Category: Inflation

Posted on

Narrow advance for stocks, bullish consolidation for gold

Falling CPI and plunging crude prices almost guarantee at least a 25-basis-point rate cut at next week’s FOMC meeting. Stocks rallied, led by mega-cap technology stocks, but the advance was narrow, with large caps failing to join the party.

Gold is bullish, boosted by falling long-term Treasury yields and a weak Dollar, but silver remains more bearish.

Stocks

Mega-cap technology stocks led the rally, with Nvidia (NVDA) posting solid gains.

Top 7 Technology Stocks

The move lifted the S&P 500 above resistance at 5500, signaling another test of the all-time high at 5670.

S&P 500

Large caps lagged, with the equal-weighted index ($IQX) failing to show much progress.

S&P 500 Equal-Weighted Index

Financial Markets

The Chicago Fed National Financial Conditions Index eased to -0.57, reflecting easy monetary policy.

Chicago Fed National Financial Conditions Index

Bitcoin respected support at $54K [red line], but the bearish declining triangle still warns of tighter financial market liquidity ahead.

Bitcoin (BTC)

Treasury Markets

Ten-year Treasury yields plunged to almost 3.6% before retracing to test new resistance at 3.7%. The steep fall from the 5.0% peak in October last year indicates market expectations of significant rate cuts ahead.

10-Year Treasury Yield

Dollar & Gold

Falling long-term interest rates are driving long-term Dollar weakness. Respect of resistance at 102 on the Dollar Index would confirm another decline, while breach of support at 100 would offer a long-term target of 93.

Dollar Index

A stronger Japanese Yen warns of a more hawkish monetary policy from the Bank of Japan. Rising Japanese interest rates will likely withdraw liquidity from US financial markets and weaken the Dollar.

Japanese Yen

Gold is expected to benefit from falling long-term interest rates and a weaker Dollar. The narrow bullish consolidation below $2,525 per ounce suggests another advance. Breakout above resistance would offer a target of $2,600.

Spot Gold

Silver lags behind gold, struggling to break resistance at $30 per ounce. Breach of support at $28 would warn of another test of long-term support at $26.50.

Spot Silver

CPI Inflation

Headline CPI fell sharply to 2.6% for the 12 months to August, but core CPI lifted to 3.3%.

CPI & Core CPI - Annual

Monthly CPI shows that the sharp drop in the headline rate is caused by the base effects of a spike in July of last year [red circle]. Rising core CPI over the past two months, with August growing at an annualized rate of 3.7%, warns of underlying inflationary pressures.

CPI & Core CPI - Monthly

Sticky prices inflation also increased, to an annualized rate of 3.5% in August, warning that underlying inflationary pressures persist.

Sticky Prices CPI

Shelter

Shelter CPI also increased to an annual rate of 5.2% in August, reflecting a trough in home prices in mid-2023. The Case-Shiller 20-City Composite Index [gray below] tends to lead Shelter by roughly 12 months.

CPI Shelter & Case-Shiller 20-City Home Price Index

Energy

However, the recent sharp fall in crude oil prices warns that inflationary pressures will likely ease in the months ahead.

Brent Crude

Energy CPI grew by -4.0% over the 12 months to August and is likely to fall further in September. The chart below shows how energy CPI [ocher below] plunged from a peak of 41.5% in June ’22, leading to a fall in headline CPI.

CPI & CPI Energy - Annual

Food

Food CPI also declined to an annual rate of 2.1% in August, close to the Fed’s target of 2.0%.

CPI Food

Conclusion

Mega-cap technology stocks lifted the S&P 500 above resistance at 5500, indicating another test of the previous high at 5670. Breakout would offer a target of 6000, but the advance is narrow. Large caps in the index show little in the way of net gains, with the equal-weighted index ($IQX) failing to make much progress.

The Chicago Fed National Financial Conditions Index continues to reflect easy monetary policy, but a bearish triangle on Bitcoin and a stronger Japanese Yen warn of tighter liquidity ahead.

The decline in headline CPI is primarily due to base effects from August last year, while core CPI and the sticky price index warn of persistent underlying inflationary pressures. However, a sharp fall in crude oil prices will likely drag overall CPI lower in September.

Falling 10-year Treasury yields reflect market expectations of significant rate cuts commencing on September 18. The Dollar rallied over the week, but the long-term downtrend is likely to persist as rates decline.

Low long-term interest rates and a weak Dollar are expected to be bullish for gold. A Dollar Index breach of support at 100 would confirm our $3,000 per ounce target for gold.

Acknowledgments

Posted on

Another S&P 500 advance likely

Stocks are poised for a breakout, signaling a fresh advance on the S&P 500. All eyes are focused on the September 17-18 FOMC meeting, with an expected rate cut of at least 25 basis points.

Stocks

The S&P 500 is testing resistance at its previous high of 5670, while Trend Index troughs above zero indicate buying pressure. Breakout would offer a target of 6000.

S&P 500

The equal-weighted index ($IQX) has already broken resistance. Retracement respected support at 7000, confirming our target of 7400.

S&P 500 Equal-Weighted Index

The Russell 2000 Small Caps ETF (IWM) lags, with the Trend Index struggling to recover above zero. A breakout above 225 would offer a target of 250.

