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Have Central Banks Lost Control Of The Gold Price?

Have Central Banks Lost Control Of The Gold Price?


Over the past few months, gold prices have completely detached from…



Have Central Banks Lost Control Of The Gold Price?


Over the past few months, gold prices have completely detached from our model-predicted prices.

While we have seen deviations between actual and predicted prices in the past, those deviations were always temporary.

What we are witnessing now is the paradigm shift we alluded to in our report from March 2023.

Some explanations for this deviation we presented in that report are still valid. However, it appears increasingly likely that the main reason for this development is the central banks’ having lost control over the gold price.

Exhibit 1: Gold prices have completely detached from model-predicted values


Source: Goldmoney Research

Earlier this year, we published a two-part report Gold prices reflect a shift in paradigm – Part I and Part II, (March 15 & 16, 2023) in which we explored the thesis that the gold market exhibits a permanent paradigm shift. Historically, gold prices followed three drivers: Real-interest rate expectations, longer-dated energy prices, and central bank policy (net gold sales and QE). In 2016 we presented a gold price model to our readers, which showed that most of the price changes in gold can be explained with these three drivers. Deviations of the observed price from the model were usually short lived and prices eventually converged with the underlying drivers. Readers unfamiliar with our model can catch up here (Gold Price Framework Vol. 2: The energy side of the equation, May 28, 2018, here (Part II, 10 July 2018) and here (Part III, 24 August 2018), as well as some follow up reports that built on the model (Gold Price Framework Update – the New Cycle Accelerates, 28 January 2021) and (Gold prices continue to weather the rate storm, 13 April, 2022.

When the Fed began to hike rates in late 2021 as a reaction to burgeoning inflation, gold prices did first what the model would predict: They began to decline. Rising interest rates usually lead to higher real interest rate expectations if long-term rates rise faster than long-term inflation expectations. Real-interest rate expectations (as measured by 10-year TIPS yields) are strongly inversely correlated with gold prices as shown in our model. In the past, gold prices often followed real interest rates almost tick-by-tick intraday without any other news.

The decline in gold prices in early 2022 on the back of rising real-interest rate expectations was somewhat cushioned by rising energy prices. Long-dated oil prices rallied from $63.90/bbl in December 2021 to $75.91/bbl by July 2022. In our model, the rise in 10-year tips lowered predicted gold prices by $400/ozt while the rise in deferred oil prices increased it by $100/ozt (see Exhibit 2). On net, by August 2022, gold stood at $1737/ozt, just $25/ozt over our model predicted price of $1712.

Exhibit 2: The effect on gold by the rise in 10-year TIPS yields was initially offset by rising longer-dated oil prices

$/bbl (LHS), % (RHS)

Source: FRED, Goldmoney Research

However, while model-predicted prices continued to decline on the back of relentlessly rising real-interest rate expectations – and later the retracement of long-dated oil prices – gold prices turned and started to go up again. By fall 2022, we began noticing that, once again, gold prices had meaningfully deviated from predicted values. By the time we wrote our March 2023 note, gold traded already $450/ozt over the model predicted price, an absolute record at the time. Now the delta is a staggering $668/ozt. At the time of writing, gold is trading at $1870/ozt. But based on our model, it should be closer to $1202/ozt (see Exhibit 1). The chart illustrates clearly how detached gold prices have become from our model, and thus, the underlying drivers.

In our March 2023 note, we explored several theories that attempted to explain this large discrepancy between actual and predicted prices and we discussed whether we thought this was just a temporary phenomenon or whether this was something more permanent. 

The first observation was that central banks of non-OECD countries have been on a massive buying spree from late summer 2022. In our March 2023 report, we highlighted that the IMFs estimate of net central bank purchases was way too low in our view. We highlighted that even the much more optimistic estimates by the World Gold Council might be too low. For our model, we are using the high end of estimates from the WGC, but if actual gold purchases were even higher, then our model-predicted price would be too low. In addition, we also explained why we think our model may underestimate the extent to which central bank purchases drive the price. Historically, changes in CB holding were relatively small, and often the reporting time did not match the actual purchase. Particularly non- OECD central banks have been very opaque when it comes to gold purchases. That means our econometric models cannot properly attribute changes in the gold price to changes in central bank gold holdings. We concluded that the true impact on the price of gold is likely larger than what our model predicts. Thus, in our March 2023 note we came to the conclusion that strong central bank gold purchases might partially explain why our model was underpredicting prices.

However, since then central banks became net sellers again. Data from the World Gold Council shows that central banks were large net gold sellers in March, April and May of this year, and only became net gold buyers again in June, July and August. 

Exhibit 3: After a few months of large increases, central banks turned to net sellers in summer 2023 again

Tonnes month-over-month

Source: WGC, Goldmoney Research

On net, central banks didn’t add more gold than normal so far in 2023. In fact, despite the strong rebound over the past few months, central banks added less gold in 2023 than on average since 2009. Hence, we can conclude that the large deviation of actual and model predicted gold prices was and is not due to abnormally high central bank gold purchases.

