“The tidal wave of risk assumption … may be turning”
By Elliott Wave International
On June 14, the yield on the 10-year U.S. Treasury note surpassed 3.45% — its highest level in more than 11 years.
Keep in mind that the lowest intraday reading for the yield on the 10-year note was 0.31% — and that was as recently as 2020. So the rise has been remarkable.
The Elliott Wave Financial Forecast, a monthly publication which provides analysis of major U.S. financial markets, was ahead of this trend reversal. Back in March 2020, the publication showed this graph of yields on global bonds, 10-year U.S. Treasury notes and general obligation municipal bonds. Here’s the commentary:
According to 150 years’ worth of data … this is the first time that 10-year Treasury note yields have dropped below 1%. Grand Supercycle-degree tops set Grand Supercycle records. Investor ebullience is the only thing that allows for an embrace of no-yield debt. The tidal wave of risk assumption, however, may be turning.
In other words: Expect the downward trend in yields to turn upward.
Shortly after that March 2020 analysis in the Elliott Wave Financial Forecast published, yields began to climb.
As you might imagine, bond portfolios have taken a substantial hit (bond prices sink as yields climb).
Shifting to corporate bond portfolios, Bloomberg had this headline on March 14 of this year:
Corporate Bond Rout Is So Severe History Books Need a Revision
The article goes on to say:
[U.S. corporate bond] losses have piled so high that they now belong in history books. A Bloomberg index of investment-grade returns is down 10.5% so far this year … There is little precedent for drops of that magnitude.
Mind you, this was back in March and yields have risen since.
As a May 12 headline from the Associated Press said:
Bonds, haven for elderly and cautious, are getting torched
The question is: What does the Wave Principle say about this rising trend in bond yields?
If you need to brush up on your knowledge of the Wave Principle, an ideal book to read is Frost & Prechter’s Elliott Wave Principle: Key to Market. Here’s a quote from this Wall Street classic:
All waves may be categorized by relative size, or degree. The degree of a wave is determined by its size and position relative to component, adjacent and encompassing waves. Elliott named nine degrees of waves, from the smallest discernible on an hourly chart to the largest wave he could assume existed from the data then available. He chose the following terms for these degrees, from largest to smallest: Grand Supercycle, Supercycle, Cycle, Primary, Intermediate, Minor, Minute, Minuette, Subminuette. Cycle waves subdivide into Primary waves that subdivide into Intermediate waves that in turn subdivide into Minor waves, and so on. The specific terminology is not critical to the identification of degrees, although out of habit, today’s practitioners have become comfortable with Elliott’s nomenclature.
When labeling waves on a graph, some scheme is necessary to differentiate the degrees of waves in the market’s progression. We have standardized a sequence of labels involving numbers and letters … .
If you’re interested in reading the entire book, know that you can gain free access to the online version once you become a member of Club EWI, the world’s largest Elliott wave educational community.
Club EWI is free to join, and members enjoy free access to a wealth of Elliott wave resources on investing and trading.
This article was syndicated by Elliott Wave International and was originally published under the headline 10-Year U.S. Treasury Yield: Anticipating the Rising Trend. EWI is the world’s largest market forecasting firm. Its staff of full-time analysts led by Chartered Market Technician Robert Prechter provides 24-hour-a-day market analysis to institutional and private investors around the world.
We are in a double bind right now. Prices are going through the roof but all the signs suggest that the economy is weakening. The answer to higher prices is normally to raise interest rates, but this also induces people and firms to spend less money. The challenge for central banks is to try and deal with both problems at the same time.
We asked three economists whether they saw a way of bringing down inflation without causing a severe recession. Here’s what they said:
Jonathan Perraton, Senior Lecturer in Economics, University of Sheffield
The Bank of England’s decision to raise interest rates by a relatively modest 0.25 percentage points to 1.25% contrasts with the US Federal Reserve’s 0.75 points hike the day before to a range of 1.5% to 1.75%. This reflects concerns in the UK that economic growth will be weaker than previously forecast.
It follows the unexpected news that the UK economy shrank by 0.3% in April, plus sobering forecasts from the Organisation for Economic Co-operation and Development (OECD) that the UK will be the worst performing major economy in 2023 apart from Russia. GDP is now only fractionally above its pre-COVID level and all major sectors are shrinking.
The Bank of England’s caution is despite inflation currently being at 9% and now expected to reach 11% in the coming months. These are levels not seen since the 1980s. Forecasts have the UK experiencing one of the highest inflation rates of the leading economies.
Inflation rates in the G20
Various sources
Inflation is a worldwide problem thanks to pressures on supply chains after COVID and higher energy and other commodity prices following Russia’s invasion of Ukraine. However, US economist Adam Posen has pointed to Brexit as a key factor in explaining Britain’s relatively high inflation. This has meant higher trading costs, weak sterling and labour shortages.
Unemployment has fallen to only 3.8%, although employment rates are still below pre-COVID levels, pointing to more people being inactive – particularly older workers. Staff shortages have become a key feature of the British economy.
You might expect this combination of low unemployment and unfilled vacancies to drive up wages. Instead regular pay, excluding bonuses, fell by 2.2% in real terms in June, the largest fall for over 20 years. So at least this does not yet appear to be a classic wage-price inflationary spiral, where firms give way to demands from workers for higher pay, pass on the costs to consumers in the form of higher prices, and workers demand even higher wages to cope. Having said that, bargaining rounds are yet to be completed and we are seeing more wage disputes in some sectors.
