Sive Morten
Special Consultant to the FPA
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Fundamentals
Today is once again a report, where we will dig in statistics data. GDP numbers are important but it is more important how it combines with overall situation and other financial information. Probably we should focus on political events instead because they are of an epic scale now. But unfortunately there is no direct relation with EUR/USD dynamic.
Market overview
The dollar was lower on Friday and on track for its first monthly decline in 2024 after data showed U.S. inflation rose in line with expectations in April, offering little clarity on how soon the U.S. Federal Reserve will be able to cut interest rates. The personal consumption expenditures (PCE) price index increased 0.3% last month, the Commerce Department's Bureau of Economic Analysis said on Friday, matching the unrevised gain in March.
Official data showed on Thursday the U.S. economy grew at an annualized rate of 1.3% from January through March, down from the previous estimate of 1.6% after downward revisions to consumer spending.
The euro edged up after data showed price pressures in the euro zone accelerated faster than expected in May, complicating the outlook for the European Central Bank. French inflation data released earlier on Friday, and German and Spanish figures earlier this week, came in slightly higher than expected. The numbers have not altered the view in markets that the ECB will cut rates when it meets next week.
According to all 82 economists polled by Reuters, an ECB rate cut on June 6 appears certain, with a majority predicting further reductions in September and December. The bigger-than-expected increase in inflation was unlikely to stop the ECB from lowering borrowing costs from a record high next week, but may cement the case for a pause in July and a slower pace of interest rate reductions in the coming months.
More significantly, a closely watched measure of underlying inflation that excludes food, energy, alcohol and tobacco came in at 2.9% from 2.7% in April. Prices in the services sector, which some policymakers have singled out as especially relevant because they reflect domestic demand, rebounded to 4.1% from 3.7%.
This was likely to mirror larger-than-expected increases in wages in the first quarter of the year, which have boosted consumers' battered disposable income after years of below-inflation pay hikes.
With coming tax tariffs on Russian wheat import, prices will raise more. Not because of wheat deficit, but because of higher logistics cost and delivery ways that will have to be changed. Downgrading of France credit rating by S&P to AA- also increase cost of borrowings to France that already have some budget balancing problems.
Markets are currently pricing around 57 basis points of ECB rate cuts in 2024, and are indicating a 25 basis point cut in June, and one more by year end. In recent weeks, however, they have been gradually paring back expectations of a third cut this year. Investors will mostly be watching for ECB comments next week rather than rate change fact itself.
Japan's Ministry of Finance released data on Friday confirming that Japanese authorities spent 9.79 trillion yen ($62.2 billion) intervening in the foreign exchange market to support the yen over the past month, in moves that kept the currency from testing new lows but are unlikely to reverse a longer-term decline. Data on Friday showed core consumer inflation in Tokyo accelerated in May, but price growth excluding the effect of fuel eased, heightening uncertainty over the timing of the Bank of Japan's next rate hike.
Global bond markets face the biggest amount of net sovereign issuance so far this year in June, just as economic data throws rate cuts into doubt, testing investors' so-far strong appetite for the debt.
Net government bond supply is likely to rise to $340 billion for the United States, euro zone countries and Britain, according to data from lender BNP Paribas, as redemptions fall and central banks continue to slash their holdings of the paper.
Although analysts expect markets to absorb the supply, it has the potential to add to upward pressure on yields. A pair of weak U.S. Treasury auctions on Tuesday may have been an early sign that the market, already grappling with strong economic data that has caused traders to push back their bets on when central banks will start cutting interest rates, is struggling to remain optimistic. Take a look how many bonds were purchased by primary dealers. This is the sign that demand from the others is decreasing. Nobody wants to buy bonds at 4.5% if it will be possible to buy it at higher yield within few months.
Elections in the United States and Britain, and for the European Union's Parliament this year are adding to the pressure to keep spending. June's elevated net supply is driven largely by a fall in maturing bonds so investors, without the return of principal sums, have less cash to reinvest in the primary market.