Exhibit 4: Central banks added less gold in 2023 than on average since 2009


Source: WGC, Goldmoney Research

The second observation we made is that something seemed to have changed in the relationship between real-interest rate expectations and gold prices. The US has a very useful financial instrument to observe real-interest rate expectations: Treasury Inflation Protected Securities (TIPS). TIPS are government issued bonds that pay a fixed interest, similar to Treasuries. However, TIPS also compensate the holders for inflation as measured by the CPI. Thus, TIPS tend to carry a lower yield than treasuries of equivalent maturity. The difference between the nominal yield of a treasury note and the equivalent TIPS is therefore the market’s expectations for future inflation. We call this the breakeven inflation. TIPS yields themselves reflect real-interest rate expectations, meaning what the market thinks holders will earn in (real) interest until maturity, after inflation has been taken into account. Until very recently, gold and 10-year TIPS yields showed a remarkable inverse correlation over decades. However, since fall 2022, that relationship has broken down (see Exhibit 5). 

Exhibit 5: The strong inverse correlation between TIPS yields and gold has broken down

% change gold price y-o-y (Log) (LHS), change in 10y TIPS yield % (RHS), inversed

Source: Goldmoney Research

10-year TIPS yields rallied sharply since the Fed started raising rates, from -1.08% to currently 2.43%. That shift alone should have pushed gold price $600/ozt lower (see Exhibit 6).

Exhibit 6: 10-year TIPS yields moved over 3.5% higher in just 18 months


Source: FRED, Goldmoney Research

Arguably, there still are periods during which gold and real-interest rate move in lockstep, but for the past months, we observed long periods during which the inverse correlation between the two has completely broken down. Why is this? One can argue that the gold market is simply pricing in different inflation expectations than the TIPS market. One possible interpretation of the resilience of gold amidst rising real-interest rate expectations is that it is actually the TIPS market that is broken and not our model. While realized inflation jumped to 9% last year, implied breakeven inflation in TIPS yields barely moved above 3% and are already back to just shy of 2%, a level similar to years prior to the jump in inflation (see Exhibit 7).

Exhibit 7: 10-year TIPS breakeven inflation expectations remained low throughout the recent inflation spike


Source: FRED, Goldmoney Research

The absence of rising long-term breakeven inflation in the TIPS amidst relentlessly rising long-term interest rates have pushed 10-year TIPS yields to the highest level since 2008 (see Exhibit 8).

Exhibit 8: 10-year TIPS have reached levels not seen since 2008 on the back of rising nominal yields


Source: FRED, Goldmoney research

Inflation expectations would not have to be much higher than what is currently priced into TIPS yields to close the gap between observed and predicted gold prices. Assuming that “true” inflation expectations are 1% higher than what is embedded in 10-year TIPS yields, our model predicted gold prices would be around $1410/ozt. 2.5% higher inflation expectations close the gap almost entirely. 

However, while we are sympathetic to the view that the gold market simply prices in higher (and in our view, more reasonable) longer-term inflation expectations than the TIPS market, this does still not explain why the correlation between changes in TIPS yields and gold prices seem to have completely broken-down multiple times since 2022. We, thus, present our readers with a third explanation. That is, we think western central banks have simply lost control over gold prices. What do we mean by that? 

Despite abandoning the gold standard decades ago, gold prices still largely reflected central bank actions since then. Arguably western central banks so far were not primarily concerned about the price of gold in their respective currency, but they do try to control some of the factors that also drive gold prices. To illustrate this with the three main drivers for gold prices we identified in our model (Central bank net gold purchases/sales, real-interest rate expectations and longer dated energy prices):

  1. Until recently, it was mainly western central banks that bought and sold large quantities of gold (mostly sold). 

  2. Central banks set interest rates, which impacted real-interest rates expectations. Central banks also control how much money is in circulation, which impacted inflation and inflation expectations. QE was just another form of manipulating interest rates (and we argue it is behind the surge in inflation).

  3. On a long enough timeline, longer dated energy prices reflect mostly inflation. 

In other words, markets understood that central banks and their policies were ultimately behind rising gold prices. But importantly, the market also believed that central banks had the power to reverse the impact of their policies and implicitly had the power to bring gold prices down. Our model shows that over the last 20+ years, sell-offs in gold prices were mainly due to falling longer-dated energy prices and / or rising real-interest rate expectations. The fact that the recent massive rally in real-interest rate expectations – which was entirely driven by central bank rate hikes – was just shrugged off by the gold market, suggests that the power of western central banks, and particularly the Fed, to implicitly control gold prices, has dramatically decreased, if not vanished. 

To go one step further, the above interpretation may look at things the wrong way around. One can argue golds reluctance to react to the Fed rate hikes is just a symptom of a much larger issue. Rather than having lost control over gold prices, the Fed may have lost control over the US dollar itself. Gold priced in US dollars simply reflects that. And the Fed is not alone, all central banks are facing the same issue. 

Gold has always been able to retain its purchasing power over the long run. But now it seems that gold is the only form of money left that retains value. All other monies are just wildly fluctuating against each other. It appears that gold is a better arbiter of value today than it has ever been since President Nixon suspended the gold standard in 1971. 

Can the fed regain control over gold prices? The sharp rise in US interest rates by the Fed may have temporarily slowed price inflation as reported in the CPI. We think there is a high chance that the sudden rise in interest rates will cause a global recession in the near term, which in turn could even lead to temporary deflation as commodity demand collapses. But all the monetary policy that preceded the recent rise in inflation has not been undone and as a result, neither have all the excesses in the financial markets. For example, while the Fed funds rate went from zero to 5.5%, the Fed only unwound a fraction of its assets, from $9 trillion to $8 trillion (see Exhibit 9). Since the start of QT, the Fed has reduced its balance sheet by roughly $13bn per week. At this pace, it would take until 2029 to bring back the Feds balance sheet to just pre-pandemic levels, and until 2034 to bring it back to pre-financial crisis levels. 

