Sive Morten
Special Consultant to the FPA
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Fundamentals
This week has become extremely important for all markets. We've got epic GDP and PCE numbers. At first glance they are nothing different from the data that we've got previously, but as we will explain below, these numbers are very special due overall economical and political environment. These numbers push all power groups inside the US to action which will make direct impact on all market in perspective of 2-3 months.
Market overview
The U.S. dollar fell on Thursday, except against the yen, vacillating after data showed unexpected slowing in economic growth and an unwelcome inflation acceleration, potentially tying the Federal Reserve's hands on a pivot to easier interest rates, although some loses have been compensated on Friday. The Commerce Department reported that U.S. gross domestic product grew at a 1.6% annualized rate in the January-March period, slower than the 2.4% rate expected by economists polled by Reuters. The report also showed that underlying inflation as measured by the core personal consumption expenditures (PCE) price index rose 3.7% in the first quarter, eclipsing forecasts for a 3.4% rise:
Following the GDP data, the U.S. rate futures market was pricing in a 58% chance of a Fed rate cut in September, down from 70% late on Wednesday, according to CME Group's FedWatch tool.
The euro, trading just above $1.06, is by no means among the weakest major currencies versus the dollar. But notably, banks have recently downgraded euro/dollar forecasts. Before the latest U.S. inflation data, markets had largely seen the European Central Bank and Federal Reserve as moving in lockstep on rate cuts. Now the ECB is expected to cut in June and an anticipated Fed cut in September has pushed the euro to five-month lows.
European Central Bank officials are sticking to plans to cut interest rates multiple times this year, even as higher U.S. inflation delays a pivot to looser policy by the U.S. Federal Reserve and tensions in the Middle East keep oil prices high. Nearly all ECB officials from the currency bloc's 20 national central banks have been more explicit, saying they expect further rate cuts to follow as inflation in the euro zone gradually declines to hit the ECB's 2% target by next year.
Euro zone lending continued to stagnate in March and consumers trimmed their inflation expectations as record-high borrowing costs kept putting the brakes on the euro zone's economy, European Central Bank (ECB) reports showed on Friday. The data was likely to cement the ECB's plan to start cutting interest rates in June after seeing inflation fall to just above its 2% goal and economic growth come to a standstill. Bank loans to companies increased by just 0.4% in March, compared with 0.3% a month earlier. Growth in lending to households, which had been more resilient until last summer, set a new decade-low at 0.2%, from 0.3% in February:
The latest developments in the Middle East and United States were generally seen as a reason for greater caution but did not fundamentally change the picture in the euro zone, French central bank governor Francois Villeroy de Galhau argued. Inflation in the euro zone has been falling in all categories apart from services.
Euro zone inflation and economic growth data due out on Tuesday next week could strengthen market bets for the European Central Bank to lower its deposit rate from a record 4% in June. Gross domestic product in the euro zone currency bloc probably expanded by just 0.1% in the first quarter, year-on-year, economists polled by Reuters expect the data to show.
U.S. regulators have seized Republic First Bancorp and agreed to sell it to Fulton Bank, underscoring the challenges facing regional banks a year after the collapse of three peers. Philadelphia-based Republic First, which had abandoned funding talks with a group of investors, was seized by the Pennsylvania Department of Banking and Securities.Republic Bank had about $6 billion in total assets and $4 billion in total deposits, as of Jan. 31, 2024. The FDIC estimated the cost of the failure to its fund will be $667 million. The decision marks the latest U.S. regional bank failure following the unexpected collapses of three lenders - Silicon Valley and Signature in March 2023 and First Republic in May. Losses on CRE loans (!), NYCB's core business, sparked a rout that wiped nearly $6 billion off its market value and sparked ratings downgrades.
A growing number of Americans have seen their savings dwindle as rising prices squeeze budgets while interest rates stay high, bankers and economists said. The deterioration in household finances for those earning less than $45,000 contrasts with financial resilience among those on higher incomes. Austan Goolsbee, Chicago Federal Reserve Bank President, said on Friday that consumer delinquencies were one of the most concerning economic data points at the moment.
As U.S. inflation worries grow, some investors are preparing for the 10-year U.S. Treasury yield to breach a 16-year high of 5% hit last October. The yield on the benchmark 10-year note is up 80 basis points this year and last stood at 4.70%, a five-month high. Global fund managers' fixed income allocations in the latest BofA Global Research survey are down to their lowest level since 2003. Bearish Treasury positioning among some classes of hedge funds stands at its highest level of the year, according to BofA data, even as other asset managers have increased their bullish bets.