UPDATE ON CURRENT SITUATION
So, GDP growth for the first quarter was revised. Instead of 1.6% it turned out to be 1.3%. Previously we already talked that fiscal stimulation of the economy is growing, but the economy itself, in fact, has simply stopped growing. It would be interesting to see the data for the second quarter, as well as how the quarter ends in terms of unemployment. Hardly we will get negative GDP, but there definitely won’t be a big plus.
That is, summing up, in the 2nd half of the year, with a deficit of 6% of GDP, growth was 4%, and in the 1st quarter, with a deficit of 8% of GDP, growth is 1.3% now. By and large, we can say that with increased fiscal stimulus, growth has slowed down. Moreover GDP details show that goods consumption has dropped and been replaced by raising demand for services. Also recall that 1.3% has been achieved with 12.7% S&P growth in IQ. Now it is stagnating.
Bank of America sees nothing bad with this moment:
So, we do know about budget deficit that now is around 8% of GDP. But somehow we miss Trading deficit issue. Yes, maybe it is not as large - just about 1 Trln:
The trade deficit has exceeded a trillion dollars for the third year now, and only the United States can afford such a luxury. The trillion-dollar hole is being covered by the flow of capital to the United States through loans to the government and corporations, and the sale of shares and real estate to foreigners.
However, the capital inflow mechanism has begun to malfunction in recent years, resulting in increased inflation and an increase in Fed rates, that is, an increase in the attractiveness of investments in the United States due to higher interest rates. In conditions of double deficit (budget and trade balance), the United States cannot afford to reduce the attractiveness of investments in the national stock market. Therefore, any correction in stock indices causes panic in the Federal Reserve and the US Treasury. They immediately begin to take emergency measures to keep the financial system from collapsing.
When you speak about global reserve currency, we should take in consideration not the amount of global commodities transactions, which are counted for ~ 30 Trln per year, but amount of global financial transactions. The US do not worry too much that Russia, China or any other countries are turning to own currencies in trading - this is puny size of the business, counted for a few hundreds of billion dollars. This was important in last century when there were no global financial markets, internet and when the power of State was based on the role in global trade. Now times have changed.
Commodities transactions stands for ~ 80 Bln per day. This is daily turnover of just Nvidia shares. Global financial transactions even without derivatives stand for 20-30 times larger amount. To control particularly this market is vital for the US. The pricing of all assets in the US Dollar.
This explains why performance of the stock indexes have lost any relation to reality. People recall about valuation and such terms as EBIT, FCF, Coverage ratio, P/E, Debt etc. only when tragedy has happened already and nothing could be returned back.
Meantime The savings rate of American households is near a historical low - 3.6% in April 24, for three months - 3.7%, for half a year - 3.7%.
• There is no potential to maintain current demand , given that incomes have been stagnant for the last six months, the savings rate is at zero, the sustainability resource has been exhausted, and loans are too expensive.
• There is no potential for repurchase of bonds and other financial assets. Now savings are only $730-750 billion a year, this money is not enough for anything.
Net government support as a percentage of disposable income is its own indicator showing the measure of the rigidity of fiscal policy relative to household income. The closer to zero, the softer the fiscal policy, as the difference between all money withdrawn from the population in favor of the state and all resources distributed from the state in favor of the population. Current net state support is at minus 7.3%. In 2020–2021 it was minus 2% and from April 20 to August 21 – plus 0.22%, i.e. over 7.5% of income was generated by the state. The current fiscal policy is not stimulating in relation to household incomes.
This makes US Treasury to make tricks to endure the bubble on stock market. Although this week we do not see any big changes in dollar reserves in the system - they remains around 3.1 Trln. Yes there were some fluctuations in TGA account, RRP, Fed balance etc. But nothing serious. Particularly speaking the US Treasury has started 15 Bln QE, or a kind of Japanese YYC if you like it more.
As we've already said two weeks ago - strategically it is time to sell all green back assets, buy commodities. Usually such steps are done not from wealth and prosper life... Even assuming no recession, CBO projections suggest catastrophic deficits and huge interest payments for the US economy. There are no revenue-raising measures that can end this death spiral.
