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Riksbank Hikes 100 bp but the Krone gets No Love

Overview: Yesterday’s late rally in US shares carried into the Asia Pacific session where all of the large markets advanced. However, the bears are not…

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Overview: Yesterday’s late rally in US shares carried into the Asia Pacific session where all of the large markets advanced. However, the bears are not abdicating and Europe’s Stoxx 600 is off for the sixth consecutive session and US futures are trading lower. The sell-off in the bond market continues. European benchmark yields are mostly 8-10 bp higher and the US 10-year Treasury yield is up nearly five basis points to approach 3.54%. The two-year continues to knock on 4%. The US dollar is firmer against all the major currencies. Despite Sweden’s 100 bp rate, the krona is among the weakest of the G10 currencies, losing ground against all but the Norwegian krone and New Zealand dollar. The central bank of South Korea has requested hourly reports from the foreign exchange traders. This seems to have deflected some selling pressure away from the won, while most other emerging market currencies are lower. Gold stalled near $1680 and near $1666 in Europe. December WTI is firm near $85. US natgas is trying to snap a three-day tumble, while Europe’s benchmark is doing the same but with greater conviction. It is up about 4.25% after falling more than 20% over the past three sessions. Iron ore fell for the fifth consecutive session and has fallen nearly 7% over this run. December copper is about 0.5% softer today after slipping marginally yesterday. December wheat has stabilized. It fell 3.4% yesterday.

Asia Pacific

Japan reported slightly higher than expected August inflation. The headline CPI rose to 3.0% from 2.6%, while the core rate, which excludes fresh food, increased to 2.8% from 2.4%. Both were 0.1% above the median forecast in Bloomberg's survey. Excluding fresh food and energy, Japan's inflation rose to 1.6% from 1.2%, also 0.1% above the median forecast. The Bank of Japan meets later this week. Today's data is unlikely to sway the BOJ to change its monetary policy. However, its challenge will intensify. It had forecast core inflation at 2.3% this year. This will have to be revised higher. Yet, the key to policy might not be this year's core but the next year and 2024. The BOJ projects a 1.4% core rate next year and 1.3% in 2024. The median forecast in Bloomberg's survey puts it at 1.6% and 0.5%, respectively.

As widely expected, China left its loan prime rate unchanged at 3.65% and 4.30% for the one-year and five-year, respectively. The President of the World Bank said that China's unwillingness more stimulus puts more pressure on the US. Malpass noted that in the past, China offered more counter-cyclical support, but acknowledged that while this may be good for the PRC, and in the long-term, it puts pressure on the US. While this sounds intuitive clear, it is anything but. The more the "pressure" is looked at the more elusive it becomes. The US is aggressively tightening monetary and fiscal policy. How do decisions in Beijing impact the thrust of US policy?  It does not. US policy, of course is set independently. If Malpass is referring to world growth, which the World Bank estimates at 0.5% next year (-0.4% on a per capita basis), then it is simply mathematical. The weaker growth in China means the US may account for a greater share of world growth. Ironically, the World Bank forecast that the US grows 2.5% this year and 2.4% next is wildly out of date. The IMF is at 2.3% and 1.0%, respectively. The Federal Reserve's median forecast will be revised later this week. In June, it was at 1.7% this year and next.

The dollar is trading at the upper end of the three-day range against the Japanese yen of roughly JPY142.65-JPY143.80. Session highs are being recorded in the European morning and the intraday momentum indicators are stretched. Yet the market may feel emboldened by the divergence of monetary policy that is on full display this week. A move above JPY143.80 would target the JPY145 area that has capped it on at least a couple attempts this month. The minutes from the Reserve Bank of Australia's meeting early this month underscored the message that rates are getting to levels that may encourage a slower pace of increase. It has boosted its cash target rate by 50 bp in each of the last four meetings. It meets again on October 4. The futures market is nearly evenly split between a quarter point and half-point move. The Aussie extended its two-day advance to almost $0.6750 and has been turned back. It found support a little below $0.6700. A break of $0.6690 could signal a retest on the base near $0.6670, but suspect a consolidative North American session is likely. The Chinese yuan consolidated its recent losses. The US dollar trading in a narrow range within yesterday's range, which was within the pre-weekend range (CNY6.9870-CNY7.0255). The PBOC set the dollar's reference rate at CNY6.9468. The medina in Bloomberg's survey was CNY6.9984.

