S. economy paves the way for the Fed to remain aggressive," said Edward Moya, chief market analyst at Oanda. King dollar has awoken from a nap and that could spell a lot more pain for the European currencies," he said.
"We continue to expect the Fed to hike by 50bp in September and November. This report contained enough good news for the Fed," analysts at Bank of America said in a note to clients.
But hawkish remarks from Secretary of Treasury Janet Yellen on Friday after the jobs data, where she was quoted as saying that U.S. inflation remained too high and that it is the Fed's job to bring it down, dampened the initial euphoria. Fresh lockdowns in China had earlier fueled concerns about global growth, and high energy costs as a result of the war in Ukraine are weighing on Europe.
"The market is laser-focused on how aggressive the Fed is going to be with its hiking cycle," said Giles Coghlan, chief currency analyst at HYCM, adding that expectations for higher rates have solidified since a speech last week by Fed Chair Jerome Powell at the Jackson Hole central banking conference. The markets are worried about "China slowing, euro zone recession and a hawkish Fed," he said.
Equity funds recorded the fourth largest weekly outflow of 2022, while bond funds saw investors pull out money for a second straight week, BofA said in a note. Here is our another 'magic" chart, showing real-time comparison current S&P dynamic with 2006-2008 subprime crisis.
In Europe, fears of a recession are increasing, with a survey showing on Thursday that manufacturing activity across the euro zone declined again last month, as consumers feeling the pinch from a deepening cost of living crisis cut spending. The European Central Bank is due to meet next week, with money markets betting on an unprecedented 75 basis point hike.
Manufacturing activity across the euro zone shrank for a second month in August, according to a survey, and while European energy costs have softened slightly this week, they remain at highly elevated levels.
Goldman Sachs expects the European Central Bank to raise interest rates by 75 basis points at its policy meeting next week after data on Wednesday showed euro zone inflation hitting a new record high. The bank's economists also raised where they expect rates to peak, to 1.75% in February 2023, from 1.50% previously.
"Given today's stronger-than-expected inflation data -together with hawkish commentary and upside risks to near-term growth - we now expect the Governing Council to hike by 75bp at the September meeting," the U.S. bank said in a note on Wednesday.
Other banks including Nordea and Danske Bank have also said they expect a 75 basis-point hike.
"Markets are focusing on discussing the message of 'coordinated tightening' from Jackson Hole as ECB and Fed appear to have re-committed to creating price stability: yields are shooting higher and risk assets are quite a bit lower since last week," said Lars Sparreso Lykke Merklin, senior analyst at Danske Bank.
The U.S. Federal Reserve will not back away from "talking tough" on the markets until there is significant progress on inflation, which will perpetuate volatility into mid-2023, UBS Global Wealth Management's chief investment officer said on Monday. Haefele expected the Fed to hike an additional 100 basis points this year, but did not see major recession in the United States.
"We do think that inflation is going to start to come down," said Haefele, who runs investment strategy for the world's largest wealth manager with $2.8 trillion in assets.
US Crisis update
Another dam has burst, with the two-year U.S. Treasury yield's rise to a 15-year high just shy of 3.50% flooding global markets with extra uncertainty and fear. The scale of the two-year U.S. bond yield rise is truly remarkable - a year ago it was as low as 16 basis points, today it nudged 350 bps. With the Fed likely to continue tightening, few would bet against it rising further.
Bloomberg Global Bond index falls for 20% since 2021 - the first in generation bear bond trend starts:
US Bond index falls for 11.5%, which is also poor result:
While Mortage rates are running into the sky while real estate market is falling apart
A storm is brewing in the housing market. - Home sales have fallen by 20% - Mortgage demand has fallen to a 22-year low - Even Blackstone has stopped buying homes! Lawrence Yun, chief economist at the National Association of Realtors, said we are in a "housing recession."
While households' mortgage expenses rises to new top:
What's in the EU?
As usual we stay focused on the US situation and use it as starting point to make a comparison of other economies. Now lets take a look at EU situation directly. Charts below obviously could show why we suggest that ECB and EU economy in general lagging behind the US and have significantly lower power reserve.
The Dutch September gas delivery contract dropped as much as 11% as Germany's economy minister said he expected prices to fall soon as Germany is making progress on its storage targets, with facilities nearly 83% full and set to hit its 85% Oct. 1 goal in early September. Supply fears pushed natural gas futures in Europe 38% higher last week, adding further fuel to the inflation bonfire as a three-day halt to Russian natural gas supplies through its main pipeline to Europe will start on Wednesday.
