Powell Sounds Dovish, But Euro-Dollar Unable to Capitalise

Markets this year have followed the same law that held during much of 2023: whatever the news, equities and credit always rally. But there are growing reasons to doubt whether the pattern will hold. 

The problem is not with the economy. Recession fears are all but forgotten. Lower inflation means real wages are growing again. Corporate profits are strong, with little sign of pressure on record margins. Despite 20-year highs in interest rates, unemployment has ticked up only slightly from record lows. Credit concerns linger, but even the prospect of losses on some tranches of commercial property debt previously rated AAA shows little sign of proving systemic. Besides, were the outlook to deteriorate, central banks would simply move to additional rate easing. 

Nor, for now, does it feel like political concerns have sufficient power to end the rally. Despite growing evidence of the electoral appeal of extremist parties and policies, markets struggle to price budgetary irresponsibility until confronted by its reality. A brief attempt to re-establish a political risk premium in France has fizzled out. And increasing expectations of Trump 2.0 for now seem more likely to be accompanied by rallying equities and bank outperformance on deregulation prospects than by bond yield tantrums. 

The reasons for doubt come instead from the flows that have fuelled the rally, and from the money creation dynamics which underlie them. At $600bn, year-to-date inflows to mutual funds and ETFs exceed those for any year bar 2021. As many a portfolio manager will acknowledge when not in marketing mode, it is ongoing inflows — not the cheapness of their asset classes — which keeps them buying. 

Historically, the inflows look like an anomaly. Current levels of interest rates would normally have spurred a rotation away from riskier assets and into money markets and treasury bills. But no such rotation has occurred. This is partly because even as central banks have been tightening with one hand, they have been easing with the other.

Ongoing quantitative tightening — the reversal of massive central bank quantitative easing programmes to support economies since the financial crisis — ought normally to have reduced the level of reserves that commercial banks hold at central banks. But other factors also drive reserves.

When governments reduce their deposits at central banks and spend it in the real economy, it boosts the deposits and reserves of commercial banks. The same happens when money market funds move money out of the Fed’s Reverse Repo Programme — a facility to store cash at the central bank — and put it to work in markets, say by buying treasury bills. In all such cases, reserves are a convenient measure of the “portfolio balance” effect: how much money is in private hands relative to how many assets are available to absorb it. 

In the six months following markets’ most recent trough last October, global reserves rose by $600bn, ongoing QT notwithstanding. As such, the risk rally was no coincidence: it was almost as though central banks had been doing QE.

More than enthusiasm about fundamentals or valuations or prospects for rate easing, this additional money was the ultimate source of the mutual fund inflows. As under QE itself, rising liquidity pushed investors into taking risk in search of returns, fuelling momentum and encouraging widespread disregard for expensive valuations. 

Central banks’ devotion to theory and focus on the impact of reserve levels on rates has largely blinded them to the impact such liquidity swings have on markets. When reserves have been drained, first in 2022, then in April this year and again briefly in late June, both fund flows and markets have fallen. A narrowing group of US equities may have outperformed but that reflects a greater focus on a smaller number of stocks as liquidity dwindles. Performance and flows in credit, emerging markets and bitcoin also have all softened since April — in line with reserves. 

Thinking in terms of these money flows — and not just rate changes — casts this year’s market performance in a very different light. Mutual fund flows in the past few weeks have remained quite strong notwithstanding the lack of support from reserves. That decoupling may have further to run. But with the liquidity torrent from central banks unlikely to be re-established in coming months, any further rally from here looks at risk of drying up. And rate easing, when it comes, is unlikely to be a substitute.  

While countries like Brazil and the United States are often seen as major pressures on OPEC oil production policies, Saudi Arabia’s ambitious Vision 2030 might pose an even greater challenge. This transformative economic strategy, spearheaded by Crown Prince Mohammed bin Salman, aims to shift the kingdom's reliance away from oil, potentially destabilizing OPEC's delicate balance.

Transformations are pricey. And Saudi Arabia’s Crown Prince Mohammed bin Salman’s grand plan to diversify its economy away from oil by embracing lavish projects like Neon is no exception. But when an oil-dependent economy such as Saudi Arabia wants to spend trillions on non-oil related projects and it feels pressured to cut oil production—their economy’s very lifeblood—to keep the bottom from falling out of the oil markets—something has to give. The question isn’t whether something has change; it’s whether the spending spree must continue to be reined in or whether production needs to be cut more to lift prices to bring the Prince’s plans to fruition.