Hints of whether the Fed still expects interest rate cuts at some point this year takes centre-stage for investors at the central bank's meeting that concludes on Wednesday next week. Rate action is unlikely, but comments from Fed Chair Jerome Powell about the potential for policy easing later in 2024 will be scrutinized.
WHY RECENT GDP/PCE DATA IS SO IMPORTANT
As I briefly said in video on Friday - it seems that the US is turning on the way to stagflation which is the worst among all the others. And not only we, here at FPA think so. At the same time, for the truth sake - we're just getting confirmation of our suggestions that we've made 6-8 months ago when this story has turned to active stage. The structural crisis itself has started even in 2021. Bloomberg writes -US Economy Slows and Inflation Jumps, Damping Soft-Landing Hopes(!):
The figures represent a notable loss of momentum at the start of 2024 after the economy wrapped up a surprisingly strong year. With the inflation pickup, Federal Reserve policymakers — who were already expected to hold interest rates at a two-decade high when they meet next week — may face renewed pressure to further delay any cuts and even to consider whether borrowing costs are high enough.
But this is just chatting. Let's take a look at dry numbers and explain why we consider recent data as absolutely stunning and treat it as possible turning point in the whole financial system. So, the US had a GDP growth of just 1.6% in Q1 2024. At the same time, in the second half of the last 2023 year, when the problem of the government debt ceiling was no longer a problem, growth was about 4%.
Now let's return to the budget deficit. In the second half of 2023, it amounted to $809 billion. This is 6% of GDP. In the 1st quarter of 2024 (!) i.e. 2 times shorter term, it is amounted to $555 billion. This is 8% of GDP.
That is, summing up, in the 2nd half of the last year, with a deficit of 6% of GDP, growth was 4%, and in the 1st quarter, with a deficit of 8% of GDP, growth was 1.6%. By and large, we can say that with increased fiscal stimulus, growth has slowed down. Moreover, goods contributed (!!!) -0.1% of GDP influence, and services contributed 1.7% of GDP.
And we've got these numbers, by the way, even though the stock market was booming, the S&P500 added 12.7% in the quarter. That is, the welfare effect, which, of course, affects demand, was very strong.
The market decline began exactly at the beginning of April. Just when, apparently, the results of the funds for the quarter are recorded. We have already lost 5% in less than a month. If only there were such systems for accepting bets, I bet that GDP growth in the second quarter would be even lower or negative. Speaking about stock market there are two reasons. First is - the S&P earnings yield already is lower than the bond yield.
Second is - new J.Biden tax law will stimulate people to fix profit prior it will turn to power. What is the sense to give 40% of profit to government if it is possible to take it now and lay less? Selling shares after taxes go up means giving the government half of the profits. For those who bought at the 2020 lows, this is about 30% of the stock price, and for those who bought in 2009, it is almost 40%.
Not occasionally JP Morgan also considers big plunge on stock market. So, it is more or less clear about GDP. Now is about inflation... there are multiple signs and sources of its growth. Major of them we already have covered previously - energy, commodities, US deficit and interest payments etc. But in recent two weeks we have additional drivers that come from inside of the US. It is money supply - it starts raising again. Inflation is going NOWHERE.
Next time Powell & Co. try telling you that inflation is going away, remember that the monetary base is almost twice the pre-pandemic level... and it's still trending upward. There are a lot of other sources that it is impossible cover just in a single report. The surge of incoming receipts from Tax Day has swelled the TGA to over $950 billion, so we basically have to get through $200 billion of that before federal debt starts to rise again. Treasury will be injecting them into markets in the coming days and weeks, which will blunt the impact of Yellen's jumbo size auctions, keeping yields down and causing RRPs to mostly move sideways for a while. But this is just temporal relief. M2 is still about $3 trillion above the pre-pandemic trend - this is the highest monthly M2 level in a year, so forget about deflation:
And this is not only the US feature. In EU we have the same story - the amount of money circulating in the euro zone - a measure that often works as a leading indicator - continued to rebound and grew by 0.9%, the fastest pace since last May. This turn actually has started at the end of 2023, and rises even faster than in the US
And the last but not least. Those who even lightly in habit with statistics knows that the the majority of values stands in the range of 1 standard deviation that includes 66% probability. The recent GDP and PCE numbers stand outside of these range (in tails), telling that deviation was extremely strong. It means that this is not just some fluctuations in expectations but directional change.