Russell 2000 Small Cap ETF (IWM)

Financial Markets

Liquidity in financial markets is gradually tightening, which could act as a handbrake on any advances. A contracting Fed balance sheet, net of TGA and reverse repo (RRP) liabilities, shows the effect of regular monthly QT reductions.

Fed Assets net of TGA & Reverse Repo (RRP) Liabilities

Commercial bank reserves are shrinking as a result.

Commercial Bank Reserves at the Fed

Bitcoin struggles to hold above support at $60K, highlighting the effects of tightening liquidity.

Bitcoin (BTC)

Treasury Markets

Ten-year Treasury yields are rallying to test resistance at 4.0%, but long-term buying pressure—signaled by Trend Index peaks below zero—is expected to keep yields low for the next quarter.

10-Year Treasury Yield

Bank of Japan

A wild card that could disrupt the system is BOJ monetary policy. The last rate hike, to 0.25%, caused the Dollar to fall sharply against the Yen and a sell-off in US financial markets as carry trade positions were unwound.

Japanese Yen

Further rate hikes are on the cards, with the next BOJ meeting scheduled in October. Jim Grant from Grant’s Interest Rate Observer:

CPI excluding fresh food in Japan’s capital grew at a 2.4% annual pace in August, data released yesterday show, topping the 2.2% consensus expectation and marking its fourth consecutive sequential increase. That data series typically serves as a leading indicator for broader price pressures in the world’s fourth-largest economy; nationwide CPI data is due on Sept. 19.

Pointing to transitory factors including expiring government subsidies for utility bills and rice shortages, Norinchukin Research Institute chief economist Takeshi Minami predicted to Reuters that “the underlying inflation trend will continue to moderate in coming months.”

However, percolating wage growth – with average pay rising 5.2% this year per data compiled by Japanese Trade Union Confederation, the highest in more than three decades – could bolster the Bank of Japan’s appetite for further tightening following the July 31 rate increase to 0.25% from a 0% to 0.1% range, as BoJ chief Kazuo Ueda suggested to parliament last week.

Considering the acute financial spasm which followed that rate adjustment and accompanying unwind of yen-funded carry trade positions, the prospect of a sequel would presumably be front of mind for Mr. Market. Investors remain confident that such an outcome is in fact far-fetched, with interest rate futures assigning only 9% odds of further tightening at the BoJ’s Oct. 18 meeting.

Some observers aren’t so sure. “My money is on another rate hike in October,” Moody’s senior economist Stefan Angrick told CNBC Friday, further predicting at least one further uptick early next year. Bloomberg economist Taro Kimura likewise anticipates an October shift to 0.5%, writing that Thursday’s data illustrate “a broad upswing in service prices,” and “increases the risk that the BoJ can’t afford to wait to pare stimulus.”

The destabilizing effect of further BOJ rate hikes should not be underestimated.

Inflation

US inflation, on the other hand, remains subdued. Core PCE inflation ticked to 2.6% for the 12 months to July, but the Trimmed Mean PCE rate declined to 2.7%.

PCE, Core PCE & Trimmed Mean PCE

Monthly core PCE and the headline rate for July are more encouraging, with both growing at an annualized rate below 2.0%.

PCE Inflation - Monthly

Dollar & Gold

The Dollar Index remains in a strong downtrend, with Trends Index peaks below zero, warning of long-term selling pressure. We expect the latest rally to encounter resistance at 102.50.

Dollar Index

Gold retraced to $2,500 per ounce, with a likely test of support at $2,475 as long-term Treasury yields rally and the Dollar strengthens. However, the precious metal is in a strong up-trend, and respect of support would confirm our target of $2,600.

Spot Gold

Silver is weaker than gold because of weak industrial demand from China’s solar industry. A breach of its current support level near $29 per ounce would warn of a decline to test long-term support at $26.50.

Spot Silver

Crude Oil

Brent crude continues to build a base between $76 and $82 per barrel. Low crude prices ease inflationary pressures in the global economy and improve the prospect of lower interest rates.

Brent Crude

Base Metals

Copper penetrated its descending trendline, suggesting that a base is forming. A correction that respects support at $8,600 per tonne would strengthen the signal.

Copper

Aluminum rallied strongly, indicating improving industrial demand. A breakout above $2,500 per tonne would be a bullish sign for copper.

Aluminum

Conclusion

Financial markets warn of gradual tightening, but low long-term interest rates, subdued inflation, and the prospect of a Fed rate cut at the FOMC meeting on September 17-18 are all bullish for stocks. We expect the S&P 500 to break through resistance at its previous high of 5670, confirming our target of 6000.

However, investors need to be aware of the risks ahead in 2025.

After the November elections, Treasury is expected to shift its quarterly funding towards longer-term coupons to take advantage of lower yields. The resulting increase in supply could drive up long-term yields while reducing liquidity in financial markets. On the other side of the Pacific, further rate rises by the Bank of Japan could spark a sell-off in US financial markets as more Yen-financed carry trades are unwound.

Either of the above actions could contract liquidity in financial markets, causing another stock sell-off.

We remain bullish on gold as long as long-term interest rates remain low, weakening the Dollar. Silver is likely to underperform due to weak industrial demand.

Acknowledgments

Posted on

Stocks rally on PPI fall

Stocks were boosted by falling producer price index (PPI) growth, which indicates low CPI readings are likely later today. Gold continues to test resistance at $2,475 per ounce, boosted by falling long-term Treasury yields and a weaker Dollar.

