Category: Economy

Analysis of the global economy

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Markets move to Risk-Off

Bitcoin broke support at $64K, warning that financial markets are moving to risk-off . Traders and investors reduce their exposure to risk and focus on protecting their capital. Follow-through below $62K would confirm, warning of a sharp fall (in BTC) and a stock market correction.

Bitcoin

The 10-Year Treasury yield has climbed to 4.67%, confirming our target of 5.0%.

10-Year Treasury Yield

The Japanese Yen fell to 154 against the Dollar, increasing pressure on the Bank of Japan to loosen the cap on long-term JGB yields — to protect the Yen. The result of such a move would be an outflow of Japanese investors from the US Treasury market, increasing upward pressure on UST yields and downward pressure on the Dollar.

USDJPY

Fed Monetary Policy

From CNN:

The US economy’s enduring strength and a “lack of progress” on inflation means the central bank likely won’t cut interest rates at its upcoming policy meeting just two weeks away, Federal Reserve Chair Jerome Powell said Tuesday.

“The recent data have clearly not given us greater confidence” that inflation is headed toward the central bank’s 2% goal, Powell said during a moderated discussion hosted by the Wilson Center. Instead, he said, there are indications “that it is likely to take longer than expected to achieve that confidence.”

Stocks

The S&P 500 broke support at 5100, warning of a correction. Lower Trend Index peaks reflect selling pressure. Our target is 4950.

S&P 500

The Equal-Weighted Index ($IQX) continued its downward path after breaking support at 6650, presenting a target of 6250.

S&P 500 Equal-Weighted Index

US Consumers

Real retail sales ticked up in March to remain on trend.

Real Retail Sales

Light vehicle sales also remain reasonably strong, at 15.5 million units (annualized) in March.

Light Vehicle Sales

Gold & the Dollar

The Dollar Index climbed above 106, strengthened by safe haven demand and the appeal of higher long-term yields. Our target is the October 2023 high at 107.

Dollar Index

Gold is again testing resistance at our target of $2400 per ounce, currently at $2383. The Shanghai Gold Exchange continues to display a premium on its international gold contract (iAu99.99) at 558.3 Yuan which translates to $2399 per Troy ounce (31.10348 grams). The domestic contract trades at an even higher price of 569 per gram but is subject to capital controls. The price premium should ensure a constant inflow of physical gold from other exchanges to China for as long it is maintained.

Spot Gold

Silver retraced from resistance at $29 per ounce and is testing support at $28. The lower Trend Index peak warns of selling pressure. Breach of $28 would warn of a correction to $26. Breakout above $29 is less likely in the short-term but would signal a fresh advance, with a medium-term target of $34.

Spot Silver

Crude & Commodities

Brent crude is in a narrow consolidation (pennant) at $90 per barrel. Continuation is likely and would test resistance at $96 per barrel.
Brent Crude

Nymex crude has retraced to test short-term support at $85 per barrel. Respect is likely and would indicate an advance to our target at $90.
WTI Light Crude

Conclusion

Geopolitical risk dominates, with an Israeli retaliatory attack on Iran expected before the end of the month.

Rising crude oil prices are likely to increase inflationary pressure and the yield on long-term Treasuries, with the 10-year yield expected to test 5.0%.

Safe haven demand from investors is concentrated on Gold, with bond prices falling and stocks warning of a correction. We expect a short retracement to test support levels but respect is likely and would signal another advance.

Bitcoin is diverging from Gold as investors grow more risk averse. Breach of support at $62K would confirm a correction, with support expected at $52K.

Acknowledgements



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Australian consumer sentiment

The Westpac Melbourne Institute Consumer Sentiment Index declined 2.4% to 82.4 in April, from 84.4 in March.

Consumer Sentiment Index

The pessimism that has dominated the consumer mood for nearly two years now is still showing few signs of lifting. The latest Index read is well below the ‘neutral’ level of 100, meaning pessimists outnumber optimists by over 15ppts. It is also in line with the average recorded over the last 24 months, marking an extended period of bleak sentiment reads by historical standards. Indeed, outside of the deep recession of the early 1990s, this is easily the second most protracted period of deep consumer pessimism since we began surveying in the mid-1970s, with all other sentiment slumps lasting nine months or less.