Since the announcement of Vision 2030, Saudi Arabia has faced substantial fiscal challenges. With oil prices no longer at their 2022 highs, the kingdom's reliance on petrodollars is more precarious. The IMF estimates that Saudi Arabia's fiscal breakeven oil price is near $100 per barrel, but current market prices fall short, complicating the funding of its large-scale diversification projects.

Saudi Arabia has long been perceived as the heavyweight of the OPEC group. Even when OPEC created OPEC+ with additional members, bringing on another oil heavyweight in Russia, Saudi Arabia’s power to rally the other members and reach consensus on matters of oil production was clear.

Of course, Saudi Arabia’s role as a stabilizer within OPEC comes at a cost. When other members shirk their duties and overproduce, members like Saudi Arabia must pick up the slack. While Saudi Arabia seems to have control of OPEC and OPEC+ when it comes to reaching production cut deals, and while there is no question of Saudi leadership’s keen understanding of the oil markets and how they operate, smaller members have continued to overproduce beyond their quota. As the member producing the most oil, Saudi Arabia always seems to be cutting additional production to make up for the laggards—and at great cost. 

At best, the cost could be Saudi Arabia having to delay even more its ambitious plans that require more oil revenues than what it has. At worst, cancelling the plans, or making adjustments to its oil production levels.

Since the OPEC+ group started to slash production last year, export revenues have failed to rise significantly. Reduced production means that while the kingdom attempts to sustain oil prices, it also sacrifices potential revenue, exacerbating the budget deficit and placing additional strain on public finances.

Neom is a huge undertaking, and it’s already been scaled back. At an estimated $1.5 trillion, the 2017 launch of this futuristic environmental utopian city—juxtaposed (and ironically only made possible by) with its well-to-do oil industry—includes The Line. The latter of which is looking like failing to live up to what many were saying was unrealistic expectations. Bloomberg estimated earlier this year that The Line will likely only be 1.5 miles long by 2030 and capable of housing 300,000 people, less than what was hoped for.  The reason for the slower pace and downgraded capacity, aside from perhaps its grandiose scale that some said was unachievable anyway, is likely budget constraints.

The government's strategy includes leveraging the state oil company, Aramco, to finance these mega-projects. This dual role of Aramco as both a national oil producer and a financial vehicle for diversification initiatives puts immense pressure on its operations and profitability.

In response to falling oil revenues, Saudi Arabia has turned to international debt, becoming the largest issuer among emerging markets. This reliance on debt, coupled with low foreign direct investment outside the oil sector, underscores the kingdom’s economic vulnerabilities. Saudi Arabia is now the largest issuer of international debt among emerging markets, and its creditworthiness and financial stability have come under scrutiny. Unfortunately for Saudi Arabia, this combined with its low levels of foreign direct investment outside the oil and gas sector, which it had hoped would be a cornerstone of its new diversified economy.

But foreign investors remain cautious due to the political climate and high fiscal breakeven oil price, which is above current market prices. Saudi Arabia is targeting $100 billion annually in FDI, but it has work to do to woo investors.

Despite the fiscal challenges, Saudi Arabia appears steadfast in its commitment to Vision 2030. The creation of an efficiency department within the Directorate General of Hydrocarbons aims to enhance oil recovery and integrate carbon capture technologies, crucial for sustaining production levels and environmental goals.

Moreover, the government is working to streamline approval processes and reduce bureaucratic hurdles, which should help accelerate project timelines and improve investor confidence.

Saudi Arabia's balancing act between maintaining OPEC stability, sustaining oil revenues, and investing in non-oil sectors is a complex endeavor. As it shoulders the burden of OPEC production cuts, the kingdom's economic transformation under Vision 2030 poses a unique challenge, potentially reshaping global oil dynamics and OPEC's future.

What Saudi Arabia won’t be able to do is forever carry the entire load of the OPEC production laggards. This may mean Saudi Arabia putting its foot down and pressuring OPEC members to keep their production in check, being careful not to upset the delicate harmony of the group, which has in recent years had a few scares with members already dissatisfied with their quotas.

