Sive Morten
Special Consultant to the FPA
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Fundamentals
This week most important news have come from the US - Industrial production jumps for 0.9% per month while Retail sales have shown a bit worse than expected results. In reality situation looks absolutely different and not in the way how it is shown by statistician authorities. You need just to look at the same numbers in dynamic to understand this. Finally we've got very interesting comments from Japan, which we treat as 3rd most important economical event of this week.
Market overview
The dollar eased against the euro on Tuesday after retail sales data indicated signs of exhaustion among U.S. consumers, boosting the case for Federal Reserve rate cuts later this year. U.S. retail sales increased less than expected in May as lower prices for gasoline and motor vehicles weighed on receipts at service stations and auto dealerships. The trend in sales growth has been slowing as higher prices and interest rates force households to prioritize essentials and cut back on discretionary spending. Fed Funds futures implied a 67% probability of at least one rate cut by the September Fed meeting, up from 63% a day ago.
US industrial production increased in May, helped by a broad-based pickup in factory output in a positive sign for a manufacturing sector that has been struggling for momentum. The 0.9% increase in production at factories, mines and utilities followed no change a month earlier, Federal Reserve data showed Tuesday. The gain exceeded all forecasts in a Bloomberg survey of economists. Manufacturing output also climbed 0.9%, led by consumer goods, after a revised 0.4% April decrease.
Output at utilities jumped 1.6%.
The figures stand in contrast to other data showing manufacturing has had difficulty building momentum amid elevated input prices, inconsistent consumer demand and high borrowing costs. The Institute for Supply Management’s latest measure of factory activity shrank in May at a faster pace as a gauge of output came close to stagnating.
Although this is not the lowest value for a year and a half since the beginning of January 2023, but the second lowest value. The three-month rate of deterioration in consumer sentiment was higher only twice since 2000 - in 2005, when Hurricane Katrina hit the south of the country (if anyone doesn’t remember, the whole of New Orleans was flooded, 700 thousand people were left without homes, almost 2 thousand people died and the total damage to the economy amounted to $125 billion) and in 2020, when the Covid lockdowns began. In general, this says something.
The dollar edged higher against other major currencies on Friday, hitting a fresh eight-week high against the yen as data showed a strong U.S. economy and as the Federal Reserve's patient approach to interest-rate cuts stood in contrast to more dovish peers. U.S. business activity hit a 26-month high in June amid a rebound in employment while price pressures subsided considerably, suggesting that a recent slowdown in inflation was likely to be sustained. Thierry Wizman, global FX & rates strategist at Macquarie, in New York sees continued dollar strength as political uncertainty in Europe could eventually sap business and consumer confidence.
Last week's rally in the dollar was mostly driven by a sharp euro sell-off after French President Emmanuel Macron called a shock snap election in response to his ruling centrist party's trouncing by Marine Le Pen's eurosceptic National Rally in the European Parliament elections. The euro has stabilised since.
The European Central Bank could also buy French bonds to avoid "unwarranted and disorderly" yield spread widening. Still, ECB chief economist Philip Lane said recent market turmoil was "not disorderly". The European Commission on Wednesday proposed widely expected disciplinary steps against France, Italy and five other European Union countries over running excessive budget deficits.
Switzerland is at the front of the rate-cutting pack among developed economy central banks, lowering borrowing costs again on Thursday, while the all-important Federal Reserve is nowhere near the starting line as the U.S. economy stays strong. The Swiss National Bank followed up on March's interest rate cut with another reduction on Thursday to 1.25%. The step lower surprised some analysts, given a recent pick-up in Swiss growth and a mild rise in inflation to 1.4% in April.
The spreads between U.S. investment-grade corporate bond yields and U.S. Treasuries have surged to their highest in over three months, in a sign of risk aversion due to political uncertainty in France and as U.S. government bonds rallied. Barclays strategists said in a note on Friday the sell-off in U.S. corporate debt was partly due to a "flight to quality" caused by political uncertainty, with investors moving to safer U.S. Treasuries, which also rallied this month after better-than-expected inflation data.