Until now, consumer demand has helped to stimulate economic activity in the UK, but this has partly been sustained by household savings. Some of this reflects households now spending more as COVID restrictions have been lifted but there are clear limits to how far households can dip into their savings as living standards are squeezed. Not surprisingly, consumer confidence is falling.
Longer term problems also remain. UK productivity has been very weak since the 2008 global financial crisis. There are many possible explanations, including weaknesses in capital investment and training – the latter reflected in current difficulties in filling vacancies.
In sum, the Bank of England is facing unprecedented challenges. Interest rate rises are a blunt tool to deal with supply-side problems in a British economy where growth is grinding to a halt. As long as inflation outstrips wages and the economy stagnates, it is likely to fall on the government rather than the Bank of England to provide people with support.
Brigitte Granville, Professor of International Economics and Economic Policy, Queen Mary University of London
Stagflation is upon us, so a natural focus for any “where next?” discussion must be whether we are on course for an episode as bad as the 1970s or even worse. My answer would be that recession is likely, but the 1970s experience of high inflation persisting despite repeated recessions should be avoidable. That said, even a relatively milder dose of stagflation will be painful for living standards.
The mildest way out of the present situation would be inflation promptly curing itself: by making people poorer in real terms so they can’t afford to buy so much. In this scenario, inflation would ease and central banks could help with the downturn in the economy by reversing their present interest-rate hikes.
There are several obstacles to such a fast turnaround, however: the context of the post-COVID recovery and the labour market.
The main inflationary impulse has come from two factors on the global supply side. First, supply chains have struggled to cope with demand collapsing and resurging during and after COVID, made worse by China’s zero-COVID policy. Second, energy and other natural resource supplies have been constrained by Russia’s war in Ukraine and the west’s sanctions.
The inflationary effects of these issues are being prolonged by pent-up demand from western firms and consumers due to COVID stimulus packages in the UK and especially the US, as well as unspent income accumulated during lockdowns. In the UK, for example, household deposit balances were still well above pre-COVID levels as recently as April.
It doesn’t help that the financial markets have been driven to such heights by loose monetary policy. Although the bubbles have been popping recently, valuations will have to fall some way further before people feel poorer and less willing to go out and buy things.
The wealth effect from the long bull market in stocks and other assets won’t peter out overnight.
Turning to the second obstacle to a rapid reversal of the inflation surge, namely the labour market, the main problem again comes from the supply side. Labour demand from firms has normalised post-COVID, but there are too few workers. This is partly to do with more people over 50 choosing not to go back to work, but the UK has the additional problem of Brexit interrupting the flow of good quality labour from central and eastern Europe.
With too few workers, companies are being forced to pay people more – UK wages are rising at about 4% a year – and to pass on the cost to customers in the prices of goods and services. Alert to the threat of a 1970s-style wage-price spiral, the Bank of England has been raising interest rates.
But leading indicators suggest that the wage-price spiral threat is not that serious. The closely watched Purchasing Managers’ Index, which gauges UK companies’ optimism about the economy, shows that those in services are becoming gloomier about the coming months. You don’t keep increasing prices if you think people are going to stop buying. And while we may have seen faint echoes of 1970s-style labour militancy in transport, for instance, pessimistic companies are generally more likely to cut hiring plans and output rather than give way to hefty wage demands – if not shut up shop altogether.
It seems to me that this will be more decisive in determining the course of inflation since it is a long-term structural issue, whereas the post-COVID issues should eventually straighten out. So overall, I expect that the UK economy’s present stagnation, quite likely dipping into mild recession, will bring inflation back down towards the 2% target. In the US, where underlying demand and credit is stronger, sharper interest hikes may be needed to achieve the same goal.
The main danger in my view is central banks becoming too dogmatic about their 2% inflation targets. In my book Remembering Inflation, I reviewed convincing research findings that inflation levels up to 5% cause little or no long-term damage to growth – especially if the inflation rate is steady rather than volatile. So once inflation eases a little, central banks should stop hiking interest rates to avoid doing more harm than good.
Chris Martin, Professor of Economics, University of Bath
The UK labour market is going to be key to how the UK economy performs in the coming months, and its prospects are finely balanced. On one hand, it proved resilient during the pandemic. The furlough schemes were a success, protecting the labour market from the worst effects of the crisis. The fall in employment was around three times lower than in the 1970s, even though the economic contraction was much greater.
Employment also recovered more quickly than in previous recessions. Vacancies are over 50% higher than before the pandemic. Average wages excluding bonuses are rising by about 4% a year, with even higher growth for drivers and workers in construction, software development and warehousing.
On the other hand, employment is still lower than before the pandemic by close to 250,000 workers. Real wages are still no higher than in 2008. And the macroeconomic context is gloomy: it is hard to see how the labour market will thrive if growth is weak or non-existent.
Several factors make the next few months hard to assess. First, unemployment is no longer a useful labour market indicator. Workers are nowadays categorised as employed, unemployed or inactive. Unemployed workers are actively seeking work but the inactive are not. Of the circa 250,000 drop in employed workers since 2019, 80% are inactive; only 20% are now unemployed.
Economists have a much weaker understanding of the inactive than the unemployed. This matters because most people getting hired are from the inactive rather than the unemployed category.
