Sive Morten
Special Consultant to the FPA
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Fundamentals
This time we have a kind of exceptional week, when political events overshadow economical ones. Indeed, last revision of GDP and flat PCE reports hardly could pretend on the "events of the week" status. Presidential debates have made more noise in media space. Thus, today we will make just an update of current situation and also show why GDP numbers and deflator are not reliable.
Market overview
The U.S. dollar rose on Tuesday, bolstered by hawkish comments from Federal Reserve officials as well as data showing a stable housing market in the world's largest economy, both suggesting that the central bank will not be in a rush to kickstart its rate-cutting cycle. Fed Governor Michelle Bowman started the ball rolling for the dollar, repeating her view on Tuesday that holding the policy rate steady "for some time" will likely be enough to bring inflation under control. She also reiterated her willingness to raise borrowing costs if needed.
Fed Governor Lisa Cook, for her part, said it would be appropriate to cut interest rates "at some point" given significant progress on inflation and a gradual cooling of the labor market. She remained vague, however, about the timing of the easing.
At the same time, J. Yellen said absolutely opposite things concerning rate and inflation. ️Treasury Secretary Janet Yellen told Yahoo Finance that she "sees no reason" for a recession in the US and expects the Federal Reserve to reach its 2% inflation target next year - at a faster pace than FOMC members had forecast.
A report showed U.S. single-family home prices increased at a steady pace in April, rising 0.2% on the month after being unchanged in March. In the 12 months through April house prices increased 6.3% after advancing 6.7% in March. That pushed the dollar a little higher. U.S. consumer confidence, however, slightly eased in June, with the index at 100.4 from a downwardly revised 101.3 in May, according to the Conference Board. The June number, however, was marginally higher than the market forecast of 100. The report didn't really hurt the dollar.
Business equipment orders from U.S. businesses fell unexpectedly in May, suggesting companies remain cautious about investing amid rising borrowing costs and weaker demand. The value of orders for basic capital goods - a measure of investment in equipment excluding aircraft and military equipment - fell 0.6% last month, its biggest drop this year.
The dollar will show advanced dynamics regardless of the outcome of the US presidential election. And much of this will be due to weakness in other countries, predicts Deutsche Bank's chief global markets strategist Alan Raskin. askin sees a scenario in which EURUSD falls to parity, while the current market consensus forecast suggests only a slight strengthening of the US currency. According to Raskin, increasing tariffs on goods not only from China, but possibly also from Europe and Mexico, will cause a sharp strengthening of the dollar.
The U.S. dollar slipped on Friday after data showed inflation in the world's largest economy subsided last month, cementing expectations the Federal Reserve will start cutting interest rates this year. Data showed the U.S. personal consumption expenditures (PCE) price index, the Fed's preferred inflation measure, was unchanged last month, and followed an unrevised 0.3% gain in April, data showed. In the 12 months through May, the PCE price index increased 2.6% after advancing 2.7% in April.
Following the inflation data, fed funds futures slightly raised the chances of easing in September to around 67%, from about 65% late Thursday, according to LSEG calculations. The market is also pricing between one to two rate cuts of 25 bps each this year.
A separate report on Thursday showed business activity in the Midwest came in better than expected, modestly helping the dollar. The Chicago purchasing managers' index (PMI) jumped to 47.4 from 35 in May, and better than the 40 that economists projected. University of Michigan consumer sentiment, meanwhile, showed a reading of a better-than-expected 68.2 for June, also dollar-supportive. In addition, respondents to the sentiment survey expect near- and long-term inflation expectations to level out at 3%.
Investors will now focus on next week's U.S. nonfarm payrolls report, in which Wall Street economists are forecasting a gain of 195,000 in June, compared with 272,000 in May.
The euro, down 1.3% against the dollar in June, was on track for its biggest monthly fall since January as political uncertainty weighed in the run-up to France's general elections. Investors fear a new French government could increase fiscal spending, threatening the sustainability of the country's public debt and the financial stability of the bloc.