U.S. bank regulators ordered Bank of America, Citigroup, Goldman Sachs and JPMorgan Chase on Friday to bolster plans for how they could be safely resolved in bankruptcy, and FDIC escalated its concerns about Citi's blueprint. Specifically, the Federal Reserve and Federal Deposit Insurance Corporation said the banks need to refine their so-called living wills to show how they could safely unwind their derivatives portfolios when they next submit plans to regulators in 2025.
The FDIC also escalated its concerns with Citi's plan to a "deficiency," meaning the regulator found it not credible, but the Fed did not follow suit. If both regulators had found Citi's plan deficient, it would have been required to resubmit an improved plan and could have potentially faced additional regulatory restrictions.
The European Central Bank will cut its deposit rate twice more this year, in September and December, according to a significant majority of economists polled by Reuters who said the risks were skewed towards fewer rate cuts than expected. That outlook was broadly unchanged from a survey conducted before the ECB delivered its widely telegraphed 25 basis point rate cut on June 6. Improving business activity, strong wage data and still-sticky price pressures have increased uncertainties around the rationale for more cuts. A near-90% majority of economists, 36 of 41, said risks were more skewed towards fewer ECB rate cuts this year than more.
The European Banking Authority (EBA) said in its quarterly "risk dashboard" that credit risks have started to materialise with an increase in non-performing loans (NPLs) in the three months to March. "The majority of banks surveyed expect further asset quality deterioration in CRE (commercial real estate), SMEs loans and consumer credit in the next 6-12 months," EBA said.
WHAT THE US DATA TELLS US
First, and before we turn to the US data directly, let's take a fast look only at one EU chart and some comments concerning EU rate change. In fact we're trading EUR/USD, so it is important to know what's going on on EU side as well. Now common opinion is to get two more rate cuts in 2024. European Central Bank policymaker Klaas Knot on Thursday backed market expectations for one or two more interest rate cuts this year as inflation appeared to be headed towards the ECB's 2% target. The European Central Bank is confident that inflation will fall back to its 2% target next year despite some "noisy" inflation along the way, the ECB's chief economist Philip Lane said on Monday.
Here I will show you only single picture, related to EU - this is Euro Area Wage Growth. It has reached +5.3% - highest level in 15 years of observation. This is not positive news, it means that the easing of monetary policy accelerates inflationary processes.
So, next rate cut or even two rate cuts this year are under question, which suggests hidden strength for EUR. Now, let's go to the US. Statistics tell that industrial production jumped 0.9% in May. Let's see what we have in the US:
By looking at these charts above, could you please explain how industrial production could rise together with dropping of Retail Sales, House market and raising unemployment? It becomes a big riddle on sources that boost industrial production and where produced goods go...
But riddle is resolving simple, if you take a look at two moments. First is - the dynamic of this indicator. Second - on datafalsification adjustments. By looking at Industrial production index you could see that it is not growing for recent 20 years and tests the same top for the 4th time. The stated increase in industrial production by 0.85% MoM is a consequence of a 0.3% revision for the worse of the data in March—April 2024 (underestimation of the base), and compared to last year, the growth is within the margin of error (+0.4% yoy).
This is the fourth peak (production ceiling) that cannot be broken. During this time, there were three crises, where in 2008-2009 the accumulated decline amounted to almost 17.3%, in 2015-2016 a decrease of 5.5%, and in 2019-2020 the collapse amounted to 18.7% at the moment. If we discard the comparison in retrospect for 10 years, the growth is only 1% and +3.2% by 2008.
Now let's take a look at famous Retail Sales. Retail sales account for a third of U.S. consumer demand and over 22% of GDP, meaning data matters. Consumer demand (goods and services) provides 68% of GDP.
From January to May 2024, retail sales increased by 2.2% YoY at face value and unchanged taking into account inflation, for two years +6.1% (+2.6% in real terms)But this is if you look at the same period last year. If we compare with December 2023, the nominal growth is within 0%, and taking into account inflation minus 0.8%.
Since 1993, there have been only 6 times, not counting 2024, when in the first 5 months of the new year, real retail sales were in the red relative to December last year, and the drop by 0.8% and worse was only twice – in 2008 (-1%) and 2020 (-5.7%).The main driver of US economic growth is steadily moving towards recession, and there is a crisis nearby."