Second, perhaps surprisingly, Brexit has not reduced migration, but it has changed it. There are fewer EU citizens employed in the UK, but more workers from Nigeria, India and similar countries. They tend to be more highly skilled and to work in health and social care, rather than in hospitality.
More skilled workers should be good for productivity and fill vital roles in health and social care, but hospitality is struggling at the same time. However, it is not yet clear if these changes are permanent, and this too makes the labour market more difficult to forecast.
In addition, the behaviour of vacancies and their relationship to hiring seems to have changed. The most recent data shows 1.3 million vacancies, around 40% higher than pre-pandemic. But this has not resulted in record numbers of workers being hired. Whatever the cause, we can no longer rely on high vacancy posting to generate rising employment.
Finally, a striking divide is opening between the public and private sectors. Private sector employment is back to pre-COVID levels, but public sector employment lags behind. Private sector wages are currently increasing by 8%, compared to just 1.5% for the public sector. Forecasting public sector employment is difficult, since it is immune to some of the market forces that drive the private sector, although there seems little prospect of noticeable growth over the next few months.
These negative forces will be offset by the large number of vacancies currently being offered by firms and by relatively large wage rises in some parts of the private sector. This may induce some of those workers back into the labour market who have withdrawn following the pandemic.
On balance, I would expect a fall in employment of up to 100,000 workers in the coming few months. That’s less than 0.1%, so it’s not going to greatly exacerbate all the other problems in the economy.
There wasn’t much dramatic tension as markets waited for the Bank of England’s latest decision on interest rates. The fifth monthly quarter-point hike in a row was largely expected, taking the base rate to 1.25% in June 2022. All the announcement really revealed, in fact, was what a mess UK economic policy is in.
Neither the Bank of England, nor the government, is now helping to deal with Britain’s economic problems. A more rational approach to monetary and fiscal policy is needed.
The Bank’s aim is to curb inflation. But the interest rate rise is unlikely to affect inflation at all. There may be a small impact on import prices, if higher rates prevent a further deterioration in the value of the pound. But raising the rate at which citizens and businesses in the UK can borrow money will not ease the global rise in oil, gas and food prices that is the main source of inflation now.
The Bank of England’s members know this, of course. Their justification for raising rates is that they want to keep inflationary expectations under control, to prevent an uncontrollable “wage-price spiral”. This can happen when expectations of future inflation lead workers to bargain for higher earnings to compensate, which only adds to inflation. The Bank of England’s fear is a return to the 1970s. Such a wage-price spiral pushed inflation to 22.6% in 1975.
But the problem with this argument is that inflation has been more than 4% since October 2021 and real earnings are not rising. Strip out bonuses being paid in a small number of sectors, and wages rose only 4.2% between February and April 2022, which in real terms (once inflation is included) is a fall of 2.2%. And the trend is downwards, not upwards.
In the 1970s, more than half the workforce were members of trade unions, giving them the muscle to bargain for higher wages. Average earnings in 1975 hit almost 30%. Today, fewer than a quarter of employees are union members, and most of these are in the public sector, where wages are currently rising by just 1.5% on average.
So there is little chance of a 1970s-style inflationary wage-price spiral. But these cuts in real wages are already starting to cause a contraction of the UK economy. Consumers have no choice but to spend more on the necessities of energy and food, much of which leaves the UK economy. So they are cutting back on discretionary spending on items such as entertainment and home goods, where more money tends to stay within the UK.
And in this situation, the Bank of England’s rate rise will actually make things worse. As interest rates rise, consumers and businesses will find it more costly to borrow to invest and spend, and aggregate demand will fall further.
Government policy
The government isn’t helping either. The emergency package of support to consumers announced by Chancellor Rishi Sunak in May represents a significant stimulus. But the government’s overall fiscal stance is still contractionary, with significant tax rises acting to withdraw demand from the economy. Sunak is still more intent on limiting public borrowing, in accordance with his self-imposed fiscal rules, than he is on keeping either taxes down or spending up.
So, on the one hand we have the Bank of England raising rates in a way that will not affect inflation, but will curb consumer spending. On the other, the government is simultaneously withdrawing demand from the economy via tax rises. And all while the UK economy is contracting.
It is hard not to see this as anything but an economic policy mess. What the UK needs is much stronger coordination between fiscal and monetary policy. If interest rates are to rise, this should only occur while the government stimulates the economy to ensure output and incomes are sustained.
And underneath all this are much deeper weaknesses in the UK economy, which date from well before COVID-19. The UK has close to the lowest rate of investment, and among the lowest productivity and weakest wage growth of any leading economy. Over the last year, business investment has been falling, deeply affected by Brexit and the overall weak outlook for growth. Productivity fell by 0.7% in the last six months. And the Office for Budget Responsibility forecasts that real wages will still be lower in 2026 than they were in 2008.
The government likes to boast about the UK’s very low unemployment rate, now just 3.8%. The labour market is currently as tight as it has ever been, with more vacancies than there are people officially unemployed. But this disguises the fact that employment has also fallen: half a million people have left the labour market since before the pandemic. Some of these have been EU citizens leaving the country; others have taken early retirement, declared themselves sick, or are unwilling to work on the wages they are being offered.