Tomorrow in Gold report we will cover few other moments of inflation that are more related to macro economy. Things that we've mentioned today already are enough to form solid picture of ongoing processes.
Conclusion:
Based on all this stuff above, we're coming to conclusion that the US economy will drop into stagflation. Inflation will keep raising, no doubts. We suggest higher interest rates and higher demand for US dollar as all markets are still trapped in "old thinking" way that doesn't let them to take healthy outlook. While it is obvious that everybody should run out of the US dollar and the US assets - investors stubbornly will keep searching safety with them. They are not worry about inflation by far - investors do not show any demand for TIPS and short positions:
So, the painful meeting with the reality is still ahead. Markets live with ancient cliche that any problems in the US are cyclical and temporal and any problems always will be resolved positive. This makes them to buy the US assets in the bad times. Until it lasts and faith in the all mighty dollar and the Fed lives - we will keep seeing raising of the US Dollar, despite awful budget statistics, economy indicators and raising US yields. The most interesting movie starts when markets finally catch up with understanding that good final will not happen this time. Probably this will not happen in 2024, but this revelance will come and this will be very painful with a lot of screaming "let me out" and total crush. But meantime, we keep following USD appreciation.
Speaking about EU - it stands even in worse situation. The inflation slowdown will finish very soon and market expectation about gradual rate cut will not realized. Inflation will return. ECB could cut in June just because of "rhetoric momentum" as they have to because they have promised. But inflation in EU also will turn up. Besides EU will be even in worse stagflation. If in the US we have now 1.6% GDP growth at least, in EU it is already about zero. So, this will not help to break bearish long-term trend on EUR/USD. It means that in long-term our view remains the same by far.
This week has become extremely important for all markets. We've got epic GDP and PCE numbers. At first glance they are nothing different from the data that we've got previously, but as we will explain below, these numbers are very special due overall economical and political environment. These numbers push all power groups inside the US to action which will make direct impact on all market in perspective of 2-3 months.
Market overview
The U.S. dollar fell on Thursday, except against the yen, vacillating after data showed unexpected slowing in economic growth and an unwelcome inflation acceleration, potentially tying the Federal Reserve's hands on a pivot to easier interest rates, although some loses have been compensated on Friday. The Commerce Department reported that U.S. gross domestic product grew at a 1.6% annualized rate in the January-March period, slower than the 2.4% rate expected by economists polled by Reuters. The report also showed that underlying inflation as measured by the core personal consumption expenditures (PCE) price index rose 3.7% in the first quarter, eclipsing forecasts for a 3.4% rise:
Following the GDP data, the U.S. rate futures market was pricing in a 58% chance of a Fed rate cut in September, down from 70% late on Wednesday, according to CME Group's FedWatch tool.
The euro, trading just above $1.06, is by no means among the weakest major currencies versus the dollar. But notably, banks have recently downgraded euro/dollar forecasts. Before the latest U.S. inflation data, markets had largely seen the European Central Bank and Federal Reserve as moving in lockstep on rate cuts. Now the ECB is expected to cut in June and an anticipated Fed cut in September has pushed the euro to five-month lows.
European Central Bank officials are sticking to plans to cut interest rates multiple times this year, even as higher U.S. inflation delays a pivot to looser policy by the U.S. Federal Reserve and tensions in the Middle East keep oil prices high. Nearly all ECB officials from the currency bloc's 20 national central banks have been more explicit, saying they expect further rate cuts to follow as inflation in the euro zone gradually declines to hit the ECB's 2% target by next year.
Euro zone lending continued to stagnate in March and consumers trimmed their inflation expectations as record-high borrowing costs kept putting the brakes on the euro zone's economy, European Central Bank (ECB) reports showed on Friday. The data was likely to cement the ECB's plan to start cutting interest rates in June after seeing inflation fall to just above its 2% goal and economic growth come to a standstill. Bank loans to companies increased by just 0.4% in March, compared with 0.3% a month earlier. Growth in lending to households, which had been more resilient until last summer, set a new decade-low at 0.2%, from 0.3% in February:
The latest developments in the Middle East and United States were generally seen as a reason for greater caution but did not fundamentally change the picture in the euro zone, French central bank governor Francois Villeroy de Galhau argued. Inflation in the euro zone has been falling in all categories apart from services.