Source

Westpac: Consumer sentiment sinks back towards historic lows, 9 April 2024

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Rising Crude and Gold warn of inflation

Brent crude continued its advance, closing at almost $89 per barrel on Tuesday. Our target is $94 per barrel would increase inflationary pressure in the months ahead and possibly delay Fed rate cuts.

Brent Crude

Rising crude oil prices have forced cancellation of plans to restock the strategic petroleum reserve (Bloomberg). US crude and petroleum inventory (including SPR) is testing the lows from January 2023.

Crude & Petroleum Inventory

Treasury Market

10-Year Treasury yields broke resistance at 4.35% but is retracing to test the new support level. Respect would confirm an advance to test resistance at 5.0%. Failure of support is less likely but would warn of another test of 4.05%.

10-Year Treasury Yield

Federal debt at 120% of GDP, deficits of 6% of GDP, and a growing interest rate burden limit the available options.

Federal Debt/GDP

The Fed can suppress long-term interest rates but the cost — in terms of inflation — is likely to be high.

Federal Debt Interest Burden

The US is well along the path to fiscal dominance as explained in this 2023 paper from the San Francisco Fed:

Fiscal dominance refers to the possibility that the accumulation of government debt and continuing government deficits can produce increases in inflation that “dominate” central bank intentions to keep inflation low….If global real interest rates returned tomorrow to their historical average of roughly 2 percent, given the existing level of US government debt and large continuing projected deficits, the US would likely experience an immediate fiscal dominance problem. Even if interest rates remain substantially below their historical average, if projected deficits occur as predicted, there is a significant possibility of a fiscal dominance problem within the next decade.

The essence of fiscal dominance is the need for the government to fund its deficits on the margin with non-interest-bearing debts. The use of non-interest-bearing debt as a means of funding is also known as “inflation taxation.” Fiscal dominance leads governments to rely on inflation taxation by “printing money” (increasing the supply of non-interest-bearing government debt).

The rise in Gold — currently at $2270 per ounce — reflects bond market fears of an inflation rebound.

Spot Gold

The same inflation fears are also driving demand for stocks.

S&P 500

US Economy

The US economy continues to display resilience, with job openings holding steady at 8.8 million in February, exceeding unemployment by a wide margin of 2.3 million.

Job Openings & Unemployment

Light vehicle sales remain robust at a seasonally-adjusted 15.8 million annual rate in February, reflecting consumer confidence.

Light Vehicle Sales

However, heavy truck sales (41.6K in February) are trending lower — with the 6-month moving average crossing below the 12- month MA — reflecting declining business confidence.

Heavy Truck Sales

Conclusion

The economy remains robust but fears of an inflation rebound are growing, fueled by rising crude oil prices and large fiscal deficits. The odds of Fed rate cuts in the second half of the year are shrinking but there are still two possible scenarios:

  1. A sharp decline in economic activity could still prompt the Fed to cut rates despite inflationary fears. That would be a strong bear signal for stocks.
  2. Fiscal dominance, with the deliberate use of inflation as a tax in order to restore the ratio of debt-to-GDP to more sustainable levels. This involves shrinking the public debt in real terms by expanding GDP through inflation. A strong bull signal for real assets such as Gold, Stocks and Commodities.

Acknowledgements

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Australian jobs & GDP

Great research note by Gareth Aird at Commbank, where he predicts that the unemployment rate in Australia will rise to 4.5% by the end of 2024.

The latest ABS report showed unemployment dropped to 3.7% in February, while the trend remained at 3.8%.

Australian Unemployment Rate

Aird says the sharp rise in employment (green below) in February is at odds with Commonwealth Bank data on the number of salary payments transferred into CBA accounts. The annual percentage change (blue) is declining steeply.

Australia: CBA Salary Payments (Number)

He says that the labor market should not be viewed in isolation but assessed against GDP data. GDP growth is falling and negative per capita GDP growth — indicating a per capita recession in the last three quarters — reinforces that the economy is growing below trend.
Australian Quarterly GDP

It is unusual to have such strong growth in employment in a slowing economy that is running well below trend. But it’s not unprecedented.