Another headache for US Treasury is the structure of national debt. It is easy to place short-term bills to plug the holes as they meet good demand due its term and high rate. But, you have to turnover it every 3-6 months. With the raising placed volume it becomes more and more difficult to do which increase peak demand for liquidity:
Also in the next 5 months, many processes will be driven by politics... so, for example, there is no guarantee that at some point the US Treasury will not decide to release its TGA cash reserve ($0.7 trillion) and increase liquidity. Because battle around budget will become hot. At the same time, the economy/financial system seems to be entering a period of more active cooling, against the backdrop of probably still high inflation - a kind of “stagflationary moment”.
Conclusion:
It seems for now that financial system stands balanced in some pitty conditions. Data shows slow but stable and stubborn degradation, but existed reserves let to keep it without shocks. In summertime hardly something big will happen, at least on economical front. Yes we could get some shakes from data surprises - NFP, CPI or whatever, but hardly it will trigger epic changes on the markets. In nearest few months inflation in EU will return. Being US vassals, they just execute its wish ignoring national interests. That's why, raising budget spendings, imposing import taxes on goods and commodities, raising shipping expenses and preparation to winter season together with external factors will keep inflation stable or even push it higher. This should make hawkish impact on ECB policy (if of course they will not be forced to cut rate more by the US). It means that EUR could return some lost positions closer to autumn.
Politics is the thing that we can't control. And it could bring a lot of surprises. But, obviously that all of them will be bad and politics will work in favor of USD anyway. Whether political factors overcome economical and will not let EUR to raise too high - we will see. But BofA seems thinks the same:
They anticipate EUR strength and what is more important - normalization of the yield curve. When? Right after elections... As we've said earlier current administration intends to keep vision of "Good times" until elections. If this will not help to win - they cut all ropes and flow the cold shower on D. Trump administration. The first big problem that they will meet is the debt ceil again as early as on January 2025.
Although mentioned BofA expects first rate cut only in December, we suggest to watch over July meeting on 30-31st. Because then the Fed takes break until September and this is perfect point to make the first cut due political motives. Until this date hardly we will get big shifts on the markets. Due to the recent statistics ECB probably will make as markets expect and will be hurry up with the 2nd rate cut.
Today is once again a report, where we will dig in statistics data. GDP numbers are important but it is more important how it combines with overall situation and other financial information. Probably we should focus on political events instead because they are of an epic scale now. But unfortunately there is no direct relation with EUR/USD dynamic.
Market overview
The dollar was lower on Friday and on track for its first monthly decline in 2024 after data showed U.S. inflation rose in line with expectations in April, offering little clarity on how soon the U.S. Federal Reserve will be able to cut interest rates. The personal consumption expenditures (PCE) price index increased 0.3% last month, the Commerce Department's Bureau of Economic Analysis said on Friday, matching the unrevised gain in March.
Official data showed on Thursday the U.S. economy grew at an annualized rate of 1.3% from January through March, down from the previous estimate of 1.6% after downward revisions to consumer spending.
The euro edged up after data showed price pressures in the euro zone accelerated faster than expected in May, complicating the outlook for the European Central Bank. French inflation data released earlier on Friday, and German and Spanish figures earlier this week, came in slightly higher than expected. The numbers have not altered the view in markets that the ECB will cut rates when it meets next week.
According to all 82 economists polled by Reuters, an ECB rate cut on June 6 appears certain, with a majority predicting further reductions in September and December. The bigger-than-expected increase in inflation was unlikely to stop the ECB from lowering borrowing costs from a record high next week, but may cement the case for a pause in July and a slower pace of interest rate reductions in the coming months.
More significantly, a closely watched measure of underlying inflation that excludes food, energy, alcohol and tobacco came in at 2.9% from 2.7% in April. Prices in the services sector, which some policymakers have singled out as especially relevant because they reflect domestic demand, rebounded to 4.1% from 3.7%.
This was likely to mirror larger-than-expected increases in wages in the first quarter of the year, which have boosted consumers' battered disposable income after years of below-inflation pay hikes.
With coming tax tariffs on Russian wheat import, prices will raise more. Not because of wheat deficit, but because of higher logistics cost and delivery ways that will have to be changed. Downgrading of France credit rating by S&P to AA- also increase cost of borrowings to France that already have some budget balancing problems.