Exhibit 9: Amidst massively tighter financial conditions, the Feds balance sheet has barely moved lower

$ millions

Source: FRED, Goldmoney Research

It is extremely unlikely in our view that we will see significantly more QT until the next crisis forces the Fed to reverse course. More and more people are recognizing that gold is a neutral anchor in an increasingly fragile currency world.

They chose to move more of their wealth in gold simply because the uncertainty of currency value remains extremely high even as observed inflation has come off substantially.

In our past reports about this topic, we concluded that the reasons why gold prices deviate from their historical drivers may well be permanent, but there is also a risk that the impending recession will crush that gap as inflation turns to deflation, real-interest rate expectations jump and investors seek refuge in the $ rather than gold, as they have done before, most notably in the early days of the great financial crisis in 2008/2009. While we still think that a sharp recession can put downward pressure on gold prices, we no longer think that the gap between observed prices and model predicted prices will close. The drivers behind the deviation are permanent in our view. Foreign central banks will most likely continue increasing their gold holdings.

“True” inflation expectations will remain high, and probably rise sharply when the Fed and other western central banks will inevitably return to ZIRP and NIRP and aggressively pursue QE. This will further undermine the Feds and other central banks ability to control the exchange rate between gold and their respective currencies. 

Tyler Durden Tue, 10/17/2023 - 15:40

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A Blue State Exodus: Who Can Afford To Be A Liberal

A Blue State Exodus: Who Can Afford To Be A Liberal

By Mish Shedlock of MishTalk

Is the blue state exodus from California, New York, and…



A Blue State Exodus: Who Can Afford To Be A Liberal

By Mish Shedlock of MishTalk

Is the blue state exodus from California, New York, and Illinois making red states like Florida, Texas, and South Carolina more liberal? Studies suggest the answer is no.

Net migration on a percentage basis from Apartment List

Still Ruby Red

South Carolina is one of the beneficiaries of a blue state exodus. But contrary to popular theory, South Carolina Is Still Ruby Red.

Fed up with pandemic restrictions, Sandy Zal uprooted her family from Schenectady, N.Y., three years ago and moved here because of its Republican tilt. She and her husband named their new company Freedom Window Tinting, a nod to South Carolina’s ethos.

The Zals are part of a migration wave that has kept South Carolina ruby red despite an influx of newcomers from blue states. A Wall Street Journal analysis of census data found that a third of the state’s new residents between 2017 and 2021 hailed from blue states and a quarter from red ones, according to census data. The remainder came from closely divided states, including nearby Georgia and North Carolina, or are immigrants.

The Palmetto State is a prime example of why a yearslong wave of migration to the South has largely failed to change its partisan tint. In Florida, for instance, 48% of people who moved there between 2017 and 2021 came from blue states while 29% came from red states, Census figures show. Among those who registered to vote, 44% are Republicans, 25% are Democrats and 28% are nonpartisan, according to L2 data. Texas also has a heavier flow of newcomers from blue states but a greater share who L2 data estimates are Republican.

When you’re younger you can afford to be a liberal—now you can’t,” he said. John Lush, who is no fan of Trump and will vote for Haley on Saturday, has enjoyed living under South Carolina’s conservative government. “The state politics are very nice. It’s agreeable,” he said.

Who Can Afford to Be a Liberal?

I disagree with the comment by Lush, “When you’re younger you can afford to be a liberal.”

Instead, I propose the first group of people who can most afford to be liberals are the political class that takes advantage of young idealistic fools. The process is accurately called “vote buying”.

The second group that can afford to be liberals are the arrogant elites such as Bill Gates and George Soros.

Understanding Blue State Exodus

Blue state exodus is largely Red or Independent because Republicans and Independents make up the majority of people with enough money to afford a house and choose to do so in a non-blue state for tax purposes.

As a result of blue state exodus, the blue states will get bluer and bluer until the whole thing blows up in the faces of blue state politicians.

What Metro Areas Are Attracting the Most New Renters?

Net migration on an absolute basis from Apartment List

The great escape from Blue states to Red states continued in 2023. California, New York, Illinois, New Jersey, and Massachusetts are the five top states people are fleeing on an absolute basis according to a National Apartment List report on migration.

Top Inbound Metro Areas

Can the young afford to be liberal? The answer is a resounding no in relation to other age groups. Stress is easy to spot by demographics.

Credit Card and Auto Delinquencies Soar

Credit card debt surged to a record high in the fourth quarter. Even more troubling is a steep climb in 90 day or longer delinquencies.

Record High Credit Card Debt

Credit card debt rose to a new record high of $1.13 trillion, up $50 billion in the quarter. Even more troubling is the surge in serious delinquencies, defined as 90 days or more past due. For nearly all age groups, serious delinquencies are the highest since 2011 at best.

Auto Loan Delinquencies

Serious delinquencies on auto loans have jumped from under 3 percent in mid-2021 to to 5 percent at the end of 2023 for age group 18-29. Age group 30-39 is also troubling. Serious delinquencies for age groups 18-29 and 30-39 are at the highest levels since 2010.

