Sive Morten
Special Consultant to the FPA
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Fundamentals
No doubts, ECB decision and following comments have made the week. Also we've got some stats and Powell's comments but he mostly just confirmed Fed's commitment to fight inflation whatever cost. Great Britain events around Royal Family have mostly political meaning, so we discuss it tomorrow in Gold research.
Market overview
The ECB lifted its deposit rate to 0.75% from zero and raised the main refinancing rate to 1.25%, their highest level since 2011, as inflation is becoming increasingly broad and was at risk of getting entrenched.
WILLEM SELS, GLOBAL CIO, PRIVATE BANKING AND WEALTH, HSBC, LONDON
Goldman Sachs recommends investors short the euro against the Swiss franc following the European Central Bank's record rate increase as they think it likely the Swiss National Bank will want to take action to arrest the franc's depreciation. In a note published on Thursday, Goldman Sachs said they recommend a short EUR/CHF trade, targeting 0.955 on a tactical horizon, with a stop at 0.985.
Following are highlights of ECB President Christine Lagarde's few most important comments at a news conference after the policy meeting.
The European Central Bank must keep raising interest rates, prioritising its fight over painfully high inflation, even if that comes at a cost to growth, European Central Bank policymakers said on Friday.
Canada and Australia also lifted rates this week. Japan, which is yet to lift rates in this cycle, is the holdout dove among the 10 big developed economies. In total, the following central banks have so far raised rates in this cycle by a combined 1,615 basis points. And it is more to come. U.S. rate futures have priced in an 87% chance the Fed will hike by another 75 bps at its next meeting on Sept. 20-21, which would increase the Fed funds rate to 3.0% to 3.25%.
Federal Reserve Chair Jerome Powell reiterated that the U.S. central bank will continue to raise interest rates in order to tame surging inflation and warned against prematurely loosening monetary policy. In remarks at a Cato Institute conference, Powell said the Fed needs to keep going until it gets the job done and is "strongly committed" to bringing inflation down
Barclays, in its latest research note, said it is also forecasting a 75-bps hike this month, noting it sees an outside chance that a softer-than-expected August CPI number will swing the pendulum back toward 50 bps. July's CPI report showed a surprising moderation in prices that helped spur a rebound in stocks. That rally has since faded with Fed chair Jerome Powell warning that the Fed's single-minded fight to tame inflation could lead to economic pain.
On an annual basis, CPI increased by a weaker-than-expected 8.5% in July, with the inflation gauge coming in flat, month-over-month. Early estimates for August call for a 0.1% decline on a monthly basis, but wildcards such as volatile energy prices are keeping investors on edge.
By our (FPA) view, indeed, August CPI numbers could be softer because the US was able to decrease gasoline prices by burning record amount of its oil piggy bank. By October, the US Strategic Petroleum Reserve will shrink to a 40-year low as the White House taps it to put a lid on global oil prices:
As a result the US gasoline prices have turned down a bit. Partially because of demand drop due cosmic prices and ending of high vacation season. Partially is because of supply increasing:
Although it has happened in September but we get numbers for August, nevertheless, the price growth slowdown could be visible in August as well. In general as we've said in recent videos - it is nothing wrong with CPI stabilizing and decreasing. The energy component is too high, showing temporal outbreak, up to 30-40% inflation. But as any radical outbreak it can't stay for too long and sooner or later but has to converge to average structural inflation which now stands around 7-9%. The drop of the energy prices is natural and driven by few factors - providing of more supply from the US government, decreasing of the demand by companies and households because of too high price, which reduce inflationary pressure. At the same time, the structural component of inflation is becoming stronger, spreading over all spheres of economy and life. CPI could decrease to 7% in mid term but as Fed as US Government have no tools right now to push it back below 2%. We explained many times already the structure of current crisis. Until they cut M2 supply for 20% and crush public consumption, matching it to production capacity of its own economy - inflation remains stable.