Markets are currently pricing around 57 basis points of ECB rate cuts in 2024, and are indicating a 25 basis point cut in June, and one more by year end. In recent weeks, however, they have been gradually paring back expectations of a third cut this year. Investors will mostly be watching for ECB comments next week rather than rate change fact itself.
Japan's Ministry of Finance released data on Friday confirming that Japanese authorities spent 9.79 trillion yen ($62.2 billion) intervening in the foreign exchange market to support the yen over the past month, in moves that kept the currency from testing new lows but are unlikely to reverse a longer-term decline. Data on Friday showed core consumer inflation in Tokyo accelerated in May, but price growth excluding the effect of fuel eased, heightening uncertainty over the timing of the Bank of Japan's next rate hike.
Global bond markets face the biggest amount of net sovereign issuance so far this year in June, just as economic data throws rate cuts into doubt, testing investors' so-far strong appetite for the debt.
Net government bond supply is likely to rise to $340 billion for the United States, euro zone countries and Britain, according to data from lender BNP Paribas, as redemptions fall and central banks continue to slash their holdings of the paper.
Although analysts expect markets to absorb the supply, it has the potential to add to upward pressure on yields. A pair of weak U.S. Treasury auctions on Tuesday may have been an early sign that the market, already grappling with strong economic data that has caused traders to push back their bets on when central banks will start cutting interest rates, is struggling to remain optimistic. Take a look how many bonds were purchased by primary dealers. This is the sign that demand from the others is decreasing. Nobody wants to buy bonds at 4.5% if it will be possible to buy it at higher yield within few months.
Elections in the United States and Britain, and for the European Union's Parliament this year are adding to the pressure to keep spending. June's elevated net supply is driven largely by a fall in maturing bonds so investors, without the return of principal sums, have less cash to reinvest in the primary market.
UPDATE ON CURRENT SITUATION
So, GDP growth for the first quarter was revised. Instead of 1.6% it turned out to be 1.3%. Previously we already talked that fiscal stimulation of the economy is growing, but the economy itself, in fact, has simply stopped growing. It would be interesting to see the data for the second quarter, as well as how the quarter ends in terms of unemployment. Hardly we will get negative GDP, but there definitely won’t be a big plus.
That is, summing up, in the 2nd half of the year, with a deficit of 6% of GDP, growth was 4%, and in the 1st quarter, with a deficit of 8% of GDP, growth is 1.3% now. By and large, we can say that with increased fiscal stimulus, growth has slowed down. Moreover GDP details show that goods consumption has dropped and been replaced by raising demand for services. Also recall that 1.3% has been achieved with 12.7% S&P growth in IQ. Now it is stagnating.
Bank of America sees nothing bad with this moment:
So, we do know about budget deficit that now is around 8% of GDP. But somehow we miss Trading deficit issue. Yes, maybe it is not as large - just about 1 Trln:
The trade deficit has exceeded a trillion dollars for the third year now, and only the United States can afford such a luxury. The trillion-dollar hole is being covered by the flow of capital to the United States through loans to the government and corporations, and the sale of shares and real estate to foreigners.
However, the capital inflow mechanism has begun to malfunction in recent years, resulting in increased inflation and an increase in Fed rates, that is, an increase in the attractiveness of investments in the United States due to higher interest rates. In conditions of double deficit (budget and trade balance), the United States cannot afford to reduce the attractiveness of investments in the national stock market. Therefore, any correction in stock indices causes panic in the Federal Reserve and the US Treasury. They immediately begin to take emergency measures to keep the financial system from collapsing.
When you speak about global reserve currency, we should take in consideration not the amount of global commodities transactions, which are counted for ~ 30 Trln per year, but amount of global financial transactions. The US do not worry too much that Russia, China or any other countries are turning to own currencies in trading - this is puny size of the business, counted for a few hundreds of billion dollars. This was important in last century when there were no global financial markets, internet and when the power of State was based on the role in global trade. Now times have changed.