By the way, Industrial Production growth is also nominal. If we make an adjustment for real inflation that is around 10-12% annually (by l. Summers) we get 0.5% drop per month. Besides, the spikes in production happens over time, as you could see on MoM chart above.
But here we're coming to most interesting US statistics tool. US statistical agencies have begun to actively use the technique of deterioration of old data to demonstrate current positive trends. By the way, this is also a very significant trend, which does not mean anything good. People usually watch for fresh data, paying low interest to revision of previous numbers, especially for multiple periods, forgetting that fresh data shows growth to downside revised previous one. So they are deceived twice. First time, when they believed in "good data" last month, second - when they believe in strong numbers now. The same is correct for job market as well, as we've mentioned many times.
Thus, consumers have been saying they’re exhausted by higher prices for some time. Now they're actually ratcheting back their spending more materially, as shown in May retail sales data. The question for markets is whether this is a welcome pullback that allows the US economy to cool just enough to tame inflation, or a more pernicious trend that hints at deeper weakness.
Now, voice of proponents of softer policy start sounds louder. Gregory Daco of Ernst & Young is worried about the latter, namely, a more material slowdown and the risk that the Federal Reserve is falling behind in cutting interest rates.
Ian Shepherdson of Pantheon Macroeconomics had a similar take — “Greg and I are going to have an agreement-fest here,” he joked — and elaborated on an argument advanced by Surveillance guests such as Mohamed El-Erian.
The US labor market stands at a potential “inflection point” where any further softness in demand for workers will hit jobs, not just job openings, according to economists at Goldman Sachs Group Inc. The current strength of labor demand is unclear, with healthy nonfarm payrolls contrasting with rising initial and continuing jobless claims in recent weeks, economist Jan Hatzius wrote in a note to clients.
Really evident hints on timing of the first rate cut.
OTHER REASONS FOR SOFTER FED POLICY
Here I mention just two - new US budget deficit forecast and US stock market stats. I also would like to write about Japan banks, but it would be too much I suppose (LOL). We will move this on tomorrow's Gold report. Besides, it has relation to general interest rates discussion. So, as you know CBO has made new forecast for budget in 2024-2025.
The nonpartisan Congressional Budget Office ramped up its estimate for this year’s US budget deficit by 27% to almost $2 trillion, sounding a fresh alarm about an unprecedented trajectory for federal borrowing. The CBO sees the deficit reaching $1.92 trillion in 2024, up from $1.69 trillion in 2023, according to updated projections released in Washington Tuesday. The new estimate is more than $400 billion larger than what the CBO anticipated in February — in part reflecting additional spending, including aid for Ukraine, enacted since then, along with Biden administration student-loan relief measures.
As a share of gross domestic product, the US deficit is now seen widening, not shrinking, for the 2024 fiscal year, which runs through September. The ratio is estimated at 6.7%, compared with the February forecast of 5.3% and the 6.3% logged for 2023.
Essentially, this is an acceptance that the United States cannot normalize the budget situation, especially given that forecasts more often underestimate the problem than overestimate it. The deficit is still covering the social sector. But in a year we will have to decide. Either overseas military operations or benefits and medicine for population.
And shortly on stock market. First is, margin debt in the US market increased by another $34 billion in May to $809 billion , the highest since the spring of 2022. This is happening against the backdrop of a continuing reduction in free cash on margin accounts to $145 billion.
As a result , the ratio of debt to free cash in accounts set a new record of 5.58 , in fact, the market continues to increase leverage, while the free cash is degrading.
Just four numbers show the scale of the bubble.
In fact you could see everything in our discussion. Why geometrically growing interest rates expenses, accelerating by new borrowings with higher rates, catastrophic budget plan, absolutely crazy ratios on stock market and massive falsification of statistics makes us think that the Fed stands at the edge of rate cut. Although currently market consensus suggests that this should happen in September, we think that it might be too late and keep watching for July rate cut, which might be a cold shower for the markets. Since the primary task for the Fed to keep stock market from collapse by any cost - July rate cut seems in time decision. At the same time we think that EU will not cut the rate in September due fast jump in wages. Both these factors could make EUR/USD turn up again. But first we need to get the Fed's cut in July to follow this scenario.