Generational Homeownership Rates

The above chart is from the Apartment List’s 2023 Millennial Homeownership Report

Those struggling with rent are more likely to Millennials and Zoomers than Generation X, Baby Boomers, or members of the Silent Generation.

The same age groups struggling with credit card and auto delinquencies.

Many Are Addicted to “Buy Now, Pay Later” Plans

Buy Now Pay Later, BNPL, plans are increasingly popular. It’s another sign of consumer credit stress.

The study did not break things down by home owners vs renters, but I strongly suspect most of the BNPL use is by renters.

There Are Two Economies But Only One Interest Rate

On average, the economy looks OK. But averages are misleading.

Homeowners are in a position to sell a home and buy one elsewhere, often for cash. They are predominately older. The have-nots cannot afford a home and are trapped where they are.

Tyler Durden Sun, 02/25/2024 - 10:30

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Luongo: Why War Bonds Are Returning In Europe

Luongo: Why War Bonds Are Returning In Europe

Authored by Tom Luongo via Gold, Goats, ‘n Guns blog,

After a mostly peaceful Security Conference…



Luongo: Why War Bonds Are Returning In Europe

Authored by Tom Luongo via Gold, Goats, 'n Guns blog,

After a mostly peaceful Security Conference in Munich over the weekend, Estonian Prime Minister Katja Kallas let the real purpose of all the recent hysteria over Ukraine funding out of the proverbial bag — Eurobonds.

Kallas was handed the bully pulpit to make the argument for $110 billion in Eurobonds be issued by the EU Commission to spend on arming Europe for the future and supporting Ukraine. It just sounds like more of the same that we’ve heard for two years now. More money for Ukraine. More war spending.

But this is a far more complex and nuanced issue than just making sure the West fights Russia to the last Ukrainian. This is ultimately about shoring up the EU’s fundamental weakness. It is an economic bloc with a common currency whose political authority is mostly powerless to control the value of that currency.

For this reason the EU leadership, nominally Davosian in their agenda, has been working their political machine towards giving the EU Commission that power through bond issuance and a centralized taxing mechanism.

They did this after COVID with their SURE Bonds, which they issued in 2020 to legitimize this process. I covered this in a long article in October last year when this very issue came up. Then ECB President Christine Lagarde made it public that they want to create a Eurobond Index to give these SURE bonds greater visibility in the vain hope someone will buy the next round of them.

There is also a major push happening offscreen for these bonds to become indexed next to everyone else’s, i.e. to more easily sell them to Muppet investors, through the imprimatur of them being official and backed by the full faith and credit of the EC. Of course, the initial investors in them have lost their ass as the bulk of them were issued when the ECB was at -0.6%. (See Here).

The ECB just held rates at 4.5%. The bond math doesn’t work. So, the EU got the last big lot of blood and treasure after the COVID operation from its investor class, who are now sitting on massive losses. Some of these investors, of course, were the member central banks themselves.

Don’t believe me? A €7 billion 0.1% coupon SURE bond maturing in October of 2040 is now trading at a yield of 3.867%. Now that doesn’t look so bad until you grep the price of that bond, which is trading with a bid/ask spread of 0.54/0.55… or a 45% loss.

This particular SURE bond has recovered in price back to around $0.61, after one of the biggest rallies in sovereign debt markets in history to end 2023. But that’s also just the quoted price. There is no price discovery on these, as there’s only on trade a week actually happening in Frankfurt where these things are listed.

They aren’t a market. They are, however, a massive political tool. Because they gave the EU Commission the ability to levy taxes to pay the 0.1% coupon on them. It’s the government tax and spend equivalent of “just the tip.” It’s only a small surcharge on your grocery bill… or whatever.

One problem is that the initial investors in these things are still sitting on 40% losses. If the first round are selling at a 40 to 50% discount what coupon are they going to have to offer to get anyone to buy the next round? nd it’s part of the reason why there is such urgency to get central banks to lower rates.

The EU can’t afford to raise the capital it needs to complete its fiscal integration plans with the ECB forced up to 4.5% to keep pace with Powell’s FED. They need these rates back near zero to fund their grand dreams of a hydrocarbon-free totalitarian future.

As always, this underscores the point I’ve been making for two-plus years now that Powell’s “higher for longer” rate policy is squeezing not just the European banking system but also it’s political objectives.

None of this is remotely sustainable at 5.5%. And for anyone who thinks the US is more vulnerable to this than the EU is, I invite you to explain that to me in grave detail with the dollar having drank nearly all of the euro’s milkshake in global trade over the past two years.

I’ll wait.

From SURE to War

The fate of these SURE bonds and all future EC bond issuances hangs in the balance here. In fact, the future of the EU itself hangs in the balance. And that’s why I was contacted by Sputnik News yesterday to give my thoughts on this subject.

“Eurobonds are the Holy Grail for European integration,” Tom Luongo, financial and geopolitical analyst, told Sputnik. “PM Kallas is telling you what the plan is. The EU’s Achilles’ heel is the euro itself and its lack of central taxing authority.”

“Eurobonds, issued through the European Commission, of this type are another way of handing that authority to Brussels, bypassing member state central banks and legislatures,” he added.