Stocks

The S&P 500 broke resistance at 5400 and is headed for a test of the descending trendline at 5500. The Trend Index is rising but below zero, warning of longer-term selling pressure.

S&P 500

The Russell 2000 Small Caps ETF (IWM) is testing resistance between 210 and 215, with the Trend Index indicating secondary buying pressure.

Russell 2000 Small Cap ETF (IWM)

Stocks will likely receive a further boost if we get low CPI growth for July, as expected.

Financial Markets

Bitcoin retraced to test its new support level at $60K [red line]. Respect of support is likely and will confirm rising liquidity in financial markets.

Bitcoin (BTC)

Treasury Markets

Ten-year Treasury yields are falling, headed for a test of support between 3.7% and 3.8%. Low Treasury yields are bullish for stocks, bonds, and especially gold.

10-Year Treasury Yield

Dollar & Gold

The Dollar Index is testing support at 102.5, while a Trend Index peak below zero indicates long-term selling pressure. A weak Dollar is also bullish for gold.

Dollar Index

Gold continues to test resistance at $2,475 per ounce, while rising Trend Index troughs above zero signal long-term buying pressure. A breakout is likely, offering a target of $2,600.

Spot Gold

Silver remains in a downtrend because of weak industrial demand from the Chinese solar industry.

Spot Silver

PPI Inflation

The producer price index (PPI) dipped to 2.27% growth for the 12 months to July.

Producer Price Index (PPI)

Monthly growth collapsed to an annualized rate of 1.2%.

Producer Price Index (PPI) - Monthly

Services inflation tends to be the most persistent, so a fall to 2.56% annual growth in services PPI is encouraging.

Producer Price Index (PPI): Services

Monthly services PPI contracted at an annualized rate of 1.9%, which flags a slowing economy.

Producer Price Index (PPI): Services - Monthly

Low PPI inflation is encouraging and increases the likelihood of low CPI readings later today. Negative services PPI warns that the economy may contract, increasing the probability of a Fed rate cut in September.

Energy

Nymex WTI crude respected resistance at $80 per barrel.

Nymex WTI Crude

Brent crude similarly found resistance at $82 per barrel.

Brent Crude

Low crude prices are expected to ease inflationary pressures, increasing the likelihood of a Fed rate cut in September.

Conclusion

We expect low CPI readings later today to further boost stocks. Falling long-term Treasury yields are bullish for stocks, bonds, and especially gold. The weakening Dollar is also bullish for gold, which continues to test resistance at $2,475 per ounce. A gold breakout is likely and will offer a target of $2,600.

Acknowledgments

Posted on

Death of the Yen carry trade

Markets seem convinced that the recent stock sell-off in the US is due to growth concerns — after a weak labor report. We think they are mistaken. The real cause of the sell-off is the unwinding Yen carry trade.

Hedge funds have been making a killing on the Yen carry trade, but they just got killed. Borrowing cheaply in Yen and investing in stocks and Treasuries in the US, the trade benefited from ultra-low interest rates in Japan, far higher short-term rates in the US, massive appreciation in the top ten stocks on the S&P 500, and a rapidly weakening Yen against the Dollar.

But the Bank of Japan just pulled the rug from under them, raising interest rates and indicating that they plan to normalize monetary policy over time. The move caused a sharp rise in the Japanese Yen, with the US Dollar plunging below 150.

USD/Japanese Yen

Japanese stocks followed, possibly due to concerns over the impact of a strong Yen on export sales.

Nikkei 225 Index

The contagion soon spread to neighboring markets.

South Korea KOSPI 100 Index

Stocks

Unwinding carry trades caused a sell-off in US stocks as traders hastily closed their leveraged positions. The S&P 500 broke support at 5400, and the Trend Index crossed to below zero, warning of a correction to test 5200.

S&P 500

The equal-weighted index ($IQX) similarly broke support at 6800, offering a target of 6600. The long tail indicates strong buying pressure but this often fails, or takes several days, to reverse a sharp market fall.

S&P 500 Equal-Weighted Index

There was nowhere to hide, with the Russell 2000 Small Caps ETF (IWM) also breaking support and the Trend Index dipping below zero.

Russell 2000 Small Cap ETF (IWM)

Treasury Markets

The Fed left rates unchanged this week but indicated that rate cuts will likely commence in September. Treasury yields fell but the primary driver was the strong flight to safety from the stock sell-off, with the 10-year yield plunging to a low 3.8%. We expect retracement to test resistance at 4.0% but the Trend Index peak below zero warns of strong buying, with downward pressure on yields.

10-Year Treasury Yield

Financial Markets

Financial market liquidity remains steady. The Chicago Fed Financial Conditions Index declined to -0.58, indicating further monetary easing.

Chicago Fed Financial Conditions Index

Commercial bank reserves at the Fed edged lower for the third consecutive week but the changes were marginal.

Commercial Bank Reserves at the Fed

Bitcoin is retracing to test support at $60K but shows no sign of a significant liquidity contraction at this stage.

Bitcoin (BTC)

Dollar & Gold

Unwinding carry trades also caused a sharp fall on the Dollar, with the Dollar Index testing support at 103.

Dollar Index

Gold failed to get much of a lift from the flight to safety, with most of the flow going to Treasuries.

Spot Gold

Silver, likewise, failed to benefit.