This week most important news have come from the US - Industrial production jumps for 0.9% per month while Retail sales have shown a bit worse than expected results. In reality situation looks absolutely different and not in the way how it is shown by statistician authorities. You need just to look at the same numbers in dynamic to understand this. Finally we've got very interesting comments from Japan, which we treat as 3rd most important economical event of this week.
Market overview
The dollar eased against the euro on Tuesday after retail sales data indicated signs of exhaustion among U.S. consumers, boosting the case for Federal Reserve rate cuts later this year. U.S. retail sales increased less than expected in May as lower prices for gasoline and motor vehicles weighed on receipts at service stations and auto dealerships. The trend in sales growth has been slowing as higher prices and interest rates force households to prioritize essentials and cut back on discretionary spending. Fed Funds futures implied a 67% probability of at least one rate cut by the September Fed meeting, up from 63% a day ago.
US industrial production increased in May, helped by a broad-based pickup in factory output in a positive sign for a manufacturing sector that has been struggling for momentum. The 0.9% increase in production at factories, mines and utilities followed no change a month earlier, Federal Reserve data showed Tuesday. The gain exceeded all forecasts in a Bloomberg survey of economists. Manufacturing output also climbed 0.9%, led by consumer goods, after a revised 0.4% April decrease.
Output at utilities jumped 1.6%.
The figures stand in contrast to other data showing manufacturing has had difficulty building momentum amid elevated input prices, inconsistent consumer demand and high borrowing costs. The Institute for Supply Management’s latest measure of factory activity shrank in May at a faster pace as a gauge of output came close to stagnating.
Although this is not the lowest value for a year and a half since the beginning of January 2023, but the second lowest value. The three-month rate of deterioration in consumer sentiment was higher only twice since 2000 - in 2005, when Hurricane Katrina hit the south of the country (if anyone doesn’t remember, the whole of New Orleans was flooded, 700 thousand people were left without homes, almost 2 thousand people died and the total damage to the economy amounted to $125 billion) and in 2020, when the Covid lockdowns began. In general, this says something.
The dollar edged higher against other major currencies on Friday, hitting a fresh eight-week high against the yen as data showed a strong U.S. economy and as the Federal Reserve's patient approach to interest-rate cuts stood in contrast to more dovish peers. U.S. business activity hit a 26-month high in June amid a rebound in employment while price pressures subsided considerably, suggesting that a recent slowdown in inflation was likely to be sustained. Thierry Wizman, global FX & rates strategist at Macquarie, in New York sees continued dollar strength as political uncertainty in Europe could eventually sap business and consumer confidence.
Last week's rally in the dollar was mostly driven by a sharp euro sell-off after French President Emmanuel Macron called a shock snap election in response to his ruling centrist party's trouncing by Marine Le Pen's eurosceptic National Rally in the European Parliament elections. The euro has stabilised since.
The European Central Bank could also buy French bonds to avoid "unwarranted and disorderly" yield spread widening. Still, ECB chief economist Philip Lane said recent market turmoil was "not disorderly". The European Commission on Wednesday proposed widely expected disciplinary steps against France, Italy and five other European Union countries over running excessive budget deficits.
Switzerland is at the front of the rate-cutting pack among developed economy central banks, lowering borrowing costs again on Thursday, while the all-important Federal Reserve is nowhere near the starting line as the U.S. economy stays strong. The Swiss National Bank followed up on March's interest rate cut with another reduction on Thursday to 1.25%. The step lower surprised some analysts, given a recent pick-up in Swiss growth and a mild rise in inflation to 1.4% in April.
The spreads between U.S. investment-grade corporate bond yields and U.S. Treasuries have surged to their highest in over three months, in a sign of risk aversion due to political uncertainty in France and as U.S. government bonds rallied. Barclays strategists said in a note on Friday the sell-off in U.S. corporate debt was partly due to a "flight to quality" caused by political uncertainty, with investors moving to safer U.S. Treasuries, which also rallied this month after better-than-expected inflation data.