However, the trend in employment (blue) is still declining and ABS research (according to Aird) has previously shown that trend data is “superior” to seasonally-adjusted data (red).

Australian Employment Trend

Declining Seek job ads (blue below) since May ’22 also show that the tight labor market is now easing.

Australia: Seek Job Ads

Conclusion

The Australian labor market is expected to weaken in 2024, with the unemployment rate rising.

Poor employment growth is likely to drag GDP growth even lower.

Commbank project three RBA rate cuts of 25 basis points each, commencing in September 2024, based on a deteriorating employment market. Our own view is  less certain, given the potential of higher crude oil prices to increase inflationary pressures and slow RBA monetary easing.

Acknowledgements

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Strong liquidity and a weak Yuan boost stocks & Gold

The S&P 500 Equal-Weighted Index ($IQX) closed at a new record high above 6800. The advance signals that the current rally is finding broader support and is not as concentrated on the top 7 mega-cap technology stocks.

S&P 500 Equal Weighted Index ($IQX)

Retracement on the Russell 2000 Small Caps ETF (IWM) respected support at 200, signaling a fresh advance. Our target is the 2021 high at 240. The breakout again signals that investors are growing more comfortable with risk,

Russell 2000 Small Caps ETF (IWM)

Financial Markets

Bitcoin retraced slightly. Respect of support at $68K is likely, however, and would confirm an advance to test $72K.

Bitcoin

The Chicago Fed Financial Conditions Index eased to -0.556, indicating plenty of liquidity in financial markets.

Chicago Fed Financial Conditions Index
The Corporate Bond Market Distress Index reflects healthy credit markets, with Investment Grade (brown below) slightly above the 25th percentile and the High Yield Index (ocher) near record lows, below the 5th percentile on the right-hand scale.
Corporate Bond Market Distress Index

Gold & the Dollar

The Dollar Index continues to test resistance at 104.5. Follow-through above 105 would offer a target of 107.
Dollar Index

Gold is strengthening despite a relatively strong Dollar, with demand from China driving up prices. Breakout above $2200 would confirm our target of $2400 per ounce.

Spot Gold

Crude Oil

Crude is retracing, with Nymex Light Crude testing support at $80 per barrel. Respect is likely and would confirm our target of $90. High crude prices are caused by (a) the Red Sea threat to shipping, forcing tankers to take the longer route to Europe around the Cape of Africa; (b) Ukrainian drone attacks on Russian refineries; and (c) OPEC extension of production cuts through June.

Nymex WTI Light Crude

Russian Gasoline Production

Conclusion

Strong liquidity in financial markets maintains upward pressure on stocks, with advances widening to include the broad S&P 500 index and small cap stocks.

Gold continues to test resistance at $2200 per ounce, driven by demand from China in response to a weakening Yuan. Breakout is likely and would confirm our target of $2400 per ounce.

Crude is retracing to test support, but respect is likely and would confirm another advance. Rising crude prices would increase inflationary pressures in the months ahead, making it difficult for the Fed to cut rates. This would add upward pressure to long-term Treasury yields and erode demand for stocks.

Acknowledgements

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What really drives inflation?

Every month, after the FOMC meeting, Fed Chairman Jay Powell fronts the media and tells everyone how the Fed is determined to maintain the fed funds rate in the same 5.25% – 5.50% range in order to contain inflation. But he is well aware that the Fed funds rate has had close to zero impact on inflation.

CPI peaked in June 2022 when the fed funds rate was an eye-watering (sic) 1.25%. CPI then plunged sharply when the Fed was still in the early stages of hiking rates. The lag between rate hikes and the resultant decline in inflation is normally 12 to 18 months. Now the Fed would have us believe that CPI declined in anticipation of rate cuts.

CPI & Fed Funds Rate Target (Minimum)

Financial conditions did tighten when the Fed introduced QT, with the Chicago Fed Financial Conditions Index (FCI) rising to -0.1%. But then FCI started a sharp decline in June 2023, when the Fed was still hiking rates, indicating monetary easing.

Chicago Fed Financial Conditions Index

Rising interest rates and tighter financial conditions had even less than usual impact on consumer spending because of a strong upsurge in personal savings during the pandemic. A large percentage of government transfers were not spent but went to increase bank deposits.