Spot Silver

Energy

Ismail Haniyeh was assassinated in Tehran, presumably by Israel. Iran’s supreme leader, Ayatollah Ali Khamenei, vowed that Israel would pay a price for killing the Hamas leader on Iranian soil, raising fears of escalation.

However, concerns over Middle East supply failed to move crude prices, with markets dominated by record US production of 13.3 million barrels per day.

EIA Crude Field Production

Nymex WTI crude is headed for a test of support between $72 and $73 per barrel. Breach would offer a target of $68. The US Department of Energy will likely support prices at this level, refilling the strategic petroleum reserve (SPR), as many shale producers’ cash costs are around $60 per barrel. Lower prices risk a drop in production as producers shut marginal wells.

Nymex WTI Crude

Uranium

Sprott Physical Uranium Trust (SRUUF) retreated below support at 18.00, confirming a bear market for uranium. Trend Index peaks below zero warn of strong selling pressure.

Sprott Physical Uranium Trust (SRUUF)

Base Metals

China over-invested in manufacturing capacity in an attempt to compensate for falling investment in their troubled real estate and infrastructure sectors. They now face resistance from international trading partners, unwilling to accept the massive surge in Chinese exports of manufactured goods and surplus steel and base metals. The dispute will likely cause increased trade protection and a sharp decline in global trade.

The down-trend in copper and aluminum is expected to continue.

Copper & Aluminum

Labor Market

A weak July labor report reinforced the Fed’s stance on early rate cuts, with job growth slowing to 114 thousand in July.

Employment Growth

The normally reliable Sahm recession indicator broke above 0.50 to indicate a recession. But the unemployment rate is rising off an unusually low base, so this time could be different.

Sahm Recession Indicator signals the start of a recession when the three-month moving average of the national unemployment rate (U3) rises by 0.50 percentage points or more relative to the minimum of the three-month averages from the previous 12 months. (Claudia Sahm)

Sahm Rule & Unemployment

Layoffs fell to 1.5 million in June which is different from what one would expect when the unemployment rate rises.

Layoffs & Discharges

Average weekly hours fell to 34.2, however, usually a warning that economic activity is slowing.

Average Weekly Hours

Job openings of 8.2 million in June are still above unemployment, indicating a tight labor market.

Job Openings

Continued claims for unemployment remain below 2.0 million, also indicating a tight labor market. Above 3.0 million would warn of recession.

Continued Claims

Average Hourly Earnings

Average hourly earnings growth declined to an annualized 2.75%, indicating that inflationary pressures are easing.

Average Hourly Earnings

Economy

Aggregate hours worked are growing at 1.3% year-on-year, suggesting low but positive GDP growth in the third quarter.Real GDP & Total Hours Worked

Heavy truck sales also held up well in July, indicating sustained economic activity.

Heavy Truck Sales

Employment in cyclical sectors — Manufacturing, Construction, and Transport & Warehousing — also grew by 40 thousand jobs in July, showing no sign of a recession.

Employment in Cyclical Sectors: Manufacturing, Construction, and Transport & Warehousing

ISM Manufacturing

ISM manufacturing PMI declined to 46.8% but remained above the 42.5% threshold typically accompanying a recession.

ISM Manufacturing PMI

Though declining new orders indicate some slowing ahead.

ISM Manufacturing New Orders

Conclusion

Stocks are expected to undergo a correction, with the S&P 500 testing support at 5200. Sales are fueled by unwinding carry trades as the Japanese Yen sharply strengthened after the Bank of Japan raised interest rates and indicated that they plan to normalize monetary policy.

The sell-off in stocks fueled a flight to safety which mainly benefited Treasuries, causing a sharp fall in the 10-year yield to 3.8%.

Gold and silver were left on the sidelines but could still benefit from low long-term interest rates and a weakening Dollar.

Declining crude oil and base metal prices warn of weak industrial demand from China. China’s efforts to compensate by exporting excess production is likely to meet stiff resistance from trading partners. Increased trade barriers are expected to further slow Chinese manufacturing and commodity imports, impacting Australia and other resource-based economies.

The Sahm rule warns of a US recession but the unemployment rate is rising from an unusually low base and there are plenty of signs of continued robust economic activity in the US economy. Expectations of a recession are likely premature, with a slow-down more likely to occur in 2025.

The full impact of a hawkish Bank of Japan monetary policy on US Treasury and financial markets should not be underestimated. However, the change is likely to be gradual, with frequent consultation with the US Treasury to minimize disruption after the initial impact of unwinding carry trades.

Acknowledgements

Posted on

Australian Outlook | Chris Joye

Central banks are too much under the sway of government and not doing enough to contain inflation. None worse than the RBA which is holding rates lower than they should be. The last time that we had inflation at 4.0% in 2008, the cash rate was 7.25%. Now the cash rate is only 4.35%.

RBNZ is far more independent and hiked their official cash rate to 5.5%. The NZ economy is in recession but they still face the threat of stagflation, with low growth and high inflation.

In Australia we have a negative output gap, where demand exceeds production capacity, far worse than in most other major economies. The only solution is to raise unemployment to lower demand. But RBA governor Michelle Bullock has publicly stated that the RBA is not looking to reduce employment.

The latest Australian government budget is highly stimulatory and likely to fuel further inflation.

The outcome is likely to be long-term inflation and higher long-term interest rates.