Euro zone inflation and economic growth data due out on Tuesday next week could strengthen market bets for the European Central Bank to lower its deposit rate from a record 4% in June. Gross domestic product in the euro zone currency bloc probably expanded by just 0.1% in the first quarter, year-on-year, economists polled by Reuters expect the data to show.
U.S. regulators have seized Republic First Bancorp and agreed to sell it to Fulton Bank, underscoring the challenges facing regional banks a year after the collapse of three peers. Philadelphia-based Republic First, which had abandoned funding talks with a group of investors, was seized by the Pennsylvania Department of Banking and Securities.Republic Bank had about $6 billion in total assets and $4 billion in total deposits, as of Jan. 31, 2024. The FDIC estimated the cost of the failure to its fund will be $667 million. The decision marks the latest U.S. regional bank failure following the unexpected collapses of three lenders - Silicon Valley and Signature in March 2023 and First Republic in May. Losses on CRE loans (!), NYCB's core business, sparked a rout that wiped nearly $6 billion off its market value and sparked ratings downgrades.
A growing number of Americans have seen their savings dwindle as rising prices squeeze budgets while interest rates stay high, bankers and economists said. The deterioration in household finances for those earning less than $45,000 contrasts with financial resilience among those on higher incomes. Austan Goolsbee, Chicago Federal Reserve Bank President, said on Friday that consumer delinquencies were one of the most concerning economic data points at the moment.
As U.S. inflation worries grow, some investors are preparing for the 10-year U.S. Treasury yield to breach a 16-year high of 5% hit last October. The yield on the benchmark 10-year note is up 80 basis points this year and last stood at 4.70%, a five-month high. Global fund managers' fixed income allocations in the latest BofA Global Research survey are down to their lowest level since 2003. Bearish Treasury positioning among some classes of hedge funds stands at its highest level of the year, according to BofA data, even as other asset managers have increased their bullish bets.
Michael Purves, head of Tallbacken Capital Advisors, wrote it's "not inconceivable" that the 10-year Treasury yield could reach its 2007 high of 5.22%, if higher prices for oil and other raw materials continue pushing up inflation. Ratings agency Fitch downgraded the U.S. credit rating last year partly due to concern over rising debt levels. Many investors anticipate a rise in term premiums - or the compensation demanded to hold long-term debt.
Hints of whether the Fed still expects interest rate cuts at some point this year takes centre-stage for investors at the central bank's meeting that concludes on Wednesday next week. Rate action is unlikely, but comments from Fed Chair Jerome Powell about the potential for policy easing later in 2024 will be scrutinized.
WHY RECENT GDP/PCE DATA IS SO IMPORTANT
As I briefly said in video on Friday - it seems that the US is turning on the way to stagflation which is the worst among all the others. And not only we, here at FPA think so. At the same time, for the truth sake - we're just getting confirmation of our suggestions that we've made 6-8 months ago when this story has turned to active stage. The structural crisis itself has started even in 2021. Bloomberg writes -US Economy Slows and Inflation Jumps, Damping Soft-Landing Hopes(!):
The figures represent a notable loss of momentum at the start of 2024 after the economy wrapped up a surprisingly strong year. With the inflation pickup, Federal Reserve policymakers — who were already expected to hold interest rates at a two-decade high when they meet next week — may face renewed pressure to further delay any cuts and even to consider whether borrowing costs are high enough.
The GDP and inflation figures represent more hurdles for President Joe Biden, who has been trying to convince Americans he’s been doing a good job on the economy. Consumer sentiment has moved sideways in recent months, and voters in key swing states are pessimistic about the outlook.
But this is just chatting. Let's take a look at dry numbers and explain why we consider recent data as absolutely stunning and treat it as possible turning point in the whole financial system. So, the US had a GDP growth of just 1.6% in Q1 2024. At the same time, in the second half of the last 2023 year, when the problem of the government debt ceiling was no longer a problem, growth was about 4%.
Now let's return to the budget deficit. In the second half of 2023, it amounted to $809 billion. This is 6% of GDP. In the 1st quarter of 2024 (!) i.e. 2 times shorter term, it is amounted to $555 billion. This is 8% of GDP.