Republican U.S. presidential candidate Donald Trump unleashed a barrage of at-times false attacks on President Joe Biden in their first campaign debate in Atlanta, with the dollar rising as Biden stumbled over his words a few times in early exchanges. The debate increased the odds of a Trump presidency and the imposition of import tariffs. Traders bought dollars overall as a Trump administration suggests more aggressive tariffs that could be inflationary and could trigger higher interest rates.
The owner of a prominent skyscraper in Germany's banking capital of Frankfurt has filed for insolvency, as the country reels from its biggest property crisis in a generation. Geschaeftshaus am Gendarmenmarkt, which owns the 186-metre, 45-floor Trianon building, filed for insolvency in a Frankfurt court on Monday and an insolvency manager has been appointed, a filing published on Tuesday showed.
The real estate boom ended when rampant inflation forced the European Central Bank to swiftly raise borrowing costs. Real-estate financing dried up, deals fizzled, projects stalled, major developers went bust, and some banks teetered. The industry has called on Berlin to intervene. Like the United States and other countries, offices in Germany and its financial capital of Frankfurt are suffering from lower occupancy rates, in part due to working from home.
TIME FOR CONTRASTS
As tougher situation in the US economy becomes as more contrasts appear. Some of them even break the common logic. For example, мery few consumers expect better business conditions, but they are optimistic about their stocks investments:
Everybody tells about decreasing inflation based on CPI/PCE numbers but nobody calculates real price changes. So why is Wall Street's view not shared by Main Street? Surveys consistently show Americans are pessimistic on the economy at large. The answer definitely has a lot to do with inflation, and probably a bit to do with political polarization widened by social media-fueled populism, misinformation and fear-mongering.
This apparent disconnect between people's personal attitudes to inflation and the wider aggregate picture is to a certain extent mirrored in people's perceptions of their personal financial well-being against the nation's. But Americans' current assessment of national economic conditions slipped to the most negative since November, and has been negative nearly every single month since March 2020.
But maybe the reason is not in human psyche, when people would rather have a recession than high inflation - if they lose their job, they can get help from friends or family, but everyone is affected by inflation. But in massive falsification of data, suggested "Strong economy". People intuitively feels mismatch when they come to stores day by day. They can't calculate statistics data, but they feel inconsistency reported information on "Strong economy" and their dropping wealth.
Let's take a look at recent GDP numbers again and this time we pay attention not to 1.4% GDP growth but to less popular indicator - GDP Deflator. It shows inflation level in the whole economy. And for the IQ we have it at 0.8%
The result is quite decent, 3.1% in annual terms. But two circumstances can be noted. First is, the deflator rose sharply compared to the previous quarter. Second - the methodology was not changed and the estimates of Larry Summers and his group were not taken into account. But if we consider… His study said that real inflation in the United States is about 10% or 2.5% per quarter.
If inflation for the first quarter is 0.8%, then to correctly assess the growth of the US economy, you need to subtract 1.7% (2.5-0.8 in deflator) from the official value. GDP growth in the first quarter was 1.4%, which means that the real value is about -0.3%. Or a decline of 1.2% per year … Do common people know that? Hardly. But they feel it from different aspects of their lives - prices, wages, savings, loans etc.
It turns out to be quite a substantial decline. And, most importantly, it has been going on for almost three years, since the autumn of 2021. In general, so far we can only state that even according to official data, inflation is not going to decrease, and even according to the figures already legalized in the American establishment, there is a steady economic decline in the country.
Finally, Consumer inflation and the GDP deflator turned out to be suspiciously close in the United States roughly 3%. But in the industry sector there is practically no price increase. The share of industry in the US GDP is about 20%, the share of private demand is slightly less than 70%. If there is no price growth in industry, then this means that in order to get 3% in the GDP deflator, it is necessary that consumer price growth have to be higher, somewhere around 4% ... such contradictions in falsifying statistics come out at every step. And in previous reports we already showed this for job market and CPI inflation data.
Analysts show us an interesting statistical case. The average expectations of the population in the United States for 5-10 years of inflation are 5.3%, while the median is about 3%. Expectations differ across groups of people depending on income, age and education. People in the bottom third of incomes have inflation expectations close to 7%, in the middle - about 4.5%, people with high incomes expect inflation of about 3.8%. Pay attention that divergence started somewhere at the end of 2021, which is clearly indicates started crisis processes, no matter what we saw in statistics.