To return to growth, the UK needs to attract more people into the labour market. This requires higher wages, not lower. It also demands an improvement in labour conditions, particularly in the insecure gig economy of zero hours contracts and precarious self-employment. Making work more attractive would require firms to invest in better equipment and skills training, in turn raising productivity.
In a rational economic policy world, the government would now be brokering sectoral productivity deals with businesses and unions, promising government support in return for higher investment and higher earnings. This could indeed be at the heart of the government’s “levelling up” strategy. But unfortunately, we are not in such a world.
The US stock market did not trade yesterday due to the banking holiday.
Stock markets in Europe traded higher yesterday. German DAX (DE30) gained 1.06%, French CAC 40 (FR40) added 0.64%, Spanish IBEX 35 (ES35) jumped by 1.72%, British FTSE 100 (UK100) was up 1.50% on Monday.
The euro increased on Monday as markets focused on the European Central Bank’s anti-fragmentation tools, ignoring the risk of political gridlock in France after President Emmanuel Macron lost an outright majority in parliamentary elections.
On Monday, ECB President Christine Lagarde confirmed plans to raise ECB interest rates twice this summer, fighting widening spreads in the cost of borrowing by various Eurozone countries.
Germany will restart its coal-fired power plants and introduce an auction scheme to cut gas consumption after Gazprom cut supplies by 60% last week. On Monday the Dutch government said it would lift restrictions on production at coal-fired power plants and activate the first phase of its energy crisis plan.
The situation in the oil market remains the same. Oil markets are keeping oil prices above $105 a barrel. Oil prices rose yesterday as traders focused on limited supplies due to a slowdown in global economic growth. Analysts expect limited production from OPEC+ countries this summer, so market shortages will remain with demand growth.
Asian markets have been trading in positive territory since the opening. Japan’s Nikkei 225 (JP225) increased by 2.26%, Hong Kong’s Hang Seng (HK50) added 1.43%, and Australia’s S&P/ASX 200 (AU200) is up by 1.41% from the opening bell.
The People’s Bank of China left key interest rates unchanged on 1-year and 5-year loans. As the economy continues to face immense challenges, recovery is likely to be slow, with unemployment a key economic problem.
Imports from China’s Xinjiang region will be banned in the US starting today after the new rules take effect. Under the laws, firms will have to prove that imports from the region are not made using forced labor. China has repeatedly denied accusations of holding Uighurs in internment camps in Xinjiang.
Reserve Bank of Australia Governor Lowe has warned that the central bank’s board will do whatever is necessary to bring inflation under control, which he now expects to reach 7% by year’s end, doubling the bank’s 2-3% target. That’s why the RBA was forced to raise the interest rate more than expected by 50 basis points at this month’s board meeting. Economists forecast another 50-basis-point hike in July and possibly another in August, raising the rate to 1.85% by year’s end.
Main market quotes:
S&P 500 (F) (US500) 0 0 (0%)
Dow Jones (US30) 0 0 (0%)
DAX (DE40) 13,265.60 +139.34 (+1.06%)
FTSE 100 (UK100) 7,121.81 +105.56 (+1.50%)
USD Index 104.47 -0.23 (-0.22%)
Important events for today:
– Australia RBA Governor Lowe Speaks at 03:00 (GMT+3);
– Australia RBA Meeting Minutes (m/m) at 04:30 (GMT+3);
This article reflects a personal opinion and should not be interpreted as an investment advice, and/or offer, and/or a persistent request for carrying out financial transactions, and/or a guarantee, and/or a forecast of future events.
A sense of normality seems to be returning to financial markets after the brutal selloff in global shares last week. Asian stocks rebounded on Tuesday following the positive cues from European markets overnight while U.S futures moved higher after their markets were closed for a holiday. While the improving sentiment could support equity bulls in the near term, caution lingers in the air with investors likely to adopt a guarded approach towards risky assets.
In the currency arena, the dollar kicked off the week in a shaky fashion while gold waited for another fresh directional catalyst to break out of its current range. Oil prices rose 1% this morning, clawing back more of last week’s steep losses as market players focused on the tight supply dynamics in the commodity.
The week ahead promises to be eventful and potentially volatile thanks to key economic reports from major economies and Fed Chair Jerome Powell’s semi-annual testimony before Congress. Major themes ranging from inflation fears, rate hike expectations, ongoing geopolitical risks, and recession concerns will influence the market mood.
All eyes on Powell’s testimony
Fed Chair Jerome Powell will be under the spotlight this week as he testifies before Congress over two days.
Last week, the Federal Reserve raised interest rates by 75 basis points – its biggest increase since 1994. However, the central bank reassured markets that such jumbo-sized rate hikes would be rare. Powell’s testimony will be closely scrutinised for hints about incoming rate hikes and the outlook for the US economy. Should Powell strike a hawkish note and offer fresh insight into rates, this may boost expectations that the central bank will maintain an aggressive approach towards rates. Traders are pricing in an 89% chance of a 75-basis point rate hike at the next FOMC meeting in July.
Taking a look at the dollar, it has weakened against most G10 currencies this morning. The Dollar Index (DXY) could extend declines if a breakdown below 104.0 is achieved. Alternatively, a move above 104.50 may signal an advance towards 105.00.
Oil prices buoyed by supply worries
Oil prices pushed higher on Tuesday as investors focused on the persistent supply constraints and tightening market conditions. Given how the global commodity remains pulled and tugged by conflicting forces, this could result in more volatility down the road.