U.S. bank regulators ordered Bank of America, Citigroup, Goldman Sachs and JPMorgan Chase on Friday to bolster plans for how they could be safely resolved in bankruptcy, and FDIC escalated its concerns about Citi's blueprint. Specifically, the Federal Reserve and Federal Deposit Insurance Corporation said the banks need to refine their so-called living wills to show how they could safely unwind their derivatives portfolios when they next submit plans to regulators in 2025.
The FDIC also escalated its concerns with Citi's plan to a "deficiency," meaning the regulator found it not credible, but the Fed did not follow suit. If both regulators had found Citi's plan deficient, it would have been required to resubmit an improved plan and could have potentially faced additional regulatory restrictions.
The European Central Bank will cut its deposit rate twice more this year, in September and December, according to a significant majority of economists polled by Reuters who said the risks were skewed towards fewer rate cuts than expected. That outlook was broadly unchanged from a survey conducted before the ECB delivered its widely telegraphed 25 basis point rate cut on June 6. Improving business activity, strong wage data and still-sticky price pressures have increased uncertainties around the rationale for more cuts. A near-90% majority of economists, 36 of 41, said risks were more skewed towards fewer ECB rate cuts this year than more.
The European Banking Authority (EBA) said in its quarterly "risk dashboard" that credit risks have started to materialise with an increase in non-performing loans (NPLs) in the three months to March. "The majority of banks surveyed expect further asset quality deterioration in CRE (commercial real estate), SMEs loans and consumer credit in the next 6-12 months," EBA said.
WHAT THE US DATA TELLS US
First, and before we turn to the US data directly, let's take a fast look only at one EU chart and some comments concerning EU rate change. In fact we're trading EUR/USD, so it is important to know what's going on on EU side as well. Now common opinion is to get two more rate cuts in 2024. European Central Bank policymaker Klaas Knot on Thursday backed market expectations for one or two more interest rate cuts this year as inflation appeared to be headed towards the ECB's 2% target. The European Central Bank is confident that inflation will fall back to its 2% target next year despite some "noisy" inflation along the way, the ECB's chief economist Philip Lane said on Monday.
Here I will show you only single picture, related to EU - this is Euro Area Wage Growth. It has reached +5.3% - highest level in 15 years of observation. This is not positive news, it means that the easing of monetary policy accelerates inflationary processes.
So, next rate cut or even two rate cuts this year are under question, which suggests hidden strength for EUR. Now, let's go to the US. Statistics tell that industrial production jumped 0.9% in May. Let's see what we have in the US:
By looking at these charts above, could you please explain how industrial production could rise together with dropping of Retail Sales, House market and raising unemployment? It becomes a big riddle on sources that boost industrial production and where produced goods go...
But riddle is resolving simple, if you take a look at two moments. First is - the dynamic of this indicator. Second - on data
This is the fourth peak (production ceiling) that cannot be broken. During this time, there were three crises, where in 2008-2009 the accumulated decline amounted to almost 17.3%, in 2015-2016 a decrease of 5.5%, and in 2019-2020 the collapse amounted to 18.7% at the moment. If we discard the comparison in retrospect for 10 years, the growth is only 1% and +3.2% by 2008.
Now let's take a look at famous Retail Sales. Retail sales account for a third of U.S. consumer demand and over 22% of GDP, meaning data matters. Consumer demand (goods and services) provides 68% of GDP.
From January to May 2024, retail sales increased by 2.2% YoY at face value and unchanged taking into account inflation, for two years +6.1% (+2.6% in real terms)But this is if you look at the same period last year. If we compare with December 2023, the nominal growth is within 0%, and taking into account inflation minus 0.8%.
Since 1993, there have been only 6 times, not counting 2024, when in the first 5 months of the new year, real retail sales were in the red relative to December last year, and the drop by 0.8% and worse was only twice – in 2008 (-1%) and 2020 (-5.7%).The main driver of US economic growth is steadily moving towards recession, and there is a crisis nearby."
By the way, Industrial Production growth is also nominal. If we make an adjustment for real inflation that is around 10-12% annually (by l. Summers) we get 0.5% drop per month. Besides, the spikes in production happens over time, as you could see on MoM chart above.