Also we could show you big divergence of financial conditions and US Dollar dynamic and some others:
Even from technical analysis we know that divergence is a harbinger of reversal. This is even more so for fundamental processes in economy.
A FEW OTHER IMPORTANT ISSUES
Last week the Fed has made stress-tests for banks and reported positive outcome. Big U.S. banks survived a hypothetical 40% drop in commercial real estate values as a part of the U.S. Federal Reserve's annual health test, easing fears about the banking sector as landlords struggle in a higher-for-longer interest rate world. As risks mount in the CRE space, investors were looking to the Fed's "stress tests" to assess how exposed America's lenders are at a time when pandemic-era work habits continue to empty office towers, sending vacancy rates past historic peaks to a record 20%.
The Fed's emergency drill tests banks' balance sheets against an imagined severe economic downturn that also includes a 36% decline in U.S. home prices, a 55% drop in equity prices and an unemployment rate of 10%. The results, released on Wednesday by the Fed, showed that 31 large banks have sufficient capital to absorb nearly $685 billion in losses. But there is one puny nuance...
Only 31 banks with assets of +$100 billion were tested. The Fed claims that everything is fine - there are enough buffers. In addition, losses grew again and balances became riskier. Unrealized losses of the entire system are again not taken into account [+$39 billion to $517 billion]. Key problem banks - regional ones [their number increased from 52 to 63, assets +$15.8 billion to $82.1 billion, FDIC] do not participate in the test.
Another moment of last week is raising Trade deficit. The entire merchandise trade deficit ($1.07 trillion per year) has to be financed precisely through external borrowings, which reached $1.05 trillion per year, at far from low rates. Moreover, rates need to be kept relatively high in order for capital inflows to continue (or to “stimulate” rice premiums outside the United States). In the long term, this design of double deficits, especially given that the budget deficit is planned to be 6-7% of GDP for many years, will create big problems for both the dollar and financial sustainability.
The traditional RRP increase at the end of the quarter took dollars out of the system. Liquidity left the system much faster due to an increase in reverse repo by $114.9 billion , which is most likely due to the end of the quarter, when banks “draw” their reports. The US budget added $38 billion to the system in a week (almost the $744 billion plan), smoothing the situation a little. As a rule, quarterly surges in reverse repo do not have a strong impact on the markets, but still there were fewer dollars in the system, which slowed down the market.
The US Treasury practically did not increase the debt this week, but held auctions - settlements for them will be on July 1 (~$200 billion, $124 billion will be repaid - repayments). But this should not affect liquidity, because The budget has large expenses on the first day of the month. In general, Yellen had to borrow a little more than planned, but not significantly; in the third quarter she will need to borrow three times more (partly due to the utilization of the Fed reverse repo).
CONCLUSION:
Obviously the tension in the US financial system is growing. Now its like a boiling pot, getting more steam inside, which manifests itself in multiple inconsistencies across major fundamental indicators. It means that now it would be better to stay aside from any financial market - bonds or stocks. We do not expect immediate collapse as US Treasury and the Fed have enough reserves to keep situation under control by far. Hardly it will go out of control until early 2025 when new (old) president will meet first challenge of debt ceil saga again. But it problems are spinning up faster. Also it is unknown politics tricks and game inside the US. Debates raise a lot of questions - results were absolutely predictable but by some reason democrats have agreed to take it. Why?
Next week market again will be under control of political events - 4th of July elections in UK, while 7th of July in France. Only NFP is a pure economical factor that we will get next week. So action once again might be very choppy and unpredictable. For us the major intrigue still is coming the Fed's meeting on July 30-31st. We suspect that the Fed still could cut the rate, which is absolutely not expected by market now. NFP report and inflation data in two weeks could shed more light on perspective of this event. 1.06 level seems vital for EUR now. While price stands above it EUR keeps theoretical chances on upside action. We will see, whether coming data will be supportive for EUR or not...