On one side of the equation, ongoing geopolitical risks and sanctions on Russian supplies continue to support prices. However, the Fed’s aggressive hawkish stance has fanned concerns of an economic slowdown which will hit the demand outlook. Despite the conflicting forces, oil benchmarks are up almost 50% since the start of the year.
In regard to the technical picture, Brent crude prices remain under pressure after the steep selloff last Friday. A breakdown below $112.00 could encourage a decline towards $104 and $100. A move above $116.00 could inspire a move back towards $120.
Commodity spotlight – Gold
After the explosive volatility last week, gold has kicked off the new week on a calmer note. The lack of momentum suggests that a fresh fundamental spark needs to be brought into the picture to trigger the next major move in gold. Such a catalyst could come in the form of Fed Chair Jerome Powell’s testimony before Congress this week.
Looking at the technical picture, gold prices are trading below the 50, 100, and 200 SMA on the daily charts. Strong support can be found at $1800 and strong resistance at $1900. There seems to be minor support around $1830. A solid breakdown below this level could encourage a decline towards $1800 and $1764. A breakout above $1858 could trigger a move higher towards $1870 and $1900, respectively. Beyond $1900, the first checkpoint can be found at $1920.
The Fed and other global central banks are trying to suppress inflation by aggressively raising interest rates. Major US stock indexes fell for the third week in a row due to concerns about the growing recession probability. At the close of the stock market on Friday, the Dow Jones Index (US30) decreased by 0.13% (-4.03% for the week), and the S&P 500 Index (US500) added 0.22% (-4.25% for the week). The Technology Index NASDAQ (US100) gained 1.43% (-1.72% for the week). All three indices were down on the week.
Over the weekend, Fed representatives Waller and Kashkari made several statements to the media stating they were prepared to support a 0.75% interest rate hike at the next Committee meeting as well. At the same time, Federal Reserve Bank of Cleveland President Loretta J. Mester said it would take two years for inflation to fall to the Central Bank’s 2% target. However, Mester added that she does not forecast a recession despite slowing growth. “We have a slowdown in growth to a little below trend, and the unemployment rate is going up a little bit. And that’s fine. We want to see some slowdown in demand to bring it in line with supply,” Mester added.
On Saturday, US President Joe Biden said he is considering lifting some tariffs on China and possibly suspending the federal gas tax to fight inflation.
Stock markets in Europe traded without a single dynamic on Friday. German DAX (DE30) gained 0.67% (-3.23% for the week), French CAC 40 (FR 40) decreased by 0.06% (-3.37% for the week), Spanish IBEX 35 (ES35) gained 0.84% (-1.91% for the week), British FTSE 100 (UK100) lost 0.41% (-4.12% for the week).
Today, ECB President Christine Lagarde will appear before the European Parliament in Brussels, and she will probably be questioned in detail about the progress of the new instrument to combat the crisis. The ECB is drawing up plans for a new procurement scheme to combat “fragmentation,” or the widening gap between the cost of borrowing paid by Germany and the larger debtors in the eurozone’s periphery, such as Italy and Spain, and Greece. Government borrowing costs have risen sharply in the Eurozone periphery after the ECB announced plans earlier this month to raise interest rates to fight inflation.
Howard Davis, deputy governor of the Bank of England from 1995 to 1997, said the Central Bank of England had to raise rates by more than 0.25 percent to lend credibility to its medium-term approach, which could potentially ease some pressure on the sterling.
The EU Commission recommends that Ukraine be granted EU candidate status.
Oil prices fell on Friday and continued to decline at the market’s opening on Monday as concerns about slowing global economic growth and fuel demand offset concerns about supply cuts. The impact was partly mitigated by the release of strategic oil reserves led by the United States and production increases by the Organization of the Petroleum Exporting Countries (OPEC) and its allies, collectively known as OPEC+. However, this was not enough amid the strong demand for the fuel. Oil from Russia, the world’s second-largest exporter, remains out of reach for most countries because of Western sanctions over the war in Ukraine.
Asian markets traded lower last week. Japan’s Nikkei 225 (JP225) decreased by 5.14% for the week, Hong Kong’s Hang Seng (HK50) lost 0.41% for the week, and Australia’s S&P/ASX 200 (AU200) was down by 7.76% for the week.
At the commodities market, lumber futures showed the biggest gain over the week (+5.36%). Futures on natural gas (-20.85%), cotton (-18.59%), WTI oil (-9.77%), gasoline (-8.07%), Brent oil (-6.88%), orange juice (-6.86%), copper (-6.59%), palladium (-5.85%), platinum (-4.3%), and wheat (-3.53%) showed the biggest drop.
Main market quotes:
S&P 500 (F) (US500) 3,674.84 +8.07 (+0.22%)
Dow Jones (US30) 29,888.78 −38.29 (−0.13%)
DAX (DE40) 13,126.26 +87.77 (+0.67%)
FTSE 100 (UK100) 7,016.25 −28.73 (−0.41%)
USD Index 104.65 +1.02 (+0.98%)
Important events for today:
– China PBoC Loan Prime Rate (m/m) at 04:15 (GMT+3);
– Eurozone ECB President Lagarde Speaks at 16:00 (GMT+3);
This article reflects a personal opinion and should not be interpreted as an investment advice, and/or offer, and/or a persistent request for carrying out financial transactions, and/or a guarantee, and/or a forecast of future events.