Gas prices are much lower in the US than in the EU, although they start rising as all "free" extracted gas sending to EU, that leads to price rising in the US as well. The US now takes 1st place among LNG exporters, ahead of Katar, Russia and other countries.
The dollar fell to a more than one-week low on Friday as investors consolidated gains after a sharp rise against most currencies, ahead of a U.S. inflation report that could determine the size of the Federal Reserve's rate hike at this month's policy meeting.
But not only the energy prices bring problems in EU. We should not forget about derivative market. Now the hazard of margin calls for $1.5 Trln stands on horizon:
Thus, if EU will not provide necessary support, EU energy market could collapse. Just for comparison - the total amount of Covid stimulus was about 2.06 Trln and all of them were covered by just printing them:
Several European countries are providing billions of euros in support to power suppliers caught out by extra collateral payments on their trades - known as margin calls - but Equinor's estimate suggests such support is a fraction of the overall bill.
Second problem is big disbalances in EU financial system. As the EU financial space has high fragmentation, and due to the rising of interest rates, the new type of problems come on surface. Here is Bundesbank "Target 2" claims to other members of EU financial system of central banks. Obviously if Germany has the claim - some other banks, supposedly Italy, Spain Portugal and other high-indebted countries have liabilities. Now they already stand around EUR 1.2 Trln and will rise more as riskless rate is coming up.
Germany 2-year swap spread stands for ~ 140 basis points and keep going higher, suggesting 1.25% (current rate) +1.4% (Swap) = 2.65% yield in two years for now:
Conclusion:
As usual, to get a view on EUR/USD perspective we make a comparison of major fundamental issues. Energy prices we've shown above. The expectations on inflation rate is also drastically differ among them. An unprecedented divergence has emerged between the rate of inflation expected in one year’s time between the EU and US. While this can largely be explained by the difference in natural gas prices, the policy divergence between the US and EU may offer an explanation too: investors may believe that the Fed is more willing to move rates and deal with inflation than its counterpart in the EU. The natural gas shock is idiosyncratic to Europe, and has led to an unprecedented divergence in expected inflation between Germany and the US. A divergence in economic activity appears likely too, with the US outperforming.
Second issue, as we've mentioned - is the ability of the ECB to raise interest rates without prompting a rise in the yield spreads between the bonds of European peripherals and German Bunds. The last time the ECB’s deposit facility rate was above zero, the euro area was in the throes of a debt crisis. Things may have changed since then, but a significant increase in the policy rate could raise the question of debt sustainability once again.
Because of this, the ECB is likely to err on the side of caution when raising interest rates in the coming months. And this could also help to explain the current interest rate differential between the US and EU. Moreover, the high price of natural gas in Europe has more to do with supply disruption than with demand – meaning that even sharp increases in the policy rate may not do much either to lower the price of European natural gas or to reduce the first-round impact of that on inflation. The fear is that the rise in gas prices could have second-round effects, and push up the prices of other goods and services, as well as wages.
Equally, the ECB must also contend with a negative economic outlook for the single currency bloc, in part due to the hit to consumers’ disposable incomes that the rise in energy prices will have. Indeed, Fathom Consulting thinks that a recession in Europe is almost inevitable, and may already have begun – the question is how deep it will be, not whether it will happen. On this basis there would be little point in the ECB hiking rates aggressively and exacerbating the downturn, especially if this policy lever is unable to do much to reduce the first-round impacts of gas prices on inflation — and if the economic downturn dampens second-round price pressures without the need for central bank intervention.
The ECB will face a series of difficult questions when setting interest rates in the coming months. These factors, coupled with possible gas shortages and the related economic damage they would cause, lead us to conclude that the economic prospects in the US for the year ahead, while not too great themselves, are rosier than those in the EU.
This leads us to suggestion that any upside action on EUR/USD now is temporal and should be treated as pullback and make us to keep 0.90 target intact.
Technical analysis on the post below...