German benchmark power prices, meanwhile, breached 1,000 euros per megawatt hour for the first time on Monday.
"I struggle to understand the sense of sharp (ECB) interest rate hikes. The big problem is energy supply, and right now it doesn't look we can get out any time soon," said Carlo Franchini, head of institutional clients at Banca Ifigest in Milan. Such a sharp rise in such a complicated economic picture will put companies and households in a very difficult situation. Trading volumes are really thin. I think it would be worth sell into any rally even though the word rally doesn't seem appropriate."
This processes make direct impact on people's wealth, destroying real income. Just to explain you the scale of the crisis, the drop in real incomes of the population in Russia at the "bottom" of 2008 was just 7%. Such a drop literally has brought down the automotive industry, the real estate market, and the banking industry.
However, all this is still ahead for Europe, and there is no good way out of the crisis. The traditional recipe is to increase budget spending by borrowing. But the southern countries of Europe are again at the epicenter of the crisis. At current rates, the only investor in the bonds of these countries is the ECB. And this means the continuation of money printing, and inflation heating up, including in the "healthy" economies of the region.
At the same time, people are loosing its savings, keep trust in own government and trying to hold usual consumption level:
While the price for the food is growing right now for 16% (YoY), with two-digits general inflation in majority of EU members. Here is great chart, showing the major difference in inflation in US and EU. Take a look that energy component is much smaller in the US, while fiscal activity is greater. Also the US have much better demand/supply balance. This chart clearly explains the pain points of the EU and why EUR has no chances against the USD in nearest time.
In general, the processes that we see in EU now is coming out of economical common sense. They care clear signs of political hysteria. We do not analyse recent G7 initiatives on gas, oil price limits because they care no economical sense and are purely political.
Speaking on difficult situation of households as in the US we record mortage rates, top consumer loans, as in EU - the drop in savings means that households still has faith to government and authorities and believe that the situation will change for the better. Therefore, they try to keep the same level of consumption. As real income falls, they try to do it by spending savings.
It is obvious that no improvements are likely to happen in coming few years, we can expect that at some point households in Germany (and in EU in general) will dramatically change their behavior, significantly increase savings (above the average, if it will be possible at all ) and drastically cut consumption. This will cause a sharp drop in German GDP, and this drop will be immediately visible in the statistics.
So, a sharp change in consumer behavior of households is called panic. Today, there is no panic in the world, people are annoyed, worried, starting to think — but so far they keep trusting the authorities. But somewhere by spring, the abscess will open and panic will begin. Perhaps it could be caused by a collapse in speculative markets.
Conclusion
So, the first signs of problems are becoming visible on the US Bond market. Data shows real drop in demand that we've warned about few months ago, as toxic negative yields destroy any interest among investors to buy it. The negative process should accelerate. At the same time, the destructive processes are spreading across all economy spheres, particularly real estate. Rising unemployment has not become a surprise as well, because we've expected this change even last month, but it has happened only in July. As vacation time is coming to an end, the problems should become sharper. Recent dynamic just confirms our major long-term view.
We suggest that Fed stands strongly focused on inflation. J. Powell has spoken about coming employment drop a month ago, so it should not become a surprise for them either. Thus, we think that unemployment, drop in business sentiment should not stop them from radical steps in rate change. We agree with UBS position and think that September change should be at 0.75%, which is mostly priced-in.
The only temptation to change just for 0.5% is the stock market. Changing rate just for 0.5% Fed could provide support to the stock market without spending a single cent. If they decide to save some existing reserves and to go in this way... maybe it could be 0.5% but, our suggestion that they could follow this measure closer to November elections, on the next meeting. Whatever decision will be made - existed Fed reserves let them to feel more or less come and confident, at least within 6-9 months. Using the reserves easily could support stock market and even keep common practice of new debt auctions and QT programme.
EU cares the major burden of energy crisis, EU step for the same 0.75% looks like a pie to the elephant and can't significantly change the situation, when CPI, PPI numbers stand above 30% and average inflation is about 10%. EU is hopelessly behind the US with no chances to change EUR/USD trend any time soon. So, we keep our mid term 0.98 target valid. With the stop of Nord Stream I, big deficit of alternative energy sources and starting of cold time the tension will keep rising. And, social unrest, tensions likely to come, additionally to economical and political problems.