Even though the June FOMC meeting is now behind us, markets will continue being laser-focused on the Fed’s quest to tame inflation, a campaign which is feared could end with a recession.
Hence, Fed Chair Jerome Powell’s testimonies before Congress over two days next week will be closely watched for more clues about its incoming rate hikes, and its tolerance for economic pain.
Powell’s testimonies are lined up alongside these scheduled economic data releases and events in the week ahead:
Monday, June 20
CNH: China loan prime rates
US markets closed for Juneteenth holidays
Tuesday, June 21
NZD: New Zealand 2Q consumer confidence
AUD: RBA Governor Philip Lowe speech, RBA June meeting minutes
CAD: Canada April retail sales
Wednesday, June 22
JPY: Bank of Japan April meeting minutes
GBP: UK May inflation
EUR: Eurozone June consumer confidence
CAD: Canada May CPI
USD: Fed Chair Jerome Powell testifies before US Senate
Thursday, June 23
AUD: Australia June PMIs
NOK: Norway’s Norges Bank rate decision
EUR: ECB economic bulletin, Eurozone June PMIs
GBP: UK June PMIs
USD: Fed Chair Jerome Powell testifies before US House
USD: US weekly initial jobless claims
US crude: EIA weekly US crude inventories
Friday, June 24
JPY: BOJ Deputy Governor Masayoshi Amamiya speech
AUD: RBA Governor Philip Lowe speech
EUR: Germany June IFO business climate
GBP: UK May retail sales
At the time of writing, the equally weighted USD index is looking to enter the weekend on a brighter note, attempting to pare losses sustained from the two days prior.
Despite the Fed triggering a jumbo-sized 75 basis point hike this week, the US central bank’s largest hike since 1994, the buck fell amid fears that the US economy will be tipped into a recession due to the central bank’s eagerness to quell runaway inflation.
From a technical perspective, this index may just have been due a healthy pullback, clearing some of the overstretched long dollar positioning. After all, its 14-day relative strength index having broken above the 70 threshold which marks overbought conditions.
The clearing of such froth could set a stronger footing from which the USD index could launch another attempt to set a new cycle high.
Note that the USD index measures the US dollar’s performance against six of its major peers, all in equal weights:
Pound
Euro
Swiss Franc
Canadian Dollar
New Zealand Dollar
Australian Dollar
To be clear, the US dollar still holds a month-to-date advance against all of its G10 peers (including the six listed above), as well as having risen against all of them so far in 2022.
It’s important to note that the stronger dollar storyline assumes two key points:
Other major central banks, such as the European Central Bank and the Bank of England, aren’t able to hike their respective rates as high and as fast as the Fed.
The US economy can withstand such lofty interest rates, and faring better relative to other major economies in a higher interest rate environment.
For comparison, the UK economy is already showing signs of cracking (April’s GDP posted a surprise contraction from March), while the EU still has a war raging off to its east.
Still, that isn’t stopping economists and Wall Street from already predicting a high chance of a US recession in the latter part of 2023.
If a rapidly darkening economic outlook forces the Fed to abandon its ultra-hawkish stance (willingness to raise rates much higher), or at least markets fear such a dismal reality, that could see the unwinding of US dollar gains.
Hence, Powell’s testimonies on Capitol Hill in the coming week will be closely scrutinized for signs whether the Fed is willing to tolerate a recession. Such an admission, if forthcoming, would likely be implicit considering that the Fed still holds to an idealized outlook for how the US economy will ultimately respond to this rate-hiking cycle.
In short, clearer signs that the Fed will acquiesce to market expectations that a US recession is inevitable could prompt more declines for the US dollar.
From a technical point of view, this USD index appears to have formed a double-top, having been twice resisted around the 1.195 region since May. Such a bearish formation would be confirmed if the low between those two peaks, specifically the 1.3828 mark, gives way as the crucial support level.
I believe that this USD index’s 50-day simple moving average should provide adequate support, noting that the US economy is set to hold up better against the likes of the EU and the UK, while the Bank of Japan still sits on its hands and leaves its own rates untouched.
Such disparity should ensure that the US dollar remains in a supportive environment.
The US initial jobless claims were 229,000, down 3,000 from the previous week. Thus, the US labor market remains strong. But as fears of recession intensified following central bank actions worldwide, the US stock indices closed on Thursday with a sharp decline. As the stock market closed yesterday, the Dow Jones Index (US30) decreased by 2.41% and the S&P 500 index (US500) lost 3.24%. The Technology Index NASDAQ (US100) fell by 4.08%. At the end of the day, all three indices were down.
Hopes that the Fed can arrange a soft economic landing are fading, and Wells Fargo analysts now see a more than 50% chance of a recession. Other banks, Deutsche Bank and Morgan Stanley, are also warning of rising recession risks.
Stock markets in Europe also fell yesterday. German DAX (DE30) decreased by 3.31%, French CAC 40 (FR40) lost 2.39%, Spanish IBEX 35 (ES35) fell by 1.18%, British FTSE 100 (UK100) was down by 3.14%.
Yesterday, European Central Bank President Christine Lagarde told Eurozone finance ministers about the ECB’s plans to limit bond spreads. Analysts believe this is the beginning of the preparation process to raise the interest rates. On the back of this news, the euro jumped sharply, while stock indices, on the contrary, declined.