Conclusion

We expect strong inflationary pressures in the next decade as governments run large fiscal deficits. Additional government spending is needed to:

  1. Address the energy transition from fossil fuels to renewables and nuclear;
  2. On-shore critical supply chains; and
  3. Increase defense spending in response to geopolitical tensions.

Long-term interest rates are expected to rise over the next decade, fueled by higher inflation.

Central banks may attempt to suppress interest rates by further expanding their balance sheets to buy long-term fiscal debt but that is short-sighted. Inflation would accelerate even higher.

Apart from the hardship to wage-earners, and the subsequent political chaos, high inflation would threaten bond market stability. Bond market investors would be reluctant to fund deficits when interest earned is below the inflation rate. Unless there are no alternatives.

That is why the long-term outlook for gold and silver is so bullish.

Posted on

S&P 500 storm in a teacup

Markets were spooked by “hawkish” comments in the latest FOMC minutes, where some participants indicated a willingness to tighten policy should such action become appropriate:

Participants discussed maintaining the current restrictive policy stance for longer should inflation not show signs of moving sustainably toward 2 percent or reducing policy restraint in the event of an unexpected weakening in labor market conditions. Various participants mentioned a willingness to tighten policy further should risks to inflation materialize in a way that such an action became appropriate. ~ Minutes of the Federal Open Market Committee: April 30–May 1, 2024

This is nothing new: all FOMC members should be prepared to hike rates if inflation spikes to the point where tighter policy is appropriate. What seems to have spooked markets is the fact that it was considered appropriate to discuss this out in the open.

10-year Treasury yields rallied to test 4.5%, ending the series of declining Trend Index peaks. Breakout above 4.5% would signal another test of 4.7% but breach of support remains likely and would signal a decline to test support between 4.0% and 4.1%.

10-year Treasury Yield

The large engulfing candle on the S&P 500 is a bearish sign. Expect a test of support at 5200 but respect is likely and would confirm our target of 5500.

S&P 500

The S&P 500 Equal-Weighted Index ($IQX) retreated sharply and is likely to test support at 6600.

S&P 500 Equal-Weighted Index ($IQX)

Financial Markets

Commercial bank reserves at the Fed climbed to $3.39 trillion on May 22, continuing the recovery of financial market liquidity after the sharp fall during April tax payment season.

Commercial Bank Reserves at the Fed

The inverted Chicago Fed Financial Conditions Index (black below) continues to climb, indicating easier monetary policy. The S&P 500 (blue) is expected to follow the FCI upwards.

S&P 500 Index & Chicago Fed Financial Conditions Index (inverted scale)

Wicksell Analysis

The chart below is based on the theory of interest and money published by Swedish economist Knut Wicksell in 1898. Monetary policy is restrictive when long-term interest rates are higher than nominal GDP growth (the marginal return on new investment) and stimulatory when LT rates are below nominal GDP growth.

We plot nominal GDP (silver) against 10-year Treasury yields (purple) below. Stimulatory monetary policy is evident in the 1960s and ’70s — with GDP growth (silver) above long-term rates (purple) — boosting growth and inflation. This followed by restrictive policies in the 1980s and ’90s before long-term rates were again suppressed to stimulate the economy in the last two decades.

10-year Treasury Yield & Nominal GDP Growth

Nominal GDP grew at an annualized rate of 5.5% in Q1 of 2024, while the 10-year yield is below 4.5%, indicating that monetary policy remains stimulatory. Further growth and inflation are likely.

Crude Oil

The counter-argument to the monetarist view is that crude oil prices are falling and likely to ease inflationary pressures in the economy.

Nymex light crude broke support at $78 per barrel, indicating a decline to test long-term support (red) at $68.

Nymex WTI Light Crude

Energy prices were the primary cause of the spike in CPI in 2021 and its subsequent fall in 2022-23.

Conclusion

Crude prices are likely to fall, easing inflationary pressures and leading to lower long-term interest rates.

We expect the Fed and US Treasury to maintain easy monetary conditions until after the November elections.

The current bull market in stocks is likely to continue until end of the year.

Ceteris paribus

The Latin phrase ceteris paribus means “all else being equal.”

If Vladimir Putin and Xi Jinping attempt to influence US elections by disrupting the global economy — through cyberattacks, damage to undersea communication cables, infrastructure, or transport bottlenecks — then all bets are off and we could be in for a wild ride.

Acknowledgements



Posted on

Australia: Resilience or recession, it depends where you look

The Judo Bank/S&P Global Composite PMI Index for May continues to signal expansion (above 50 on LHS), albeit at a slightly slower rate of 52.6 compared to 53.0 in April.

Judo Bank/S&P Global Composite PMI

The Manufacturing PMI continues to signal contraction (below 50) but the rate slowed to 49.6 in both April and May.

Judo Bank/S&P Global Manufacturing PMI

The Services PMI continues to flag expansion, however, but at a slower rate of 53.1 compared to 53.6 in April.

Judo Bank/S&P Global Services PMI

The May report was quite upbeat. Warren Hogan, Chief Economic Advisor at Judo Bank:

“The increase in the employment index to its highest level in more than six months suggests that private sector demand for labour remains strong, particularly in light of the weakness in consumer spending over the first three months of the year. The results are consistent with the official employment figures, which show an average monthly increase in total employment in Australia of around 40,000 in 2024, made up of both full-time and part-time jobs.