“If one was cynical, which I am, one would suspect that the EU’s support for the war in Ukraine was mostly driven by this desire to centralize power in Brussels,” Luongo argued. “You start a war in Ukraine by purposefully crossing Russia’s red lines, drive inflation up locally, and empty the military coffers of all the post-WWII weapons and ammunition that is now outdated. (…) If you are losing, as you are now, you play up the threat of Russia not stopping at Ukraine to justify shifting your domestic spending to a military build-up, issuing Eurobonds to pay for it.”

This plan for war bonds was shepherded by the usual suspects for EU militarization, French President Emmanuel Macron and EU President Charles Michel. And I want to stress here that nothing about this project is economic. It is purely political. They will expend whatever political capital they must to force this outcome on the people of Europe.

To folks like Macron, Michel, Ursula Von der Leyen and their bosses, European bourgeoisie and proletariats alike are just tax cattle. No wonder they are so against them eating beef.

So, let’s connect another couple of dots. Because now it should be obvious that this is why they threatened Hungary’s Viktor Orban with economic devastation for holding up their $50 billion aid package for Ukraine.

They need to keep Ukraine going to justify now spending another $100+ billion to launder into failing French and German banks sitting on massive losses from all the debt they bought during the NIRP (Negative Interest Rate Policy) period.

This is just the beginning of their plans for transferring sovereignty out of the hands of the member states and handing it to Brussels. But to sell this to global investors they have to prove to the world they have all the wayward voices under control.

Sovereign debt is secured through taxation and the productive capacity of the population. At this point the EU has neither.

NATO Forever

Now when I think about what all the principle players have been harping about for the past couple of weeks the common theme was NATO uber alles. This was echoed by everyone from President Biden at his latest press conference and Vice President Harris at Munich, to Hillary Clinton, clearly on more than a proof of life tour.

We had Alexei Navalny’s death used to raise money for war. Reports of Russia shooting US satellites out of orbit. Locusts!

It never stops with these people. There’s always a convenient Russian or Chinese bogeyman lurking behind every headline. But the underlying theme is to keep the money flowing into NATO. Trump’s comments on standing aside if Putin attacked a NATO country that didn’t pay its way were used by all of them to breathlessly support MOAR NATO.

But, in the end, this is just about the exercise of raw power against domestic populations. Putin and his army are no more a threat to Berlin than they are a threat to Kiev at this point.

NATO, and the plans to morph it into a global police force under UN control, is the reason for all of this. Europe wants the US to be a vassal after spending itself to death fighting the phantom menace of Putin. Eurobonds are the real story.

The rest is just noise.

N.B. As always, I will publish everything I sent to Sputnik News for the sake of transparency

Sputnik: The EU needs to work on a plan to issue $107.8 billion in eurobonds to boost the continent’s defense industry, and in the meantime do more to get weapons to Ukraine, Estonian Prime Minister Kaja Kallas told Bloomberg in an interview at the Munich Security Conference on Sunday. “We are in a place where we need to invest more and [explore] what we can do together, because the bonds that would be issued by separate countries individually are too small to scale up,” she said. “Eurobonds could have a much bigger impact.”

What is your overall opinion on this idea and its potential effectiveness?

Eurobonds are the Holy Grail for European integration.  PM Kallas is telling you what the plan is.  The EU’s Achilles’ heel is the euro itself and its lack of central taxing authority.  Eurobonds, issued through the European Commission, of this type are another way of handing that authority to Brussels, bypassing member state central banks and legislatures.

If one was cynical, which I am, one would suspect that the EU’s support for the war in Ukraine was mostly driven by this desire to centralize power in Brussels.  You start a war in Ukraine by purposefully crossing Russia’s red lines, drive inflation up locally, and empty the military coffers of all the post-WWII weapons and ammunition that is now outdated.  If you win the war it’s great.  Russia’s been subjugated and a new colonial frontier opens up for Europe to grab the collateral needed for the next iteration of Imperial Europe.

If you are losing, as you are now, you play up the threat of Russia not stopping at Ukraine to justify shifting your domestic spending to a military buildup, issuing Eurobonds to pay for it.  The EU Commission has to be given direct taxing authority to guarantee the bonds to investors.  Their SURE bonds, issued after COVID-19, were the first proof of this mechanism. 

This is why they were so angry with Viktor Orban over blocking Ukraine aid.  It legitimizes their central authority to guarantee to investors they can impose their will on EU members. while keeping Ukraine on financial life support to justify re-arming Europe.

While funding for Ukraine remains at a standstill in the US Congress, the EU appears to be heading towards accumulating more debt. What sort of risks does this method of joint borrowing pose for European countries? What anticipated and unforeseen consequences do you expect?

The risks are mostly political for the people of Europe.  Because it means that if you think that things are out of control in Brussels now, just wait when you are paying taxes directly to the EU Commission.  What you saw over the past month with Orban was a warning to the rest of the EU.  There is no partnership here, there is only the exercise of raw power from the central authority.

By putting these words into the mouth of a rabid Russophobe like Estonia’s PM Kallas it’s meant to shame the rest of the EU to go along with this.  What’s left of national sovereignty in Europe will die if the EU Commission continues getting these special bond issuances, €100 billion at a time.

While everyone was at Munich this past weekend talking about their ‘sacred commitment’ to NATO, the reality is that proposals like this will eventually blow apart NATO.  NATO in the mind of the Eurocrats and globalists in DC is a precursor to a global police force administered by the United Nations.  The more these people push for total integration of military, regulatory, political and economic cohesion, the more they will alienate the people they are trying to subjugate.