Europe

The idea that the BOJ could simply raise rates and that would stop the yen from falling seems naive. Ask Sweden. The Riksbank delivered a 100 bp hike today to 1.75%. Most economists had expected a 75 bp move, while the swaps markets saw the risk of a larger move. The Riksbank sees the deposit rate at 2.5% a year from now. The krona initially rose but is weaker now against the dollar and euro. Swedish inflation reached 9% last month. The Riksbank cut next year's growth forecast to -0.7% from previously expecting growth to be of that magnitude.

The eurozone reported a nearly 20 bln euro current account deficit in July. It swamped the 15.6 bln euro surplus reported in the first half. Consider that in the first seven months of 2021, the EMU reported an average monthly current account surplus of about 30.6 bln euros. While goods trade balance has eroded, the service surplus has grown. The primary income account, which includes profits, dividends, coupon payments, royalties, licensing fees, and the like has swung into deficit, but also its deficit on its secondary income account (transfer payments) widened. We suggest that the deterioration of the eurozone's external balance is important, it is worth considering the secondary effects, such as beneficiaries of its export of surplus savings.

The euro rose to a five-day high near $1.0050 but was quickly sold back off to $1.0000 in early European turnover. There are large options struck there that expire tomorrow and Thursday (2.3 bln euros and 3.9 bln, respectively). Given that the euro has been straddling that level for several weeks, it is difficult to know or have a sense of what has been hedged or neutralized. Broad consolidation still seems to be the most likely near-term scenario. Sterling extended yesterday's recovery to $1.1460 today, stopping short of the pre-weekend high closer to $1.1480. So far, today is shaping up to be the third consecutive session that sterling has not traded above $1.15. Note that strike activity is set to resume with dock workers in Liverpool for two weeks, and next week Felixstowe dock workers also strike. More rail strikes are planned too.

America

The US reports some housing data before the conclusion of the FOMC meeting tomorrow. On tap today are August housing starts. They are getting a bad rap. Since the end of last year, US housing starts have alternated between gains and declines on a monthly basis. July was down, so August should be higher. The median in Bloomberg does in fact look for a small increase. In the first seven months of the year, they have averaged 1.65 mln (seasonally adjusted annual rate). During the first seven months of 2021, when rates were lower and the economy more vibrant, housing starts averaged 1.58 mln. In the Jan-July period in 2019, housing starts averaged 1.2 mln a month.

Canada report August CPI today. The broad pattern is expected to echo what we saw in the US. While the headline pace is slowly moderating the core rates ae proving sticky, that speaks to the breadth of the price pressures. Headline CPI is expected to have slowed for the second month, after peaking at 8.1% in June. The 7.3% projected by the median forecast in the Bloomberg survey would be the lowest since April. The Bank of Canada has three core measures (common, median, and trim). They are likely to have firmed to an average of 5.4% from 5.3%. The average was 3.4% at the end of last year. It stood at almost 3.8% in Q1 and 5.2% at the end of Q2. After lifting rates by 100 bp in July and 75 bp earlier this month, the Bank of Canada is expected to hike by 50 bp next month and 25 bp at the last meeting of the year. That would put the target rate at 4%. The swaps market has the terminal about 4.25%.

The potential bearish shooting star candlestick in the dollar-CAD exchange rate seen yesterday has gone for nought. Initial follow-through USD selling was quickly exhausted near CAD1.3225 and the reversal of US equities helped lift the greenback toward CAD1.33. Yesterday's new two-year high was set by CAD1.3345, meeting the 38.2% retracement of the US dollar's decline from the March 2020 pandemic peak (~CAD1.4670). That said, the intraday momentum indicator is stretched, but watch stocks for the cue. The US dollar posted its lowest settlement against the Mexican peso in five sessions yesterday, but here too follow-through has been minimal. The US dollar is bouncing off the MXN19.90 area. In the broader picture, the greenback has been in mostly confined to a MXN19.80-MXN20.20 range since mid-August. 


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Economics

Nearly Half Of Americans Making Six-Figures Living Paycheck To Paycheck

Nearly Half Of Americans Making Six-Figures Living Paycheck To Paycheck

Roughly 60% of Americans say they’re living paycheck to paycheck -…

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Nearly Half Of Americans Making Six-Figures Living Paycheck To Paycheck

Roughly 60% of Americans say they're living paycheck to paycheck - a figure which hasn't budged much overall from last year's 55% despite inflation hitting 40-year highs, according to a recent LendingClub report.

Even people earning six figures are feeling the strain, with 45% reporting living paycheck to paycheck vs. 38% last year, CNBC reports.

"More consumers living paycheck to paycheck indicates that many are continuing to lose their financial stability," said LendingClub financial health officer, Anuj Nayar.