….The Flash PMI report points to resilience in Australia’s business sector despite ongoing cost pressures and skill shortages. Most impressive has been the ability for businesses to navigate this difficult operating environment as well as weak consumer spending. With the Government injecting more than $30bn into household finances in 2024/25 through cost-of-living relief and tax cuts, Australian businesses should be expecting to see some improvement in consumer spending.”

April unemployment rose to 4.1% in April despite the increase in hiring — the result of a workforce swollen by record-high immigration.

Unemployment

Real per capita income tells a more depressing tale for consumers, declining more than 5.0% p.a. in 2023.

Real Per Capita Disposable Income

Household mortgage arrears have climvbed to 0.70%, the highest rate in the last 8 quarters.

Mortgage Arrears

Source: Equifax

Insolvencies

All is not well in the business sector despite the composite PMI signaling expansion. Insolvencies (green) soared to a monthly high of 1,136 in March.
Insolvency Trends

Source: Equifax

Late payments are also rising, with the average days beyond terms rising to 6.5 days in Q1 of 2024, the highest since 2020.

Days Beyond Terms

Source: Equifax

Cyclical Sectors

The construction sector has been hard hit, with 2758 insolvencies, or 2.1% of all business entities, in Q1 of 2024.

Construction Insolvency

Source: Equifax

Accommodation and food services had a lower number of insolvencies, at 1484 in Q1, but is a higher 3.3% of all entities.

Insolvency Volumes by Sector

Source: Equifax

Trade payment data also flags financial stress in the construction sector, with average days beyond terms rising to 12.3 days in Q1 of 2024, from 10.2 days in the preceding quarter.

Trade Payments

Source: Equifax

Conclusion

Australia is already in a real recession, with real per capita GDP and real disposable income both falling. This is disguised by a massive surge in immigration which has kept aggregate GDP growth above zero.

Real GDP grew 0.2% in Q4 of 2023 but per capita GDP declined by 0.3%. Annual GDP growth of 1.5% for 2023 falls to -1.0% when measured per capita.

Real GDP per Capita

Construction and Accommodation & Food Services are the largest cyclical employers in the economy:

Employment by Sector

Household finances may receive a boost from the latest budget but unemployment is expected to rise as the number of small business failures increases.

Acknowledgements

Posted on

Gold, Crude, Copper and the Elephant

Gold, crude and copper is where the action is, while stocks and Treasuries take a back seat for the present.

Markets are signalling a reluctance to take on risk, while long-term Treasury yields threaten to trend higher.

We also revisit rising Treasury debt — the elephant in the room — and examine the CBO’s budget projections in more detail.

Crude Oil

Brent crude respected resistance at $84 per barrel, signaling a decline to below $80.

Brent Crude

Nymex light crude breach of support at $78 per barrel would confirm the reversal. A decline in crude oil is likely and would ease inflationary pressures, with the expected fall in long-term yields bullish for stocks, bonds and precious metals.

Nymex Light Crude

Crude oil production remains steady at a massive 13.1 million barrels per day according to the EIA report for the week to May 3.

EIA: Crude Oil Production

Inventories (including SPR) recovered to above 1.6 trillion barrels, while market concerns eased over Iran-Israel tensions.

EIA: Total Crude Oil and Petroleum Products (Incl. SPR) Inventory

Copper

Copper is testing short-term resistance at $10K per metric ton. Breakout is likely and would test major resistance (green) at $10.5K.

Copper

The rise, however, is caused by a production halt at Cobre Panama. Production could be resumed if the mine-owner First Quantum can reach agreement with the new president-elect Jose Raul Mulino. From Reuters:

Mulino, a 64-year-old former security minister, won Panama’s election on Sunday [May 5] with 34% of the vote and said his government would be pro-investment and pro-business, adding that the Central American country would honor its debts, while he vowed to not forget the poor. He won with the help of popular former President Ricardo Martinelli who was barred from running due to a money laundering conviction. Mulino, who served as security minister during Martinelli’s administration from 2009 to 2014, had been Martinelli’s vice presidential candidate and took his place.

Gold & the Dollar

The Dollar Index continues to test support at 105. Respect remains likely, with Trend Index troughs above zero signaling buying pressure, unless Janet Yellen at Treasury intervenes to weaken the Dollar in support of the UST market.

Dollar Index

Gold broke resistance at $2350 per ounce, signaling another advance. But first expect retracement to test the new support level. Respect would confirm a target of $2500 per ounce.

Spot Gold

Shanghai Gold Exchange domestic contract Au99.99 is trading at 553 RMB/gram, equivalent to a USD price of $2380 per ounce at the current USDCNY exchange rate of 7.2268.

Stocks

The S&P closed above 5200 on Friday but a doji candlestick and lower Trend Index peaks indicate a lack of enthusiasm from buyers.

S&P 500

The Russell 2000 small caps ETF (IWM) reflects the lack of broad market support for the rally, with Trend Index peaks below zero warning of selling pressure. Another test of support at 200 is likely.

Russell 2000 Small Caps ETF (IWM)

Financial Markets

Ten-year Treasury yields continue to test the band of support between 4.4% and 4.5%. Recovery above 4.5% would signal another test of 4.7%.

10-Year Treasury Yield

Bitcoin is testing support at $61K. Follow-trough below say $60K would confirm the decline — initially signaled by breach of support at $64K — and warn that financial markets are moving to a risk-off position.

Bitcoin (BTC)

Commercial bank reserve balances at the Fed, however, grew by $78 billion in the week to May 8, indicating that financial market liquidity is improving.