No doubts, ECB decision and following comments have made the week. Also we've got some stats and Powell's comments but he mostly just confirmed Fed's commitment to fight inflation whatever cost. Great Britain events around Royal Family have mostly political meaning, so we discuss it tomorrow in Gold research.
Market overview
The ECB lifted its deposit rate to 0.75% from zero and raised the main refinancing rate to 1.25%, their highest level since 2011, as inflation is becoming increasingly broad and was at risk of getting entrenched.
WILLEM SELS, GLOBAL CIO, PRIVATE BANKING AND WEALTH, HSBC, LONDON
Goldman Sachs recommends investors short the euro against the Swiss franc following the European Central Bank's record rate increase as they think it likely the Swiss National Bank will want to take action to arrest the franc's depreciation. In a note published on Thursday, Goldman Sachs said they recommend a short EUR/CHF trade, targeting 0.955 on a tactical horizon, with a stop at 0.985.
Following are highlights of ECB President Christine Lagarde's few most important comments at a news conference after the policy meeting.
The European Central Bank must keep raising interest rates, prioritising its fight over painfully high inflation, even if that comes at a cost to growth, European Central Bank policymakers said on Friday.
Canada and Australia also lifted rates this week. Japan, which is yet to lift rates in this cycle, is the holdout dove among the 10 big developed economies. In total, the following central banks have so far raised rates in this cycle by a combined 1,615 basis points. And it is more to come. U.S. rate futures have priced in an 87% chance the Fed will hike by another 75 bps at its next meeting on Sept. 20-21, which would increase the Fed funds rate to 3.0% to 3.25%.
Federal Reserve Chair Jerome Powell reiterated that the U.S. central bank will continue to raise interest rates in order to tame surging inflation and warned against prematurely loosening monetary policy. In remarks at a Cato Institute conference, Powell said the Fed needs to keep going until it gets the job done and is "strongly committed" to bringing inflation down
The Fed "could very well do" a 75-bps increase at its September meeting, said Chicago Fed President Charles Evans on Thursday, who has tended to be on the dovish side of monetary policy debates. While Fed Governor Christopher Waller said on Friday that the U.S. central bank should be aggressive with rate hikes while the economy "can take a punch."
Barclays, in its latest research note, said it is also forecasting a 75-bps hike this month, noting it sees an outside chance that a softer-than-expected August CPI number will swing the pendulum back toward 50 bps. July's CPI report showed a surprising moderation in prices that helped spur a rebound in stocks. That rally has since faded with Fed chair Jerome Powell warning that the Fed's single-minded fight to tame inflation could lead to economic pain.
On an annual basis, CPI increased by a weaker-than-expected 8.5% in July, with the inflation gauge coming in flat, month-over-month. Early estimates for August call for a 0.1% decline on a monthly basis, but wildcards such as volatile energy prices are keeping investors on edge.
By our (FPA) view, indeed, August CPI numbers could be softer because the US was able to decrease gasoline prices by burning record amount of its oil piggy bank. By October, the US Strategic Petroleum Reserve will shrink to a 40-year low as the White House taps it to put a lid on global oil prices:
As a result the US gasoline prices have turned down a bit. Partially because of demand drop due cosmic prices and ending of high vacation season. Partially is because of supply increasing:
Although it has happened in September but we get numbers for August, nevertheless, the price growth slowdown could be visible in August as well. In general as we've said in recent videos - it is nothing wrong with CPI stabilizing and decreasing. The energy component is too high, showing temporal outbreak, up to 30-40% inflation. But as any radical outbreak it can't stay for too long and sooner or later but has to converge to average structural inflation which now stands around 7-9%. The drop of the energy prices is natural and driven by few factors - providing of more supply from the US government, decreasing of the demand by companies and households because of too high price, which reduce inflationary pressure. At the same time, the structural component of inflation is becoming stronger, spreading over all spheres of economy and life. CPI could decrease to 7% in mid term but as Fed as US Government have no tools right now to push it back below 2%. We explained many times already the structure of current crisis. Until they cut M2 supply for 20% and crush public consumption, matching it to production capacity of its own economy - inflation remains stable.