This time we have a kind of exceptional week, when political events overshadow economical ones. Indeed, last revision of GDP and flat PCE reports hardly could pretend on the "events of the week" status. Presidential debates have made more noise in media space. Thus, today we will make just an update of current situation and also show why GDP numbers and deflator are not reliable.
Market overview
The U.S. dollar rose on Tuesday, bolstered by hawkish comments from Federal Reserve officials as well as data showing a stable housing market in the world's largest economy, both suggesting that the central bank will not be in a rush to kickstart its rate-cutting cycle. Fed Governor Michelle Bowman started the ball rolling for the dollar, repeating her view on Tuesday that holding the policy rate steady "for some time" will likely be enough to bring inflation under control. She also reiterated her willingness to raise borrowing costs if needed.
Fed Governor Lisa Cook, for her part, said it would be appropriate to cut interest rates "at some point" given significant progress on inflation and a gradual cooling of the labor market. She remained vague, however, about the timing of the easing.
At the same time, J. Yellen said absolutely opposite things concerning rate and inflation. ️Treasury Secretary Janet Yellen told Yahoo Finance that she "sees no reason" for a recession in the US and expects the Federal Reserve to reach its 2% inflation target next year - at a faster pace than FOMC members had forecast.
A report showed U.S. single-family home prices increased at a steady pace in April, rising 0.2% on the month after being unchanged in March. In the 12 months through April house prices increased 6.3% after advancing 6.7% in March. That pushed the dollar a little higher. U.S. consumer confidence, however, slightly eased in June, with the index at 100.4 from a downwardly revised 101.3 in May, according to the Conference Board. The June number, however, was marginally higher than the market forecast of 100. The report didn't really hurt the dollar.
Business equipment orders from U.S. businesses fell unexpectedly in May, suggesting companies remain cautious about investing amid rising borrowing costs and weaker demand. The value of orders for basic capital goods - a measure of investment in equipment excluding aircraft and military equipment - fell 0.6% last month, its biggest drop this year.
The dollar will show advanced dynamics regardless of the outcome of the US presidential election. And much of this will be due to weakness in other countries, predicts Deutsche Bank's chief global markets strategist Alan Raskin. askin sees a scenario in which EURUSD falls to parity, while the current market consensus forecast suggests only a slight strengthening of the US currency. According to Raskin, increasing tariffs on goods not only from China, but possibly also from Europe and Mexico, will cause a sharp strengthening of the dollar.
The U.S. dollar slipped on Friday after data showed inflation in the world's largest economy subsided last month, cementing expectations the Federal Reserve will start cutting interest rates this year. Data showed the U.S. personal consumption expenditures (PCE) price index, the Fed's preferred inflation measure, was unchanged last month, and followed an unrevised 0.3% gain in April, data showed. In the 12 months through May, the PCE price index increased 2.6% after advancing 2.7% in April.
Following the inflation data, fed funds futures slightly raised the chances of easing in September to around 67%, from about 65% late Thursday, according to LSEG calculations. The market is also pricing between one to two rate cuts of 25 bps each this year.
A separate report on Thursday showed business activity in the Midwest came in better than expected, modestly helping the dollar. The Chicago purchasing managers' index (PMI) jumped to 47.4 from 35 in May, and better than the 40 that economists projected. University of Michigan consumer sentiment, meanwhile, showed a reading of a better-than-expected 68.2 for June, also dollar-supportive. In addition, respondents to the sentiment survey expect near- and long-term inflation expectations to level out at 3%.
Investors will now focus on next week's U.S. nonfarm payrolls report, in which Wall Street economists are forecasting a gain of 195,000 in June, compared with 272,000 in May.
The euro, down 1.3% against the dollar in June, was on track for its biggest monthly fall since January as political uncertainty weighed in the run-up to France's general elections. Investors fear a new French government could increase fiscal spending, threatening the sustainability of the country's public debt and the financial stability of the bloc.