With Europe having its industries severely impacted by the financial crisis and many of them relocating their production, to what extent can this eurobonds strategy boost the continent’s defense industry? Is it wishful thinking by the Estonian Prime Minister?

It’s not wishful thinking on her part, it’s part of the process the laid out on the proverbial whiteboard in Brussels.  Europe embarked on a very dangerous path by purposefully gutting their domestic economies through COVID lockdowns to get the first round of Eurobonds agreed to.  Now they are using the phantom threat of a Russian invasion to get the second round issued. 

The incipient inflation and overly strong euro as a currency is pushing their industries offshore as a result.  But that is, again, part of the strategy.  Because for every BASF plant built in the US, what comes with it are the strings of EU regulations which the local and federal governments must adopt.  These are designed to collapse the competitive advantage of the foreign nation by raising their costs locally. 

It’s always a poisoned carrot with these people.  Always.

The fly in this ointment for them is their having to raise interest rates to keep pace with the Federal Reserve.  With each month that passes where the Fed refuses to back off on interest rates the more the risks to Brussels’ plans multiply.  The entire project is predicated on using cheap credit dollars to fund the transition to their preferred hydrocarbonless future, while simultaneously hollowing out their biggest competitor, the US, by tying it down in useless skirmishes like Ukraine through NATO.

Tyler Durden Sun, 02/25/2024 - 07:00

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Week Ahead: With the Markets Converging (Again) with Fed’s Dots, Is the Interest Rate Adjustment Over?

The US
dollar and interest rates appear to be at an inflection point. Much of the past
several weeks have been about correcting the overshoot that took…



The US dollar and interest rates appear to be at an inflection point. Much of the past several weeks have been about correcting the overshoot that took place in  Q4 23, when the derivatives markets were pricing in nearly seven quarter-point rate cuts by the Federal Reserve this year. US two- and 10-year interest rates set new three-month highs last week. With the help of economic data and comments by Fed officials, the market, as it did a few times last year, has converged to the Federal Reserve. That adjustment seems to have run its course. We look for softer US economic data in the coming weeks, which may help cap US rates. At the same time, the technical condition of many of the G10 currencies has improved and momentum indicators are turning higher. Growth impulses from are still faint in most other high-income countries, but the key, as seen in Q4 23, are the developments in the US. 

Another developing story is in China. Beijing has taken formal and informal steps to support equities. The CSI 300 rose every day last week, as the mainland markets re-opened from the extended holiday. The last time it did that in five-day week was November 2020. In fairness, the CSI 300 rose in the four sessions before the holiday commenced. During the Great Financial Crisis and again during Covid, many high-income countries moved to support their stock markets and limited short sales. Many see the threat to financial stability posed by dramatic losses in the equity market to be part of the so-called "Fed put."  It may be even more significant in China where the property market has shuttered a key savings vehicle and central government bond yields are too low. Weak stocks encouraged Chinese investors to export savings to the extent possible and purchase gold. Foreign investors, using the Hong Kong Connect were also active buyers in recent days, perhaps as the "fear of missing out" kicks-in. 

Another theme that we think is already emerged with Canada's January CPI last week and will be extended to the preliminary estimate of the eurozone's February CPI this week, is a sharp deceleration of inflation. The eurozone, UK, and Canada saw dramatic jumps in consumer prices in the Feb-May 2023 period. As these drop out of the year-over-year measure, headline rates will fall more than many may appreciate. Eurozone and UK inflation likely to slow below 2%, assuming a conservative average monthly gain of 0.3%. With the same assumption, Canada's headline CPI may hold slightly above 2%.

United States: The January CPI and PPI reports saw market expectations again move closer to the Fed's December dot plot, which anticipated that three rate cuts this year would be appropriate. Fed Chair Powell has warned that as the quarter progresses, the snapshot of views offered by the Summary of Economic Projections (dot plot) may become dated, but thus far, most of the Fed officials who have spoken do not appear to have changed their minds. At the end of last week, the Fed funds futures show three rates’ cuts are now discounted and less than a 30% chance of a fourth cut. This is about half of the easing that was discounted late last year. 

Among market participants, there seems to be two key issues. The first is about the strength of the economy here at the start of Q1 24. January jobs growth appeared solid, but retail sales and industrial output were weaker than expected. While all business cycles are unique, during this one, many standard metrics do not seem to be working, including yield-curve inversion, the contraction in M2, and the collapse of leading economic indicators, to name a few. On balance, with the data in hand, we suspect the economy is growing faster than the Fed's long-term non-inflationary pace of 1.8%. But is slowing and we expect this to be more evident with this month's data. Weak Boeing orders will weigh on durable goods orders and the early call for nonfarm payrolls is less than half of January's 353k increase (March 8). The second issue is inflation. The personal consumption deflator, which the Fed targets, has a different methodology and assigns different weights than the CPI. The PCE deflator rose at an annualized rate of 2% in H2 23, while the core measure rose by 1.8%. A 0.3% increase in January would allow the year-over-year rate to ease to 2.3% from 2.6%, given the 0.6% rise in January 2023. The core rate may rise by 0.4%, which would see the year-over-year rate slip to 2.8% from 2.9%. 