The consumer price index, which measures the average change in prices for consumer goods and services, rose a higher-than-expected 8.3% in August, driven by increases in food, shelter and medical care costs.

Although real average hourly earnings also rose a seasonally adjusted 0.2% for the month, they remained down 2.8% from a year ago, which means those paychecks don’t stretch as far as they used to. -CNBC

Meanwhile, Bank of America found that 71% of workers say their income isn't keeping pace with inflation - resulting in a five-year low in terms of financial security.

"It is no secret that prices have been increasing for everyday Americans — not only in the goods and services they purchase but also in the interest rates they’re paying to fund their lives," said Nayar, who noted that people are relying more on credit cards and carry a higher monthly balance, making them financially vulnerable. "This can have detrimental consequences for someone who pays the minimum amount on their credit cards every month."

According to an Aug. 30 report from the Federal Reserve Bank of New York, credit card balances increased by $46 billion from last year, becoming the second-biggest source of overall debt last quarter.

And as Bloomberg noted last month, more US consumers are saddled with credit card debt for longer periods of time. According to a recent survey by CreditCards.com, 60% of credit card debtors have been holding this type of debt for at least a year, up 50% from a year ago, while those holding debt for over two years is up 40%, from 32%, according to the online credit card marketplace.

And while total credit-card balances remain slightly lower than pre-pandemic levels, inflation and rising interest rates are taking a toll on the already-stretched finances of US households.

About a quarter of respondents said day-to-day expenses are the primary reason why they carry a balance. Almost half cite an emergency or unexpected expense, including medical bills and home or car repair.

The Federal Reserve is likely to raise interest rates for the fifth time this year next week. Credit-card rates are typically directly tied to the Fed Funds rate, and their increase along with a softening economy may lead to higher delinquencies. 

Total consumer debt rose $23.8 billion in July to a record $4.64 trillion, according to data from the Federal Reserve. -Bloomberg

The Fed's figures include credit card and auto debt, as well as student loans, but does not factor in mortgage debt.

Tyler Durden Tue, 10/04/2022 - 20:25

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Plunging pound and crumbling confidence: How the new UK government stumbled into a political and financial crisis of its own making

Liz Truss took over as prime minister with an ambitious plan to cut taxes by the most since 1972 – investors balked after it wasn’t clear how she would…

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The hard hats likely came in handy recently for Prime Minister Liz Truss and Chancellor of the Exchequer Kwasi Kwarteng. Stefan Rousseau/Pool Photo via AP

The new British government is off to a very rocky start – after stumbling through an economic and financial crisis of its own making.

Just a few weeks into its term on Sept. 23, 2022, Prime Minister Liz Truss’ government released a so-called mini-budget that proposed £161 billion – about US$184 billion at today’s rate – in new spending and the biggest tax cuts in half a century, with the benefits mainly going to Britain’s top earners. The aim was to jump-start growth in an economy on the verge of recession, but the government didn’t indicate how it would pay for it – or provide evidence that the spending and tax cuts would actually work.

Financial markets reacted badly, prompting interest rates to soar and the pound to plunge to the lowest level against the dollar since 1985. The Bank of England was forced to gobble up government bonds to avoid a financial crisis.

After days of defending the plan, the government did a U-turn of sorts on Oct. 3 by scrapping the most controversial component of the budget – elimination of its top 45% tax rate on high earners. This calmed markets, leading to a rally in the pound and government bonds.

As a finance professor who tracks markets closely, I believe at the heart of this mini-crisis over the mini-budget was a lack of confidence – and now a lack of credibility.

A looming recession

Truss’ government inherited a troubled economy.

Growth has been sluggish, with the latest quarterly figure at 0.2%. The Bank of England predicts the U.K. will soon enter a recession that could last until 2024. The latest data on U.K. manufacturing shows the sector is contracting.

Consumer confidence is at its lowest level ever as soaring inflation – currently at an annualized pace of 9.9% – drives up the cost of living, especially for food and fuel. At the same time, real, inflation-adjusted wages are falling by a record amount, or around 3%.

It’s important to note that many countries in the world, including the U.S. and in mainland Europe, are experiencing the same problems of low growth and high inflation. But rumblings in the background in the U.K. are also other weaknesses.

Since the financial crisis of 2008, the U.K. has suffered from lower productivity compared with other major economies. Business investment plateaued after Brexit in 2016 – when a slim majority of voters chose to leave the European Union – and remains significantly below pre-COVID-19 levels. And the U.K. also consistently runs a balance of payments deficit, which means the country imports a lot more goods and services than it exports, with a trade deficit of over 5% of gross domestic product.