Commercial Bank Reserves

Consumers

Consumer sentiment retreated to 67.4 in the University of Michigan survey for May 2024, but the up-trend continues.

University of Michigan: Consumer Sentiment

Five-year inflation expectations jumped to 3.1% but the three-month moving average, ranging between 2.9% and 3.0%, signals little change in the long-term outlook.

University of Michigan: 5-Year Inflation Expectations

The Elephant in the Room

Last week we published a note suggesting that investors were distracted by short-term noise and ignoring the elephant in the room — the precarious level of US federal debt. The bipartisan Congressional Budget Office (CBO) projects that Treasury debt will grow to a clearly unsustainable 172% of GDP by 2034.

CBO: Debt-to-GDP

The US fiscal deficit is projected to grow from $1.6 trillion in 2024 to $2.6 trillion by 2034. Remember: all projections are wrong, but some are useful.

CBO: Projected Deficits

Often the most useful part of a projection is the underlying assumptions.

Real GDP growth below is a modest 1.5% in 2024, reaching 2.2% by 2026 — nothing controversial there. But the inflation projection is Pollyannaish, assuming a steady CPI decline from 3.2% in 2023 to 2.2% by 2034 — totally unrealistic if the budget deficit is to remain at close to 6.0% of GDP.

CBO: Economic Projections

Assumed inflation (above) also impacts on projected nominal interest rates, with the projected fed funds rate declining to 2.9% by 2027 and 10-year Treasury yields to a low 3.8%. Every 1.0% overshoot in inflation would be likely to cause a similar increase in both long- and short-term interest rates.

The budget projection below is equally unrealistic. Defense spending, the CBO would have us believe, declines to 2.5% of GDP by 2034. Given rising geopolitical tensions with Russia-China-Iran, defense spending is likely to exceed the long-term average of 4.2%.

CBO: Budget Projections

Net interest is budgeted to grow from 2.4% of GDP to 3.9% of GDP by 2034 but is based on unrealistic interest rate projections.

CBO: Interest Rate Projections

Treasury debt is likely to grow a lot faster than projections — because of the likely understatement of both defense spending and interest costs. That means that debt held by the “public” will have to grow a lot higher than the $48.3 trillion projected by 2034. If real interest rates are too low, any shortfall in take up by the public will have to be absorbed directly or indirectly by the Fed.

Conclusion

Rising inventory and easing Middle East tensions have weakened crude oil prices. A long-term decline in crude would be likely to relieve inflationary pressures and allow the Fed to cut interest rates.

Copper is rising steeply due to supply shortages, but prices could fall just as rapidly if the Cobre Panama mine is reopened by the new president-elect.

Gold broke resistance at $2350 per ounce, signaling another advance. Retracement that confirms the new support level at $2350 would offer a target of $2500.

Long-term Treasury yields are testing support. Respect of support is likely and would confirm the recent up-trend.

Perceptions of market risk are rising, with Bitcoin testing support at $61K and the Russell 2000 small caps ETF (IWM) warning of selling pressure.

Financial market liquidity, however, recovered slightly in the last week.

Consumer sentiment continues to trend higher, while long-term inflation expectations remain steady at close to 3.0%.

The elephant in the room remains Treasury debt, with CBO projections understating likely deficits due to unrealistic assumptions for inflation, interest rates and defense spending. Debt issuance by Treasury is expected to exceed demand from foreign investors and the general public, leaving the shortfall to be absorbed by the Fed or commercial banks.

The result is likely to be higher long-term inflation, boosting real asset prices while eroding the value of financial assets.

We are long-term bullish on Gold, Defensive stocks, the Heavy Electrical sector, and Critical Materials (Lithium and Copper). The last two stand to benefit from the energy transition. We are also overweight short-term financial assets with duration of 2 years or less:  Mortgages, Term Deposits and Money Market Funds.

We remain underweight Growth stocks — which we consider overpriced — and long-duration financial assets.

Acknowledgements

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The elephant in the room

A weak seasonally-adjusted increase of 175K in non-farm payrolls had a surprisingly bullish effect on stocks. The increased prospect of rate cuts from the Fed excited investors. The opposite of what one would expect from a sign that the economy is slowing.

Markets are focused on the immediate impact of shifts in data and policy but ignoring the elephant in the room — the long term consequences of current monetary and fiscal policy.

Labor market

Job growth slowed to 175K jobs in April, the lowest since October 2023.

Non-Farm Employment

Average hourly earnings growth remained low at 0.20% in April (2.4% annualized), signaling that inflationary pressures are easing.

Average Hourly Earnings Growth

The unemployment rate is still low at 3.9%. The Sahm Recession Indicator is at 0.37. Devised by former Fed economist Claudia Sahm, the indicator signals the start of a recession when the red line below rise to 0.50%.

The Sahm Rule signals the start of a recession when the three-month moving average of the national unemployment rate (U3) rises by 0.50 percentage points or more relative to the minimum of the three-month averages from the previous 12 months.

The rule has proved a reliable recession indicator in the past but we need to remember that: (a) it is not a leading indicator and normally only crosses above 0.5% after the start of a recession; and (b) this is a far from normal labor market.

Sahm Rule & Unemployment Rate

Non-residential construction jobs are way above previous highs as the industry benefits from fiscal spending on infrastructure and the drive to on-shore key industries such as semiconductors.