Government Transfers & Commercial Bank Deposits

Energy is driving inflation

The primary cause of the strong upsurge in CPI in ’21/22 was energy prices. The chart below shows how energy CPI (orange) led CPI (red) higher, reaching a peak of 41.5% in June 2022 — the same month that CPI peaked at 9.0%. Energy prices then plunged to a low of -16.7% in June 2023. CPI followed, reaching a low of 3.1% in the same month. Since then, CPI energy has recovered to close to zero, producing a floor in the annual CPI rate.

CPI & Energy CPI

Energy CPI is a relatively small component of CPI — 6.6% of total CPI — but it is a major cost component of most other variables. Food, for example, requires energy for planting, irrigation, harvesting, processing, refrigeration and transport. Cement requires energy for heating limestone in kilns, crushing and transportation. Steel needs energy for extraction and transport of iron ore, smelting and transportation. Even online services. The latest AI data centers require up to 1 GW of electricity capacity — enough to power 300,000 homes.

The most important determinant of energy prices is crude oil. Nymex light crude peaked between March and June 2022 at prices of $100 to $120 per barrel before commencing a prolonged decline to between $70 and $80 by December of the same year.

Nymex WTI Light Crude

Conclusion

Raising the fed funds rate has had little impact on actual inflation. Rate hikes are more about restoring the Fed’s credibility as an inflation hawk after a disastrous performance in 2021. High energy prices and easy monetary policy and were a recipe for inflation.

CPI & Fed Funds Rate Target (Minimum)

The sharp decline in CPI in the 12 months to June ’23 was caused by falling energy prices. Energy CPI fell from an annual increase of 41.5% in June 2022 to a low of -16.7% a year later.

Nymex light crude has now broken resistance at $80 per barrel. Expect retracement to test the new support level but respect is likely and would confirm another advance, with a target of $90 per barrel.

Nymex WTI Light Crude

A sharp rise in crude prices would be likely to cause a significant upsurge in CPI — and long-term interest rates. With bearish consequences for stocks and long-duration bonds.



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Crude sets the cat amongst the pigeons

Brent crude broke resistance at $84, signaling a fresh advance. Expect retracement to test the new support level but respect is likely and would confirm our target of $94 per barrel.

Brent Crude

Nymex light crude similarly broke resistance at $80, offering a target of $90 per barrel.

Nymex WTI Light Crude

The threaten upsurge in inflation spooked bond investors, with the 10-year Treasury yield breaking resistance at 4.20%.

10-Year Treasury Yield

We expect a test of resistance at our target of 4.35%.

10-Year Treasury Yield


The Dollar Index jumped above resistance at 103 in response.

Dollar Index

Gold retreated to test support at $2150 per ounce. Narrow consolidation is a bullish sign and follow-through above $2200 would confirm our target of $2400 per ounce. Breach of $2150 is less likely but would indicate a test of $2075.

Spot Gold

The S&P 500 eased in response to higher long-term bond yields. Lower Trend Index peaks warn of a correction. Breach of support at 5100 would confirm.

S&P 500

The Russell 2000 small caps ETF (IWM) reacted with greater alarm, testing support at 200.  Lower Trend Index peaks again warn of a correction and breach of support at 200 would confirm, offering a short-term target of 190.

Russell 2000 Small Caps ETF (IWM)

Conclusion

An upward spike in crude oil threatens higher inflation which in turn would be likely to delay rate cuts by the Fed, causing long-term interest rates to rise.

We are short-term bullish on Crude and Gold; bearish on Stocks and long-duration Bonds.

 



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Why China’s efforts to resolve hidden government debt could fall short | Caixin Global

Local governments make extensive use of local government finance vehicles (LGFVs) to conceal debt and present a healthy balance sheet. The hidden debt presents a major risk for central government as the economy threatens a debt-deflation spiral.

From Caixin Global, March 14 2024:

China’s central government has rolled out a new round of measures since the second half of last year to help local governments swap or restructure their off-the-books borrowing in a bid to control debt risk.

However, the sheer scale of the country’s local government hidden debt — up to more than 70 trillion yuan ($9.8 trillion) according to some estimates, more than twice Germany’s GDP — means that the measures at best are far inadequate and will provide only temporary relief to what experts say is a looming liquidity crisis for regional authorities….