But here we're coming to most interesting US statistics tool. US statistical agencies have begun to actively use the technique of deterioration of old data to demonstrate current positive trends. By the way, this is also a very significant trend, which does not mean anything good. People usually watch for fresh data, paying low interest to revision of previous numbers, especially for multiple periods, forgetting that fresh data shows growth to downside revised previous one. So they are deceived twice. First time, when they believed in "good data" last month, second - when they believe in strong numbers now. The same is correct for job market as well, as we've mentioned many times.
Thus, consumers have been saying they’re exhausted by higher prices for some time. Now they're actually ratcheting back their spending more materially, as shown in May retail sales data. The question for markets is whether this is a welcome pullback that allows the US economy to cool just enough to tame inflation, or a more pernicious trend that hints at deeper weakness.
Now, voice of proponents of softer policy start sounds louder. Gregory Daco of Ernst & Young is worried about the latter, namely, a more material slowdown and the risk that the Federal Reserve is falling behind in cutting interest rates.
Ian Shepherdson of Pantheon Macroeconomics had a similar take — “Greg and I are going to have an agreement-fest here,” he joked — and elaborated on an argument advanced by Surveillance guests such as Mohamed El-Erian.
The US labor market stands at a potential “inflection point” where any further softness in demand for workers will hit jobs, not just job openings, according to economists at Goldman Sachs Group Inc. The current strength of labor demand is unclear, with healthy nonfarm payrolls contrasting with rising initial and continuing jobless claims in recent weeks, economist Jan Hatzius wrote in a note to clients.
Really evident hints on timing of the first rate cut.
OTHER REASONS FOR SOFTER FED POLICY
Here I mention just two - new US budget deficit forecast and US stock market stats. I also would like to write about Japan banks, but it would be too much I suppose (LOL). We will move this on tomorrow's Gold report. Besides, it has relation to general interest rates discussion. So, as you know CBO has made new forecast for budget in 2024-2025.
The nonpartisan Congressional Budget Office ramped up its estimate for this year’s US budget deficit by 27% to almost $2 trillion, sounding a fresh alarm about an unprecedented trajectory for federal borrowing. The CBO sees the deficit reaching $1.92 trillion in 2024, up from $1.69 trillion in 2023, according to updated projections released in Washington Tuesday. The new estimate is more than $400 billion larger than what the CBO anticipated in February — in part reflecting additional spending, including aid for Ukraine, enacted since then, along with Biden administration student-loan relief measures.
As a share of gross domestic product, the US deficit is now seen widening, not shrinking, for the 2024 fiscal year, which runs through September. The ratio is estimated at 6.7%, compared with the February forecast of 5.3% and the 6.3% logged for 2023.
Essentially, this is an acceptance that the United States cannot normalize the budget situation, especially given that forecasts more often underestimate the problem than overestimate it. The deficit is still covering the social sector. But in a year we will have to decide. Either overseas military operations or benefits and medicine for population.
And shortly on stock market. First is, margin debt in the US market increased by another $34 billion in May to $809 billion , the highest since the spring of 2022. This is happening against the backdrop of a continuing reduction in free cash on margin accounts to $145 billion.
As a result , the ratio of debt to free cash in accounts set a new record of 5.58 , in fact, the market continues to increase leverage, while the free cash is degrading.Just four numbers show the scale of the bubble.
- Capitalization-to-GDP ratio hits 187%. Compare it with DotCom bubble - 145%;
- Capitalization to Disposable Income is 2.65. DotCom Bubble - 2.0;
- Capitalization to M2 is 265%. DotCom bubble - 300%, while average level of 2017-2019 is 179%.
- Personal Savings to Capitalization is 1.37%. DotCom bubble - 3.65%. It is three time lower than pre-Covid era.
In fact you could see everything in our discussion. Why geometrically growing interest rates expenses, accelerating by new borrowings with higher rates, catastrophic budget plan, absolutely crazy ratios on stock market and massive falsification of statistics makes us think that the Fed stands at the edge of rate cut. Although currently market consensus suggests that this should happen in September, we think that it might be too late and keep watching for July rate cut, which might be a cold shower for the markets. Since the primary task for the Fed to keep stock market from collapse by any cost - July rate cut seems in time decision. At the same time we think that EU will not cut the rate in September due fast jump in wages. Both these factors could make EUR/USD turn up again. But first we need to get the Fed's cut in July to follow this scenario.