Non-Residential Construction Jobs

Average hourly earnings growth (green below) slowed to 4.0% for the 12 months to April (for production and non-supervisory employees) indicating that inflationary pressures are easing. In the past, average hourly earnings growth above the unemployment rate (blue) has caused high inflation as in the 1970s (red circle).

Unemployment Rate & Average Hourly Earnings Growth

Economic Activity

Aggregate weekly hours worked are growing at an annual rate of 1.8%. This is below the rate of real GDP growth, suggesting either that (a) productivity gains from AI and other new technologies are having an effect; or (b) real GDP growth is likely to slow.

Real GDP & Aggregate Hours Worked

The GDPNow model from the Atlanta Fed forecasts an optimistic 3.3% annualized real growth rate in Q2.

GDPNow

But the Lewis-Mertens-Stock Weekly Economic Index is far more cautious at an annualized rate of 1.7% for Q2 (so far).

Real GDP & Weekly Economic Index

ISM Services PMI declined to 49.4% for April, indicating a contraction in the large services sector. Earlier, the ISM Manufacturing PMI was slightly weaker, at 49.2%.

ISM Services

The Services New Orders sub-index remains above zero, suggesting some improvement ahead.

ISM Services - New Orders

The Employment sub-index, however, shows a sharp contraction, falling to 45.9%. The services sector is the major employer in the economy and the negative outlook warns that overall jobs growth could slow rapidly.

ISM Services - Employment

The Prices sub-index, on the other hand, warns of persistent inflation, rebounding to a strong 59.2%.

ISM Services - Prices

Financial Markets

Bitcoin rallied strongly to again test resistance at $64K. Respect of resistance, signaled by a fall below $61K, would confirm the down-trend and warn of contracting liquidity in financial markets.

Bitcoin (BTC)

The Chicago Fed Financial Conditions Index recovered slightly to -0.47, also warning that easy monetary conditions are receding.

Chicago Fed Financial Conditions Index

Ten-year Treasury yields declined on news of the weak labor report, testing support at 4.5%. Breach would indicate a decline to 4.2%.

10-Year Treasury Yield

The S&P 500 jumped above resistance at 5100, suggesting another test of resistance at 5250. But we first expect retracement to test support.

S&P 500

Gold & the Dollar

The Dollar weakened in line with falling Treasury yields, with the Dollar Index testing support at 105. Breach would signal a correction, with follow-through below 104 signaling end of the up-trend.

Dollar Index

Gold continues to test support at $2300 per ounce. If support holds, with recovery above $2350, the shallow correction would be a bull signal, suggesting another strong advance. Otherwise, a test of $2200 is likely.

Spot Gold

Crude Oil

Brent crude broke support at $84 per barrel as tensions in the Middle East ease. Follow-through below support at $82 would warn that the up-trend has weakened and is likely to reverse.

Brent Crude

Conclusion

Financial markets, like Pavlov’s dog, are conditioned to react bullishly to rate cuts. Long-term Treasury yields declined and stocks jumped in response to a weak labor report. However, weak jobs growth is not a bull signal, suggesting that the economy is likely to slow. This is borne out by a weak ISM Services PMI for April, warning of a contraction.

The unemployment rate remains low but average hourly earnings growth is declining, indicating that inflationary pressures are easing. ISM Prices sub indices for both Manufacturing and Services, however, warn of strong producer price pressures.

Brent crude broke its rising trendline and follow-through below the next support level at $82 per barrel would warn of reversal to test primary support at $75. Declining energy prices would help to ease inflationary pressures.

The Fed is likely to hold off cutting rates until the outlook for inflation is clearer.

Gold could weaken to $2200 per ounce in the short- to medium-term — if it can break stubborn support at $2300. But we remain long-term bullish on Gold. The elephant in the room is Government debt which is growing at a rate of more than $1 trillion a year, with little prospect of a bipartisan agreement in Congress to address the shortfall. The chart below shows the bipartisan CBO’s projection of federal debt as a percentage of GDP from 2024 to 2054.

CBO Projections of Federal Debt

The only practical way to solve this is to increase GDP at a faster rate than the debt, through inflation. That would erode the real value of the debt but is likely to send Gold and other real assets soaring.

Acknowledgements



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Australian CPI disappoints

CPI disappointed, coming in at 1.0% for the March quarter, against expectations of 0.8%. The year-on-year measure declined to 3.6% but there are some worrying signs for the RBA.

Australian CPI

Non-tradable inflation — reflecting domestic goods and services as opposed to imports — remains high at 5.0%.

Australian CPI - Non-Tradable

That includes rent inflation which jumped to a year-on-year rate of 7.8%.

Australian CPI - Rent

It is also distorted by low electricity price inflation at 2.0% which has been adjusted downwards by inclusion of government Energy Bill Relief Rebates. The increase before rebates is 17.0% according to the ABS.

Australian CPI - Electricity

Alex Joiner from IFM Investors shows the Sticky Inflation rate for Australia, calculated using the Atlanta Fed methodology, is at a similar rate to non-tradable inflation:

Australian CPI - Sticky Inflation

Conclusion

Prospects of rate cuts from the RBA in 2024 are fading. Long-term government bond rates jumped on release of the report, with the 10-year AGB yield rising to 4.38%. Rising long-term rates are bearish for stocks but particularly for A-REITs.

ASX 200 A-REITs

Acknowledgements

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