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Strong US jobs data but signs that growth is slowing

The S&P 500 retreated Friday, the bearish engulfing candle and a lower peak on the Trend Index warn of a test of support at 5050. The longer-term outlook remains bullish, with rising Trend Index troughs above zero signaling unusual buying pressure.

S&P 500

S&P 500 (purple below) outperformed the broader Equal-Weighted S&P 500 (lime green) in February, a bullish sign. Periods when $IQX outperforms the general index ($INX) can highlight when the top stocks are no longer participating in the advance — a strong bear signal.

S&P 500 & S&P 500 Equal-Weighted Index

Labor Market

The economy added 275,000 jobs in February, a strong result.

Employment

Of the cyclical sectors that normally lead the economic cycle, manufacturing showed a small loss of 4K jobs but construction and transport & warehousing showed gains of 23K and 20K respectively.

Employment: Cyclical Sectors

The unemployment rate increased to 3.9% as more people entered the workforce. The 3-month moving average of the unemployment rate has increased 27 basis points (red below) from its preceding low. According to the Sahm Rule — developed by former Fed economist Claudia Sahm — a 50 basis point increase signals the start of a recession, while 35 points provides an early warning.

Unemployment Rate & 3-Month Moving Average

Average weekly hours worked ticked up to 34.3 hours but the downward trend warns that the economy is slowing.

Average Weekly Hours Worked

Another good indicator is the quit rate which soars when the labor market is tight and jobs are readily available. The down-trend since 2022 indicates that the heat is coming out of the job market.

Quit Rate

The decline in average hourly earnings annual growth is slowing.

Average Hourly Earnings

But the February monthly rate fell sharply, after a strong January. The 3-month moving average growth rate of 1.0% — 4.0% annualized — suggests further easing ahead despite a robust economy.

Average Hourly Earnings - Monthly Change

Aggregate weekly hours worked (purple below) are growing at an annual rate of 1.2%. We are unlikely to see productivity benefits from AI this year and real GDP growth (blue) is expected to converge with the slower labor growth rate.

Real GDP Growth & Aggregate Weekly Hours Worked

Financial Markets

10-Year Treasury yields found short-term support above 4.0%. Retracement to test the new resistance level at 4.20% is now likely. Respect of resistance would confirm the target of 3.80%.

10-Year Treasury Yield

The Chicago Fed Financial Conditions Index ticked up to -0.47 but continues below zero, signaling easy monetary policy.

Chicago Fed Financial Conditions Index

Commercial bank cash assets — primarily reserves at the Fed — are leveling off at $3.6 trillion.

Commercial Bank Cash Assets (Primarily Reserves at the Fed)

Strong growth in bank reserves over the last 6 months is unlikely to be repeated, with a decline expected after the Fed’s reverse repo (RRP) balance is drained. Money market funds are switching to T-Bills. After the RRP is depleted, further Treasury issuance is likely to be taken up by private investors — either through direct purchases or by switching from bank deposits to money market funds.

Reverse Repo (RRP)

Bank time deposits are still growing but the rate of growth, especially in retail deposits (blue below), has fallen dramatically over the past 12 months. Negative growth would be a strong recession warning.

Commercial Bank Time Deposits

Gold & the Dollar

The Dollar Index broke support at 103, warning of a decline to 100. Retracement that respects the new resistance level at 103 would confirm the target.

Dollar Index

Gold continues to climb, reaching close to $2200 per ounce on during the day. A weaker close signals some profit taking but is so far insufficient to set off retracement. Follow-through above $2200 would lead us to revise our short-term target to $2250 — calculated as $2050 + ($2050 – 1850).

Spot Gold

Our long-term target of $2450 is calculated as $2050 + ($2050 – $1650).

Spot Gold

Crude & Commodities

Brent crude continues in a narrow range between $82 and $84 per barrel. Downward breakout would offer short-term relief but supply issues threaten a rally to test resistance at $90 per barrel — warning of higher inflation in the months ahead.