Commodities transactions stands for ~ 80 Bln per day. This is daily turnover of just Nvidia shares. Global financial transactions even without derivatives stand for 20-30 times larger amount. To control particularly this market is vital for the US. The pricing of all assets in the US Dollar.
This explains why performance of the stock indexes have lost any relation to reality. People recall about valuation and such terms as EBIT, FCF, Coverage ratio, P/E, Debt etc. only when tragedy has happened already and nothing could be returned back.
Meantime The savings rate of American households is near a historical low - 3.6% in April 24, for three months - 3.7%, for half a year - 3.7%.
• There is no potential to maintain current demand , given that incomes have been stagnant for the last six months, the savings rate is at zero, the sustainability resource has been exhausted, and loans are too expensive.
• There is no potential for repurchase of bonds and other financial assets. Now savings are only $730-750 billion a year, this money is not enough for anything.
Net government support as a percentage of disposable income is its own indicator showing the measure of the rigidity of fiscal policy relative to household income. The closer to zero, the softer the fiscal policy, as the difference between all money withdrawn from the population in favor of the state and all resources distributed from the state in favor of the population. Current net state support is at minus 7.3%. In 2020–2021 it was minus 2% and from April 20 to August 21 – plus 0.22%, i.e. over 7.5% of income was generated by the state. The current fiscal policy is not stimulating in relation to household incomes.
This makes US Treasury to make tricks to endure the bubble on stock market. Although this week we do not see any big changes in dollar reserves in the system - they remains around 3.1 Trln. Yes there were some fluctuations in TGA account, RRP, Fed balance etc. But nothing serious. Particularly speaking the US Treasury has started 15 Bln QE, or a kind of Japanese YYC if you like it more.
As we've already said two weeks ago - strategically it is time to sell all green back assets, buy commodities. Usually such steps are done not from wealth and prosper life... Even assuming no recession, CBO projections suggest catastrophic deficits and huge interest payments for the US economy. There are no revenue-raising measures that can end this death spiral.
Another headache for US Treasury is the structure of national debt. It is easy to place short-term bills to plug the holes as they meet good demand due its term and high rate. But, you have to turnover it every 3-6 months. With the raising placed volume it becomes more and more difficult to do which increase peak demand for liquidity:
Also in the next 5 months, many processes will be driven by politics... so, for example, there is no guarantee that at some point the US Treasury will not decide to release its TGA cash reserve ($0.7 trillion) and increase liquidity. Because battle around budget will become hot. At the same time, the economy/financial system seems to be entering a period of more active cooling, against the backdrop of probably still high inflation - a kind of “stagflationary moment”.
Conclusion:
It seems for now that financial system stands balanced in some pitty conditions. Data shows slow but stable and stubborn degradation, but existed reserves let to keep it without shocks. In summertime hardly something big will happen, at least on economical front. Yes we could get some shakes from data surprises - NFP, CPI or whatever, but hardly it will trigger epic changes on the markets. In nearest few months inflation in EU will return. Being US vassals, they just execute its wish ignoring national interests. That's why, raising budget spendings, imposing import taxes on goods and commodities, raising shipping expenses and preparation to winter season together with external factors will keep inflation stable or even push it higher. This should make hawkish impact on ECB policy (if of course they will not be forced to cut rate more by the US). It means that EUR could return some lost positions closer to autumn.
Politics is the thing that we can't control. And it could bring a lot of surprises. But, obviously that all of them will be bad and politics will work in favor of USD anyway. Whether political factors overcome economical and will not let EUR to raise too high - we will see. But BofA seems thinks the same:
They anticipate EUR strength and what is more important - normalization of the yield curve. When? Right after elections... As we've said earlier current administration intends to keep vision of "Good times" until elections. If this will not help to win - they cut all ropes and flow the cold shower on D. Trump administration. The first big problem that they will meet is the debt ceil again as early as on January 2025.
Although mentioned BofA expects first rate cut only in December, we suggest to watch over July meeting on 30-31st. Because then the Fed takes break until September and this is perfect point to make the first cut due political motives. Until this date hardly we will get big shifts on the markets. Due to the recent statistics ECB probably will make as markets expect and will be hurry up with the 2nd rate cut.
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