That is, summing up, in the 2nd half of the last year, with a deficit of 6% of GDP, growth was 4%, and in the 1st quarter, with a deficit of 8% of GDP, growth was 1.6%. By and large, we can say that with increased fiscal stimulus, growth has slowed down. Moreover, goods contributed (!!!) -0.1% of GDP influence, and services contributed 1.7% of GDP.
And we've got these numbers, by the way, even though the stock market was booming, the S&P500 added 12.7% in the quarter. That is, the welfare effect, which, of course, affects demand, was very strong.
The market decline began exactly at the beginning of April. Just when, apparently, the results of the funds for the quarter are recorded. We have already lost 5% in less than a month. If only there were such systems for accepting bets, I bet that GDP growth in the second quarter would be even lower or negative. Speaking about stock market there are two reasons. First is - the S&P earnings yield already is lower than the bond yield.
Second is - new J.Biden tax law will stimulate people to fix profit prior it will turn to power. What is the sense to give 40% of profit to government if it is possible to take it now and lay less? Selling shares after taxes go up means giving the government half of the profits. For those who bought at the 2020 lows, this is about 30% of the stock price, and for those who bought in 2009, it is almost 40%.
Not occasionally JP Morgan also considers big plunge on stock market. So, it is more or less clear about GDP. Now is about inflation... there are multiple signs and sources of its growth. Major of them we already have covered previously - energy, commodities, US deficit and interest payments etc. But in recent two weeks we have additional drivers that come from inside of the US. It is money supply - it starts raising again. Inflation is going NOWHERE.
Next time Powell & Co. try telling you that inflation is going away, remember that the monetary base is almost twice the pre-pandemic level... and it's still trending upward. There are a lot of other sources that it is impossible cover just in a single report. The surge of incoming receipts from Tax Day has swelled the TGA to over $950 billion, so we basically have to get through $200 billion of that before federal debt starts to rise again. Treasury will be injecting them into markets in the coming days and weeks, which will blunt the impact of Yellen's jumbo size auctions, keeping yields down and causing RRPs to mostly move sideways for a while. But this is just temporal relief. M2 is still about $3 trillion above the pre-pandemic trend - this is the highest monthly M2 level in a year, so forget about deflation:
And this is not only the US feature. In EU we have the same story - the amount of money circulating in the euro zone - a measure that often works as a leading indicator - continued to rebound and grew by 0.9%, the fastest pace since last May. This turn actually has started at the end of 2023, and rises even faster than in the US
And the last but not least. Those who even lightly in habit with statistics knows that the the majority of values stands in the range of 1 standard deviation that includes 66% probability. The recent GDP and PCE numbers stand outside of these range (in tails), telling that deviation was extremely strong. It means that this is not just some fluctuations in expectations but directional change.
Tomorrow in Gold report we will cover few other moments of inflation that are more related to macro economy. Things that we've mentioned today already are enough to form solid picture of ongoing processes.
Conclusion:
Based on all this stuff above, we're coming to conclusion that the US economy will drop into stagflation. Inflation will keep raising, no doubts. We suggest higher interest rates and higher demand for US dollar as all markets are still trapped in "old thinking" way that doesn't let them to take healthy outlook. While it is obvious that everybody should run out of the US dollar and the US assets - investors stubbornly will keep searching safety with them. They are not worry about inflation by far - investors do not show any demand for TIPS and short positions:
So, the painful meeting with the reality is still ahead. Markets live with ancient cliche that any problems in the US are cyclical and temporal and any problems always will be resolved positive. This makes them to buy the US assets in the bad times. Until it lasts and faith in the all mighty dollar and the Fed lives - we will keep seeing raising of the US Dollar, despite awful budget statistics, economy indicators and raising US yields. The most interesting movie starts when markets finally catch up with understanding that good final will not happen this time. Probably this will not happen in 2024, but this revelance will come and this will be very painful with a lot of screaming "let me out" and total crush. But meantime, we keep following USD appreciation.
Speaking about EU - it stands even in worse situation. The inflation slowdown will finish very soon and market expectation about gradual rate cut will not realized. Inflation will return. ECB could cut in June just because of "rhetoric momentum" as they have to because they have promised. But inflation in EU also will turn up. Besides EU will be even in worse stagflation. If in the US we have now 1.6% GDP growth at least, in EU it is already about zero. So, this will not help to break bearish long-term trend on EUR/USD. It means that in long-term our view remains the same by far.