In other words, investors were already predisposed to view the long-term trajectory of the U.K. economy and the British pound in a negative light.

An ambitious agenda

Truss, who became prime minister on Sept. 6, 2022, also didn’t have a strong start politically.

The government of Boris Johnson lost the confidence of his party and the electorate after a series of scandals, including accusations he mishandled sexual abuse allegations and revelations about parties being held in government offices while the country was in lockdown.

Truss was not the preferred candidate of lawmakers in her own Conservative Party, who had the task of submitting two choices for the wider party membership to vote on. The rest of the party – dues-paying members of the general public – chose Truss. The lack of support from Conservative members of Parliament meant she wasn’t in a position of strength coming into the job.

Nonetheless, the new cabinet had an ambitious agenda of cutting taxes and deregulating energy and business.

Some of the decisions, laid out in the mini-budget, were expected, such as subsidies limiting higher energy prices, reversing an increase in social security taxes and a planned increase in the corporate tax rate.

But others, notably a plan to abolish the 45% tax rate on incomes over £150,000, were not anticipated by markets. Since there were no explicit spending cuts cited, funding for the £161 billion package was expected to come from selling more debt. There was also the threat that this would be paid for, in part, by lower welfare payments at a time when poorer Britons are suffering from the soaring cost of living. The fear of welfare cuts is putting more pressure on the Truss government.

a man in a brown stocking hat inspects souvenirs near a bunch of UK flags and other trinkets
The cost of living crisis in the U.K. has everyone looking for deals where they can. AP Photo/Kirsty Wigglesworth

A collapse in confidence

Even as the new U.K. Chancellor of the Exchequer Kwasi Kwarteng was presenting the mini-budget on Sept. 23, the British pound was already getting hammered. It sank from $1.13 the day before the proposal to as low as $1.03 in intraday trading on Sept. 26. Yields on 10-year government bonds, known as gilts, jumped from about 3.5% to 4.5% – the highest level since 2008 – in the same period.

The jump in rates prompted mortgage lenders to suspend deals with new customers, eventually offering them again at significantly higher borrowing costs. There were fears that this would lead to a crash in the housing market.

In addition, the drop in gilt prices led to a crisis in pension funds, putting them at risk of insolvency.

Many members of Truss’ party voiced opposition to the high levels of borrowing likely necessary to finance the tax cuts and spending and said they would vote against the package.

The International Monetary Fund, which bailed out the U.K. in 1976, even offered its figurative two cents on the tax cuts, urging the government to “reevaluate” the plan. The comments further spooked investors.

To prevent a broader crisis in financial markets, the Bank of England stepped in and pledged to purchase up to £65 billion in government bonds.

Besides causing investors to lose faith, the crisis also severely dented the public’s confidence in the U.K. government. The latest polls showed the opposition Labour Party enjoying a 24-point lead, on average, over the Conservatives.

So the government likely had little choice but to reverse course and drop the most controversial part of the plan, the abolition of the 45% tax rate. The pound recovered its losses. The recovery in gilts was more modest, with bonds still trading at elevated levels.

Putting this all together, less than a month into the job, Truss has lost confidence – and credibility – with international investors, voters and her own party. And all this over a “mini-budget” – the full budget isn’t due until November 2022. It suggests the U.K.‘s troubles are far from over, a view echoed by credit rating agencies.

David McMillan does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.

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Economics

Roubini: The Stagflationary Debt Crisis Is Here

Roubini: The Stagflationary Debt Crisis Is Here

Authored by Nouriel Roubini via Project Syndicate,

The Great Moderation has given way to…

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Roubini: The Stagflationary Debt Crisis Is Here

Authored by Nouriel Roubini via Project Syndicate,

The Great Moderation has given way to the Great Stagflation, which will be characterized by instability and a confluence of slow-motion negative supply shocks. US and global equities are already back in a bear market, and the scale of the crisis that awaits has not even been fully priced in yet.

For a year now, I have argued that the increase in inflation would be persistent, that its causes include not only bad policies but also negative supply shocks, and that central banks’ attempt to fight it would cause a hard economic landing. When the recession comes, I warned, it will be severe and protracted, with widespread financial distress and debt crises. Notwithstanding their hawkish talk, central bankers, caught in a debt trap, may still wimp out and settle for above-target inflation. Any portfolio of risky equities and less risky fixed-income bonds will lose money on the bonds, owing to higher inflation and inflation expectations.