Gas prices are much lower in the US than in the EU, although they start rising as all "free" extracted gas sending to EU, that leads to price rising in the US as well. The US now takes 1st place among LNG exporters, ahead of Katar, Russia and other countries.
The dollar fell to a more than one-week low on Friday as investors consolidated gains after a sharp rise against most currencies, ahead of a U.S. inflation report that could determine the size of the Federal Reserve's rate hike at this month's policy meeting.
But not only the energy prices bring problems in EU. We should not forget about derivative market. Now the hazard of margin calls for $1.5 Trln stands on horizon:
Thus, if EU will not provide necessary support, EU energy market could collapse. Just for comparison - the total amount of Covid stimulus was about 2.06 Trln and all of them were covered by just printing them:
Several European countries are providing billions of euros in support to power suppliers caught out by extra collateral payments on their trades - known as margin calls - but Equinor's estimate suggests such support is a fraction of the overall bill.
Second problem is big disbalances in EU financial system. As the EU financial space has high fragmentation, and due to the rising of interest rates, the new type of problems come on surface. Here is Bundesbank "Target 2" claims to other members of EU financial system of central banks. Obviously if Germany has the claim - some other banks, supposedly Italy, Spain Portugal and other high-indebted countries have liabilities. Now they already stand around EUR 1.2 Trln and will rise more as riskless rate is coming up.
Germany 2-year swap spread stands for ~ 140 basis points and keep going higher, suggesting 1.25% (current rate) +1.4% (Swap) = 2.65% yield in two years for now:
Conclusion:
As usual, to get a view on EUR/USD perspective we make a comparison of major fundamental issues. Energy prices we've shown above. The expectations on inflation rate is also drastically differ among them. An unprecedented divergence has emerged between the rate of inflation expected in one year’s time between the EU and US. While this can largely be explained by the difference in natural gas prices, the policy divergence between the US and EU may offer an explanation too: investors may believe that the Fed is more willing to move rates and deal with inflation than its counterpart in the EU. The natural gas shock is idiosyncratic to Europe, and has led to an unprecedented divergence in expected inflation between Germany and the US. A divergence in economic activity appears likely too, with the US outperforming.
Second issue, as we've mentioned - is the ability of the ECB to raise interest rates without prompting a rise in the yield spreads between the bonds of European peripherals and German Bunds. The last time the ECB’s deposit facility rate was above zero, the euro area was in the throes of a debt crisis. Things may have changed since then, but a significant increase in the policy rate could raise the question of debt sustainability once again.
Because of this, the ECB is likely to err on the side of caution when raising interest rates in the coming months. And this could also help to explain the current interest rate differential between the US and EU. Moreover, the high price of natural gas in Europe has more to do with supply disruption than with demand – meaning that even sharp increases in the policy rate may not do much either to lower the price of European natural gas or to reduce the first-round impact of that on inflation. The fear is that the rise in gas prices could have second-round effects, and push up the prices of other goods and services, as well as wages.
Equally, the ECB must also contend with a negative economic outlook for the single currency bloc, in part due to the hit to consumers’ disposable incomes that the rise in energy prices will have. Indeed, Fathom Consulting thinks that a recession in Europe is almost inevitable, and may already have begun – the question is how deep it will be, not whether it will happen. On this basis there would be little point in the ECB hiking rates aggressively and exacerbating the downturn, especially if this policy lever is unable to do much to reduce the first-round impacts of gas prices on inflation — and if the economic downturn dampens second-round price pressures without the need for central bank intervention.
The ECB will face a series of difficult questions when setting interest rates in the coming months. These factors, coupled with possible gas shortages and the related economic damage they would cause, lead us to conclude that the economic prospects in the US for the year ahead, while not too great themselves, are rosier than those in the EU.
This leads us to suggestion that any upside action on EUR/USD now is temporal and should be treated as pullback and make us to keep 0.90 target intact.
Technical analysis on the post below...
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