Faster-than-expected land inventory drawdowns due to seaborne trade disruptions from the Red Sea crisis have prompted Goldman Sachs to revise up its forecast for summer peak Brent Crude prices to $87 per barrel, up by $2 from earlier expectations.

“OECD commercial stocks on land have drawn somewhat faster than expected as the redirection of flows away from the Red Sea has increased inventories on water,” analysts at the investment bank wrote in a Sunday note, as carried by Reuters. ~ Oilprice.com

Brent Crude

Copper broke through resistance at $8500 per metric ton, signaling an advance to $9000, but expect retracement to test the new support level first.

Copper

China’s real estate/financial woes are weighing more heavily on iron ore which continues to test support at $114 per metric ton.

Iron Ore

Uranium has fallen about 20% from its peak earlier in the year, with the Sprott Physical Uranium Trust (SRUUF) testing support at 20. Respect of support would suggest another advance with a target of 30.

Sprott Physical Uranium Fund

Please note: This is not a recommendation to buy SRUUF. It is simply being used as an indicator of physical uranium prices.

Growth in electricity demand is likely to have more than doubled in 2023 as data centers, crypto-mining and re-shored manufacturing facilities joined the grid.

Washington Post: US Electricity Demand

Conclusion

Demand for stocks and Gold is booming. Investors seek real assets ahead of anticipated June rate cuts by the Fed and a likely resurgence in inflation.

The labor market remains tight but there are signs that upward pressure on average hourly earnings is easing as growth in aggregate weekly hours worked slows.

Declining reverse repo (RRP) balances at the Fed warn that bank reserves are likely to decline in the not-too-distant future. Liquidity is expected to tighten unless the Fed slows QT after the RRP is drained. The current $95 billion per month reduction in the Fed holdings of securities cannot be sustained without hurting liquidity in financial markets. A liquidity contraction is unlikely before the November elections but would cause a sharp fall in stock prices.

An alternative for the Fed would be to encourage commercial banks to buy Treasuries by excluding USTs from bank SLR leverage calculations. But that seems less likely than tapering QT, especially after the Silicon Valley Bank disaster where SVB took huge losses on their holdings of long-duration Treasuries and mortgage-backed securities.

We are overweight Gold, Critical Materials and Defensive stocks. We feel that Technology stocks and Industrial Real Estate are over-priced and will wait for better opportunities in 2025.

Acknowledgements

 

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Gold soars as UST yields fall

The S&P 500 has retraced to test short-term support at 5050, accompanied by a retreat in the Equal-Weighted Index and Russell 2000 Small Caps. The outlook remains bullish, however, with Trend Index troughs high above zero signaling extraordinary buying pressure.

S&P 500

Bond market anticipation of June rate cuts is growing. 10-Year Treasury yields broke support at 4.20%, signaling a decline to test support at 3.80%.

10-Year Treasury Yield

Gold is at a new high of $2129 per ounce. We expect retracement to test support at $2080 but respect would offer a ST target of $2180 per ounce.

Spot Gold

Gold versus TIPS

Economic Activity

ISM Services PMI recorded its 14th month of expansion in February, retreating to 52.6% from 53.4% in January. The decline suggests continued but slower growth.

ISM Services PMI

Crude & Commodities

Nymex WTI light crude continues to respect resistance at $80 per barrel. Breach of $78 would suggest a correction to the ascending trendline at $75.

Nymex Light Crude

Copper continues to test resistance at $8500 per metric ton, indicating some resilience in the Chinese economy — by far the biggest buyer of industrial metals.

Copper

In China, Caixin Services PMI eased to 52.5 in February, from 52.7 in January — maintaining the expansion since January last year.

Caixin Services PMI

Earlier, Caixin Manufacturing PMI edged up to 50.9, compared to 50.8 in January. But whipsawing around 50 indicates poor and erratic growth which is affecting metals prices.

Caixin Manufacturing PMI

Iron ore continues to test support at $114 per metric ton. Breach would warn of another test of $100. The Chinese government is likely to do enough to keep the economy from collapse but does not have the means to stimulate on a large scale.

Iron Ore

Conclusion

The 10-year treasury yield is expected to test support at 3.80%, offering further upside for Gold.

Our short-term target is $2180 per ounce and our long-term target is $2450.

Acknowledgements

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