The Bank of England on Thursday implemented its fifth consecutive interest rate hike to curb skyrocketing inflation. The Monetary Policy Committee voted 6-3 to raise the bank rate by 25 basis points to 1.25%, with three dissenting members voting for a 50 basis point increase to 1.5%. The committee also said that it would take the actions necessary to bring inflation back to the 2% target in the medium term in a sustainable manner.
Switzerland’s Central Bank surprises markets with its first rate hike since 2007. The Swiss National Bank raised interest rates for the first time in 15 years, joining other central banks in tightening monetary policy to combat resurgent inflation and sharply raising the franc, a haven currency for many investors. The Central Bank raised the discount rate to 0.25% from 0.75%. “At this point, we see that inflation in Switzerland has increased – we have it close to 3% – and we have also noticed that we have some risk of secondary effects,” said SNB Chairman Thomas Jordan. The franc’s strength has cushioned the impact of inflation in Switzerland by reducing fuel prices and food imports increases. Nevertheless, the SNB raised its inflation forecast for 2022 to 2.8% from 2.1%.
Oil prices jumped yesterday after the United States announced new sanctions on Iranian oil, ahead of President Joe Biden’s visit to the Middle East to meet with Persian Gulf leaders, including Saudi Crown Prince Mohammed. This year’s record gasoline prices in the US due to a global decline in oil supplies and a drop in popularity among potential voters have Biden looking for ways to deal with high gasoline prices. Analysts say the goal of the visit is to increase oil production in order to lower oil prices.
Asian equity markets traded flat yesterday. Japan’s Nikkei 225 (JP225) gained 0.40%, Hong Kong’s Hang Seng (HK50) ended down by 2.17%, and Australia’s S&P/ASX 200 (AU200) fell by 0.15%. On Friday, the Bank of Japan kept interest rates ultra-low and its guidance to keep borrowing costs at “current or lower” levels, signaling its determination to focus on supporting the recovery from the COVID-19 pandemic. In a sign that the recent sharp drop in the yen could impact the economy, the Central Bank said it would keep a close eye on how changes in the exchange rate could affect the economy.
Main market quotes:
S&P 500 (F) (US500) 3,667.24 −122.75 (−3.24%)
Dow Jones (US30) 29,929.31 −739.22 (−2.41%)
DAX (DE40) 13,038.49 −446.80 (−3.31%)
FTSE 100 (UK100) 7,044.98 −228.43 (−3.14%)
USD Index 103.76 -1.40 (-1.33%)
Important events for today:
– Japan BoJ Interest Rate Decision at 06:00 (GMT+3);
– Japan BoJ Monetary Policy Statement at 06:00 (GMT+3);
– Eurozone Consumer Price Index (m/m) at 10:30 (GMT+3);
– US Fed Chair Powell Speaks at 15:45 (GMT+3);
– US Industrial Production (m/m) at 16:15 (GMT+3).
This article reflects a personal opinion and should not be interpreted as an investment advice, and/or offer, and/or a persistent request for carrying out financial transactions, and/or a guarantee, and/or a forecast of future events.
It’s hard to imagine that three random words have the power to both map the globe and keep your private data secure. The secret behind this power is just a little bit of math.
What3words is an app and web-based service that provides a geographic reference for every 3-meter-by-3-meter square on Earth using three random words. If your brain operates more naturally in the English measurement system, 3 meters is about 9.8 feet. So, you could think of them as roughly 10-foot-by-10-foot squares, which is about the size of a small home office or bedroom. For example, there’s a square in the middle of the Rochester Institute of Technology Tigers Turf Field coded to brilliance.bronze.inputs.
This new approach to geocoding is useful for several reasons. First, it’s more precise than regular street addresses. Also, three words are easier for humans to remember and communicate to one another than, say, detailed latitude and longitude measurements. This makes the system well suited for emergency services. Seeing these advantages, some car manufacturers are starting to integrate what3words into their navigation systems.
Ordered triples
Here’s how three random words in English or any other language can identify such precise locations across the whole planet. The key concept is ordered triples.
Start with the basic assumption that the Earth is a sphere, recognizing that this is an approximate truth, and that its radius is approximately 3,959 miles (6,371 kilometers). To compute the surface area of the Earth, use the formula 4πr2. With r = 3,959 (6,371), this works out to approximately 197 million square miles (510 million square kilometers). Remember: What3words is using 3-meter-by-3-meter squares, each of which contains 9 square meters of surface area. So, working in the metric system, Earth’s surface area is equivalent to 510 trillion square meters. Dividing 9 into 510 trillion reveals that uniquely identifying each square requires around 57 trillion ordered triples of three random words.
An ordered triple is just a list of three things in which the order matters. So “brilliance.bronze.inputs” would be considered a different ordered triple than “bronze.brilliance.inputs”. In fact, in the what3words system, bronze.brilliance.inputs is on a mountain in Alaska, not in the middle of the RIT Tigers Turf Field, like brilliance.bronze.inputs.
The next step is figuring out how many words there are in a language, and whether there are enough ordered triples to map the globe. Some scholars estimate there are more a million English words; however, many of them are very uncommon. But even using only common English words, there are still plenty to go around. You can find many word lists online.