How do these predictions stack up? First, Team Transitory clearly lost to Team Persistent in the inflation debate. On top of excessively loose monetary, fiscal, and credit policies, negative supply shocks caused price growth to surge. COVID-19 lockdowns led to supply bottlenecks, including for labor. China’s “zero-COVID” policy created even more problems for global supply chains. Russia’s invasion of Ukraine sent shockwaves through energy and other commodity markets. And the broader sanctions regime – not least the weaponization of the US dollar and other currencies – has further balkanized the global economy, with “friend-shoring” and trade and immigration restrictions accelerating the trend toward deglobalization.

Everyone now recognizes that these persistent negative supply shocks have contributed to inflation, and the European Central Bank, the Bank of England, and the US Federal Reserve have begun to acknowledge that a soft landing will be exceedingly difficult to pull off. Fed Chair Jerome Powell now speaks of a “softish landing” with at least “some pain.” Meanwhile, a hard-landing scenario is becoming the consensus among market analysts, economists, and investors.

It is much harder to achieve a soft landing under conditions of stagflationary negative supply shocks than it is when the economy is overheating because of excessive demand. Since World War II, there has never been a case where the Fed achieved a soft landing with inflation above 5% (it is currently above 8%) and unemployment below 5% (it is currently 3.7%). And if a hard landing is the baseline for the United States, it is even more likely in Europe, owing to the Russian energy shock, China’s slowdown, and the ECB falling even further behind the curve relative to the Fed.

Are we already in a recession? Not yet, but the US did report negative growth in the first half of the year, and most forward-looking indicators of economic activity in advanced economies point to a sharp slowdown that will grow even worse with monetary-policy tightening. A hard landing by year’s end should be regarded as the baseline scenario.

While many other analysts now agree, they seem to think that the coming recession will be short and shallow, whereas I have cautioned against such relative optimism, stressing the risk of a severe and protracted stagflationary debt crisis. And now, the latest distress in financial markets – including bond and credit markets – has reinforced my view that central banks’ efforts to bring inflation back down to target will cause both an economic and a financial crash.

I have also long argued that central banks, regardless of their tough talk, will feel immense pressure to reverse their tightening once the scenario of a hard economic landing and a financial crash materializes. Early signs of wimping out are already discernible in the United Kingdom. Faced with the market reaction to the new government’s reckless fiscal stimulus, the BOE has launched an emergency quantitative-easing (QE) program to buy up government bonds (the yields on which have spiked).

Monetary policy is increasingly subject to fiscal capture. Recall that a similar turnaround occurred in the first quarter of 2019, when the Fed stopped its quantitative-tightening (QT) program and started pursuing a mix of backdoor QE and policy-rate cuts – after previously signaling continued rate hikes and QT – at the first sign of mild financial pressures and a growth slowdown. Central banks will talk tough; but there is good reason to doubt their willingness to do “whatever it takes” to return inflation to its target rate in a world of excessive debt with risks of an economic and financial crash.

Moreover, there are early signs that the Great Moderation has given way to the Great Stagflation, which will be characterized by instability and a confluence of slow-motion negative supply shocks. In addition to the disruptions mentioned above, these shocks could include societal aging in many key economies (a problem made worse by immigration restrictions); Sino-American decoupling; a “geopolitical depression” and breakdown of multilateralism; new variants of COVID-19 and new outbreaks, such as monkeypox; the increasingly damaging consequences of climate change; cyberwarfare; and fiscal policies to boost wages and workers’ power.

Where does that leave the traditional 60/40 portfolio? I previously argued that the negative correlation between bond and equity prices would break down as inflation rises, and indeed it has. Between January and June of this year, US (and global) equity indices fell by over 20% while long-term bond yields rose from 1.5% to 3.5%, leading to massive losses on both equities and bonds (positive price correlation).

Moreover, bond yields fell during the market rally between July and mid-August (which I correctly predicted would be a dead-cat bounce), thus maintaining the positive price correlation; and since mid-August, equities have continued their sharp fall while bond yields have gone much higher. As higher inflation has led to tighter monetary policy, a balanced bear market for both equities and bonds has emerged.

But US and global equities have not yet fully priced in even a mild and short hard landing. Equities will fall by about 30% in a mild recession, and by 40% or more in the severe stagflationary debt crisis that I have predicted for the global economy. Signs of strain in debt markets are mounting: sovereign spreads and long-term bond rates are rising, and high-yield spreads are increasing sharply; leveraged-loan and collateralized-loan-obligation markets are shutting down; highly indebted firms, shadow banks, households, governments, and countries are entering debt distress.

The crisis is here.

Tyler Durden Tue, 10/04/2022 - 17:25

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