The Dollar Index peaked with the release of the January CPI on February 13 near 105.00, overshooting the (61.8%) retracement of the losses from Q4 23 decline. It has fallen in seven of the eight sessions since peak. A break now of the 103.30 area could signal a test on 102.80 initially and then 102.30. The five-day moving average crossed below the 20-day moving average at the end of last week for the first time since early January. The momentum indicators have turned lower.

China:  China reports February PMI and the Caixin manufacturing PMI in the coming days. Many western economists argue that the China's developmental model has failed. As we have noted before, Nobel prize-winning economy Paul Krugman argued before Xi's claim to life-time rule, Beijing's "wolf diplomacy, and harassment of its neighbors, and the unwinding of economic and political reforms since the death of Mao, that Chinese model hit a "great wall." Many of the architects of Trump's tariffs, which have been continued and extended by the Biden administration, cut their teeth on confronting Japan in the 1980s. We have suggested China was on a path set into place by Deng Xiaoping and Xi has taken China off that path. The idea of "peaceful rise" or "peaceful development," which minimized the friction with the US has been replaced by that notion that "you can't hide an elephant behind a tree." What makes the current situation exceptionally fraught with risk is that Beijing seems to think that US is in some inexorable decline. In this sense both sides conclude the other is in decline and that would seem to boost the risk of underestimating one's adversary. Beijing is not content with the current pace and composition of growth and regardless of the latest PMI print, we expect additional stimulus. Last week, it moved to deter institutional investors from selling at the open or close and put a stigma on selling short. In the Great Financial Crisis and during Covid, some market economies banned short selling in some sectors. That ought not be the issue. However, China's approach seems clumsier and less transparent.

Through formal and informal mechanisms, Beijing appears to have put a floor under Chinese stocks. The CSI 300 has strung together back-to-back weekly gains for the first time in three months. It rose 3.7% last week after rallying 5.8% in the week before the Lunar New Year holiday. It is now higher on the year. This may take some pressure off the yuan. However, the continued weakness of the Japanese yen warns that the CNY7.20 area that has capped the dollar last month and this month could come under further pressure. Assuming the fix continues to be steady, the dollar could rise toward CNY7.24, though we suspect it won't.

Eurozone: Starting with the preliminary CPI on March 1, headline inflation is set to fall sharply in the EMU. This will likely encourage speculation that the ECB can cut rates sooner, especially in the context of the recent cuts in the growth outlook. In February-April 2023, eurozone CPI rose at an annualized rate of 9.2%. With a conservative assumption of an average monthly increase of 0.3% in the February-April period this year, the headline rate will fall below 2%. It will likely be near 2% by the time the ECB meets on April 11. The core rate is firmer at 3.3% year-over-year in January. It was at 5.5% as recently at the middle of last year. The swaps market has about a 33% chance of a cut in April discounted. It had been fully discounted as recently as the end of January. For the first two weeks of the year, the US two-year rate rose less than Germany's and the US premium over Germany narrowed to about 155 bp from about 190 bp at the end of 2023. It has since recovered fully and approached 190 bp in mid-February. Eurostat will also report the region's January unemployment rate. It seems like an underappreciated story. The eurozone has withstood not only the ECB's tightening but also a stagnant or worse economy without a pick-up in the unemployment rate, which finished last year at 6.4%. Before the pandemic struck, the unemployment rate was at 7.5%, which was lowest since 2008. It reached the EMU-area low of 7.4% in late 2007. It has not been above there since July 2021. 

The euro spiked to three-week high in Asia on February 22 near $1.0890 but European and North American participants sold it back to almost $1.08. Still, the technical tone is solidifying with the momentum indicators turning up and the five-day moving average crossing above the 20-day moving average for the first time since early January. The euro recorded its first weekly advance in six weeks. We suspect the $1.0900-20 area needs to be surpassed to signify something more than broad consolidation after falling by about 4.5-cents since late last year. A close below the $1.0790-$1.0800 suggests that forging the low will take more time.

Japan:  The signal from the January CPI has already been given by the Tokyo estimate several weeks ago. That signal is of disinflationary forces. Due primarily to different weights, the Tokyo CPI is running a couple of tenths of a percent below the national figures. The January Tokyo headline and core CPI tumbled to 1.6% from 2.4% and 2.1%, respectively. In December, the national CPI was 2.6% and the core was 2.3%. Both may have slipped below 2% last month. This, like recent news that showed the Japanese economy unexpectedly contracted in Q4 23, could be seen as hampering what had been expected to be the BOJ's exit from the negative policy rate. We have argued that rather than an economic issue, the BOJ appears to be approaching it as a technocratic issue. Negative interest rates making it more difficult to conduct monetary policy. While the knee-jerk market reaction may disagree, we do not think the sharp drop in January industrial production will change the BOJ's drive either. The earthquake in early January was a significant disruption.  

Japan also reports retail sales. Japanese consumption on a GDP basis contracted for three consecutive quarters through the end of last year. Consumer spending fell by 0.9% at an annualized rate it Q4 23, which was the least of the three quarters, even though retails fell by an average of 1.1% a month, the most in the early days of Covid. Still, a poor retail sales report could contribute to the negative sentiment after having been surprised by the Q4 23 economic contraction. While consumption in Q4 23 was weak, production was strong. Industrial output rose by an average of 0.6% in Q4 23, the strongest quarterly performance in two years. The January report estimate is due on February 29. At the same time, Japan will report January employment figures. The unemployment rate finished last year at three-year low of 2.4%, despite the back-to-back quarterly contractions. Before the pandemic, at the end of 2019, it was 2.2%.