Republican U.S. presidential candidate Donald Trump unleashed a barrage of at-times false attacks on President Joe Biden in their first campaign debate in Atlanta, with the dollar rising as Biden stumbled over his words a few times in early exchanges. The debate increased the odds of a Trump presidency and the imposition of import tariffs. Traders bought dollars overall as a Trump administration suggests more aggressive tariffs that could be inflationary and could trigger higher interest rates.
The owner of a prominent skyscraper in Germany's banking capital of Frankfurt has filed for insolvency, as the country reels from its biggest property crisis in a generation. Geschaeftshaus am Gendarmenmarkt, which owns the 186-metre, 45-floor Trianon building, filed for insolvency in a Frankfurt court on Monday and an insolvency manager has been appointed, a filing published on Tuesday showed.
The real estate boom ended when rampant inflation forced the European Central Bank to swiftly raise borrowing costs. Real-estate financing dried up, deals fizzled, projects stalled, major developers went bust, and some banks teetered. The industry has called on Berlin to intervene. Like the United States and other countries, offices in Germany and its financial capital of Frankfurt are suffering from lower occupancy rates, in part due to working from home.
TIME FOR CONTRASTS
As tougher situation in the US economy becomes as more contrasts appear. Some of them even break the common logic. For example, мery few consumers expect better business conditions, but they are optimistic about their stocks investments:
Everybody tells about decreasing inflation based on CPI/PCE numbers but nobody calculates real price changes. So why is Wall Street's view not shared by Main Street? Surveys consistently show Americans are pessimistic on the economy at large. The answer definitely has a lot to do with inflation, and probably a bit to do with political polarization widened by social media-fueled populism, misinformation and fear-mongering.
This apparent disconnect between people's personal attitudes to inflation and the wider aggregate picture is to a certain extent mirrored in people's perceptions of their personal financial well-being against the nation's. But Americans' current assessment of national economic conditions slipped to the most negative since November, and has been negative nearly every single month since March 2020.
But maybe the reason is not in human psyche, when people would rather have a recession than high inflation - if they lose their job, they can get help from friends or family, but everyone is affected by inflation. But in massive falsification of data, suggested "Strong economy". People intuitively feels mismatch when they come to stores day by day. They can't calculate statistics data, but they feel inconsistency reported information on "Strong economy" and their dropping wealth.
Let's take a look at recent GDP numbers again and this time we pay attention not to 1.4% GDP growth but to less popular indicator - GDP Deflator. It shows inflation level in the whole economy. And for the IQ we have it at 0.8%
The result is quite decent, 3.1% in annual terms. But two circumstances can be noted. First is, the deflator rose sharply compared to the previous quarter. Second - the methodology was not changed and the estimates of Larry Summers and his group were not taken into account. But if we consider… His study said that real inflation in the United States is about 10% or 2.5% per quarter.
If inflation for the first quarter is 0.8%, then to correctly assess the growth of the US economy, you need to subtract 1.7% (2.5-0.8 in deflator) from the official value. GDP growth in the first quarter was 1.4%, which means that the real value is about -0.3%. Or a decline of 1.2% per year … Do common people know that? Hardly. But they feel it from different aspects of their lives - prices, wages, savings, loans etc.
It turns out to be quite a substantial decline. And, most importantly, it has been going on for almost three years, since the autumn of 2021. In general, so far we can only state that even according to official data, inflation is not going to decrease, and even according to the figures already legalized in the American establishment, there is a steady economic decline in the country.
Finally, Consumer inflation and the GDP deflator turned out to be suspiciously close in the United States roughly 3%. But in the industry sector there is practically no price increase. The share of industry in the US GDP is about 20%, the share of private demand is slightly less than 70%. If there is no price growth in industry, then this means that in order to get 3% in the GDP deflator, it is necessary that consumer price growth have to be higher, somewhere around 4% ... such contradictions in falsifying statistics come out at every step. And in previous reports we already showed this for job market and CPI inflation data.
Analysts show us an interesting statistical case. The average expectations of the population in the United States for 5-10 years of inflation are 5.3%, while the median is about 3%. Expectations differ across groups of people depending on income, age and education. People in the bottom third of incomes have inflation expectations close to 7%, in the middle - about 4.5%, people with high incomes expect inflation of about 3.8%. Pay attention that divergence started somewhere at the end of 2021, which is clearly indicates started crisis processes, no matter what we saw in statistics.