The developers at what3words came up with a list of 40,000 English words. (The what3words system works in 50 different languages with independently assigned words.) The next question is determining how many ordered triples of three random words can be made from a list of 40,000 words. If you allow repeats, as what3words does, there would be 40,000 possibilities for the first word, 40,000 possibilities for the second word, and 40,000 possibilities for the third word. The number of possible ordered triples would then be 40,000 times 40,000 times 40,000, which is 64 trillion. That provides plenty of “three random word” triples to cover the globe. The excess combinations also allow what3words to eliminate offensive words and words that would be easily confused for one another.
Passwords you can actually remember
While the power of three random words is being used to map the Earth, the U.K. National Cyber Security Centre (NCSC) is also advocating their use as passwords. Password selection and related security analysis are more complicated than attaching three words to small squares of the globe. But a similar calculation is illuminating. If you string together an ordered triple of words – such as brilliancebronzeinputs – you get a nice long password that a human should be able to remember far more easily than a random string of letters, numbers and special characters designed to meet a set of complexity rules.
If you increase your word list beyond 40,000, you’ll get even more possible passwords. Using the “Corncob list” of 58,000 English words, you could generate more than 195 trillion “three random word”-style passwords.
It’s important to note that there are a fair number of trade-offs among the different approaches to password selection and complexity rules. So, while “three random words” doesn’t give you a fail-safe for password security, the complexity of language does provide some amazing power in this realm as well.
Wall Street had been expecting a half-point increase, but the latest consumer prices report released on June 10 prompted the Fed to take a more drastic measure. The big risk, however, is that higher rates will push the economy into a recession, a fear aptly expressed by the recent plunge in the S&P 500 stock index, which is down over 20% from its peak in January, making it a “bear market.”
The Federal Open Market Committee, the Fed’s policymaking arm, had been pondering how much and how quickly to raise its benchmark interest rate over the coming months to fight inflation. The stakes for the U.S. economy, consumers and businesses are very high.
Often policymakers must prioritize one or the other. When the economy is weak, inflation is usually subdued and the Fed can focus on keeping rates down to stimulate investment and boost employment. When the economy is strong, unemployment is typically quite low, and that allows the Fed to focus on controlling inflation.
To do this, the Fed sets short-term interest rates, which in turn help it influence long-term rates. For example, when the Fed lifts its target short-term rate, that increases borrowing costs for banks, which in turn pass those higher costs on to consumers and businesses in the form of higher rates on long-term loans for houses and cars.
At the moment, the economy is quite strong, unemployment is low, and the Fed is able to focus primarily on reducing inflation. The problem is, inflation is so high, at an annualized rate of 8.6%, that bringing it down may require the highest interest rates in decades, which could weaken the economy substantially.
And so the Fed is trying to execute a so-called soft landing.
3. What’s a ‘soft landing’ and is it likely?
A soft landing refers to the way that the Fed is attempting to slow inflation – and therefore economic growth – without causing a recession.
In order to stabilize prices while not hurting employment, the Fed expects to increase interest rates very rapidly in the coming months. Including the latest rate hike, the Fed has already lifted rates by 1.5 percentage points this year, putting its benchmark interest rate at a range of 1.5% to 1.75%.
Historically, when the Fed has had to raise rates quickly, economic downturns have been difficult to avoid. Can it manage a soft landing this time? Fed Chair Jerome Powell has insisted that the central bank’s policy tools have become more effective since its last inflation fight in the 1980s, making it possible this time to stick the landing. Many economists and other observers remain uncertain. And a recent survey of economists notes that many anticipate a recession beginning next year.
4. Is there any way to tell what the Fed might do next?
Each time the Federal Open Market Committee meets, it seeks to communicate what it plans to do in the future to help financial markets know what to expect so they aren’t taken by surprise.
One piece of guidance about the future that the committee provides is a series of dots, with each point representing a particular member’s expectation for interest rates at different points in time. This “dot plot” previously indicated that the Fed will raise interest rates to 2% by the end of the year and close to 3% by the end of 2023.
The latest inflation news is forcing it to change its tune. The dot plot now suggests the Fed expects rates to near 3.5% by December – implying several large rate hikes are still in store this year – and almost 4% in 2023 before falling again in 2024.
Long-term interest rates, such as U.S. Treasury yields and mortgage rates, already reflect these rapid changes. Some investors, however, think the Fed may have to move even faster and are forecasting rates approaching 4% by the end of 2022.
5. What does this mean for consumers and the economy?
Interest rates represent the cost of borrowing, so when the Fed raises the target rate, money becomes more expensive to borrow.
First, banks pay more to borrow money, but then they charge individuals and businesses more interest as well, which is why mortgage rates rise accordingly. This is one reason mortgage payments have been rising so rapidly in 2022, even as housing markets and prices start to slow down.
When interest rates are higher, fewer people can afford homes and fewer businesses can afford to invest in a new factory and hire more workers. As a result, higher interest rates can slow down the growth rate of the economy overall, while also curbing inflation.
And this isn’t an issue affecting just Americans. Higher interest rates in the U.S. can have similar impacts on the global economy, whether by driving up their borrowing costs or increasing the value of the dollar, which makes it more expensive to purchase U.S. goods.
But what it ultimately means for consumers and everyone else will depend on whether the pace of inflation slows as much and as quickly as the Fed has been forecasting.
This article was updated to include results of FOMC interest rates announcement.
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