US yields rose to new highs for the year last week and the dollar closed higher last week, as it has done every week so far this year.  As we have noted, implied three-month vol is near a two-year low (~8%). Still, the market looks orderly, and with negative policy rate, Japan probably does not get a sympathetic hearing from its counterparts for material intervention. Nevertheless, the market may turn cautious as the JPY152 area is approached. That capped the greenback in 2022 and 2023. Not to lean too far ahead of our skis, but we look for softer data, including US February jobs data that will help cap US rates and take some pressure off the yen. 

United Kingdom: February Nationwide house price index and January consumer credit and mortgage lending is the not the stuff that typically moves sterling. The UK holds its third by-election of the month in Rochdale. The Labour MP passed and hence the byelection. However, what makes it interesting is that both Labour and the Greens have distanced themselves from their respective candidates for comments about the Middle East. Meanwhile a former Labour MP (2010) who was suspended from the party in 2017 (explicit emails to a 17-year-old girl) is running as the Reform Party candidate (led by Nigel Farage). The UK holds local elections in May and a national election is expected to be call later this year. 

Sterling rose last week for the first time since mid-January and its nearly 0.55% gain was the most since mid-December. The weekly settlement was the highest since January 26.  The momentum indicators have turned up and the five-day moving average pushed above the 20-day moving average for the first time since early January. Sterling has recovered from the breakdown to around $1.2520 earlier this month and it has returned to the middle of the $1.26-$1.28 trading range that dominated from mid-December through early February. The $1.2750-$1.2800 area offers what appears to be formidable resistance. 

Australia: The Antipodeans are seen as among the laggards in upcoming easing cycle, ex-Japan. Indeed, the swaps market continues to price odds of another rate hike by the Reserve Bank of New Zealand with around a 60% chance by the end of May, the last meeting of H1 24. That said, the swap market has a cut fully discounted (-90%) by the end of November. The futures market shows a clear easing bias for the Reserve Bank of Australia but does not have the first cut fully discounted until September (though there is around an 85% chance of a cut in August). Australia's month's CPI measure (as opposed to the traditional quarterly report) has fallen from 8.4% at the end of 2022 to 3.4% at the end of last year. The Q4 23 CPI fell to 4.1% from 5.4% in Q3 23. The RBA forecast CPI to fall to 3.2% this year. A faster than expected decline in inflation could spur speculation of an earlier rate cut, but the market, like policymakers, seem to put more stock on the quarterly measures. Australia will also report January retail sales. They were dreadful in January, falling 2.7% month-over-month. This overstates the weakness of the Aussie consumer after the recent rate hikes (last one was in November 2023). 

The Australian dollar has strung together three consecutive weekly gains after falling for first five weeks of the year. It posted its highest settlement since February 1 ahead of the weekend. It will begin the week with an eight-day rally in tow. The five-day moving average crossed above the 20-day moving average for the first time since early January and the momentum indicators are trending higher. The $0.6600-$0.6625 area posted the next technical hurdle. On the downside, a break of the $6520 area would be disappointing. 

Canada: Canada is among the last of the G10 countries to estimate Q4 23 GDP. The December monthly and fourth-quarter GDP will be reported on February 29. The economy contracted by 1.1% in Q3 23 but likely returned to growth in Q4. The economy may have grown by around 0.2% in December after expanding by 0.2% in November, which ended a three-month stagnation. The median forecast in Blomberg's month survey is for 0.3% in each of the first two quarters this year. The swaps market has about a 75% chance of a June cut. It was completely discounted at the start of the month. 

The US dollar traced a range on February 13, the day the January CPI was reported, against the Canadian dollar that has remained intact since then: roughly CAD1.3440-CAD1.3585. Another way to think of the range is that it is between the 50- and 100-day moving averages (~CAD1.3410-CAD1.3540).The 200-day moving is in the middle of the range The Canadian dollar continues to be sensitive to the general risk environment. The rolling 30-day correlation of changes in the exchange rate and the S&P 500 is around 0.56, the upper end of where is has been over the past year.  

Mexico:  The economic diary is jammed in the coming days: January trade figures, the central bank's new inflation report, unemployment, and worker remittances. Also manufacturing PMI and IMEF February surveys are due. However, the data are unlikely to change the impression that the Mexican economy is slowing down. The central bank has already signaled that it is preparing the first rate cut. Even with a quarter-point cut that may be delivered as soon as next month, Mexico's rates are attractive. Its external account is solid. Last year, for example, Mexico recorded an average monthly trade deficit of $455 mln (vs. an average monthly deficit of $2.2 bln in 2022). Worker remittances averaged nearly $5.3 bln in 2023 (~$4.9 bln average in 2022).

Since mid-January, the US dollar has recorded lower highs and found support near MXN17.00. We continue to detect a change in sentiment toward the peso. A down trendline off the late January high and early February high comes in near MXN17.1170 at the start of the new week and falls to about MXN17.07 by the end of the week. This month, the greenback has not closed outside of the MXN17.03-MXN17.20 range. Our bias is toward an upside break as overweight positions are trimmed. In the futures market, speculators have the largest net long peso since early 2020. Three-month implied volatility has fallen below 9% for the first time since before the pandemic.




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