Also we could show you big divergence of financial conditions and US Dollar dynamic and some others:
Even from technical analysis we know that divergence is a harbinger of reversal. This is even more so for fundamental processes in economy.
A FEW OTHER IMPORTANT ISSUES
Last week the Fed has made stress-tests for banks and reported positive outcome. Big U.S. banks survived a hypothetical 40% drop in commercial real estate values as a part of the U.S. Federal Reserve's annual health test, easing fears about the banking sector as landlords struggle in a higher-for-longer interest rate world. As risks mount in the CRE space, investors were looking to the Fed's "stress tests" to assess how exposed America's lenders are at a time when pandemic-era work habits continue to empty office towers, sending vacancy rates past historic peaks to a record 20%.
The Fed's emergency drill tests banks' balance sheets against an imagined severe economic downturn that also includes a 36% decline in U.S. home prices, a 55% drop in equity prices and an unemployment rate of 10%. The results, released on Wednesday by the Fed, showed that 31 large banks have sufficient capital to absorb nearly $685 billion in losses. But there is one puny nuance...
Only 31 banks with assets of +$100 billion were tested. The Fed claims that everything is fine - there are enough buffers. In addition, losses grew again and balances became riskier. Unrealized losses of the entire system are again not taken into account [+$39 billion to $517 billion]. Key problem banks - regional ones [their number increased from 52 to 63, assets +$15.8 billion to $82.1 billion, FDIC] do not participate in the test.
Another moment of last week is raising Trade deficit. The entire merchandise trade deficit ($1.07 trillion per year) has to be financed precisely through external borrowings, which reached $1.05 trillion per year, at far from low rates. Moreover, rates need to be kept relatively high in order for capital inflows to continue (or to “stimulate” rice premiums outside the United States). In the long term, this design of double deficits, especially given that the budget deficit is planned to be 6-7% of GDP for many years, will create big problems for both the dollar and financial sustainability.
The traditional RRP increase at the end of the quarter took dollars out of the system. Liquidity left the system much faster due to an increase in reverse repo by $114.9 billion , which is most likely due to the end of the quarter, when banks “draw” their reports. The US budget added $38 billion to the system in a week (almost the $744 billion plan), smoothing the situation a little. As a rule, quarterly surges in reverse repo do not have a strong impact on the markets, but still there were fewer dollars in the system, which slowed down the market.
The US Treasury practically did not increase the debt this week, but held auctions - settlements for them will be on July 1 (~$200 billion, $124 billion will be repaid - repayments). But this should not affect liquidity, because The budget has large expenses on the first day of the month. In general, Yellen had to borrow a little more than planned, but not significantly; in the third quarter she will need to borrow three times more (partly due to the utilization of the Fed reverse repo).
CONCLUSION:
Obviously the tension in the US financial system is growing. Now its like a boiling pot, getting more steam inside, which manifests itself in multiple inconsistencies across major fundamental indicators. It means that now it would be better to stay aside from any financial market - bonds or stocks. We do not expect immediate collapse as US Treasury and the Fed have enough reserves to keep situation under control by far. Hardly it will go out of control until early 2025 when new (old) president will meet first challenge of debt ceil saga again. But it problems are spinning up faster. Also it is unknown politics tricks and game inside the US. Debates raise a lot of questions - results were absolutely predictable but by some reason democrats have agreed to take it. Why?
Next week market again will be under control of political events - 4th of July elections in UK, while 7th of July in France. Only NFP is a pure economical factor that we will get next week. So action once again might be very choppy and unpredictable. For us the major intrigue still is coming the Fed's meeting on July 30-31st. We suspect that the Fed still could cut the rate, which is absolutely not expected by market now. NFP report and inflation data in two weeks could shed more light on perspective of this event. 1.06 level seems vital for EUR now. While price stands above it EUR keeps theoretical chances on upside action. We will see, whether coming data will be supportive for EUR or not...