Former President Donald Trump has selected Ohio Senator J.D. Vance as his vice presidential candidate for the 2024 election.

Trump’s decision stems from Vance’s support for Bitcoin and the broader crypto industry. Moreover, it highlights a strategic shift toward crypto’s growing influence in politics.

Trump announced this on Monday via his Truth Social account. In the post, Trump praised Vance’s military service, academic achievements, and career in technology and finance.

As a Yale Law School graduate and author of “Hillbilly Elegy,” Vance has been a vocal supporter of Bitcoin since his election to the Senate in 2022. His advocacy for digital assets is evident through his legislative efforts.

Vance has introduced and supported legislation in the Senate favoring digital assets. He opposes US Securities and Exchange Commission (SEC) Chairman Gary Gensler’s stringent regulatory approach.

Furthermore, Vance’s stance to vote on repealing Staff Accounting Bulletin 121 (SAB 121), which restricts certain financial institutions from holding digital assets, demonstrates his commitment to a crypto-friendly regulatory environment. Additionally, according to federal financial disclosures, Vance has made a personal investment in Bitcoin, ranging between $100,001 and $250,000.

Prominent figures in the crypto industry have expressed support for Vance’s candidacy. Nic Carter, founder of Castle Island Ventures, praised Trump’s choice on his X account.

Charles Hoskinson, founder of Cardano, also commended Vance’s pro-crypto stance in a recent video. He acknowledged Vance’s significant contributions to the industry.

Trump’s campaign has increasingly branded itself as crypto-friendly. The former president has supported the industry through various gestures, including accepting cryptocurrency donations and speaking at the Bitcoin Conference 2024 in Nashville.

His efforts appear to be bearing fruit, garnering backing from several key industry figures. BeInCrypto reported earlier that the Winklevoss twins, the founders of crypto exchange Gemini, have donated $2 million in Bitcoin for Trump’s campaign. Additionally, a recent report by the Washington Post revealed that David Bailey, CEO of Bitcoin Magazine, will hold a fundraiser for Trump later this month.

Given his previous skepticism, Trump’s shifting stance on Bitcoin and the crypto industry is noteworthy. In 2019, he publicly denounced Bitcoin and cryptocurrencies as “not money” and “based on thin air.” Thus, this change raises questions about his sincerity and potential policy changes.

Arthur Hayes, founder of BitMEX, offered a critical perspective, suggesting that Trump’s support for crypto is politically motivated. Hayes emphasized that Trump’s pivot aims to capture votes from the crypto community in key swing states, rather than reflecting genuine belief.

Bitcoin shed over 3% on July 16 as what analysis called “FUD” involving defunct exchange Mt. Gox resurfaced.

Data from Cointelegraph Markets Pro and TradingView showed BTC price action under pressure after hitting $65,000 on Bitstamp.

The downturn came as BTC belonging to Mt. Gox shifted between wallets affiliated with its rehabilitation program.

According to data from crypto intelligence firm Arkham, the amount involved totaled some 92,000 BTC (approximately $5.7 billion) in outflows from Mt. Gox’s cold wallet — around two thirds of the exchange’s total holdings.

“Mt. Gox moved 44,527 $BTC(2.84B) to an internal wallet 5 minutes ago, which may be preparing for repayment,” onchain analytics platform Look Into Bitcoin responded on X (formerly Twitter).

Similar events surrounding Mt. Gox, now due to distribute refunds to creditors who originally lost them when it was hacked and closed down more than a decade ago, have had a detrimental effect on price, with markets fearing mass BTC sales as a result.

Some, however, believe those fears do not match reality.

“And here is the next Bitcoin FUD,” popular crypto investor and YouTuber Quinten Francois wrote in part of an X reaction.

As Cointelegraph reported, sell-side pressure spooking markets in recent weeks also came from the German government, whose stocks of confiscated BTC are now depleted.

The flurry of concern disrupted what had been arguably Bitcoin’s best performance in months.

BTC/USD last saw $65,000 on June 21, a significant level being Bitcoin’s short-term holder cost basis.

Also known as realized price, the cost basis of speculators traditionally functions as support during bull markets, and had last been violated in August 2023.

Look Into Bitcoin put the short-term holder cost basis at $64,835 as of July 15.

September S&P 500 E-Mini futures are trending up +0.12% this morning as market participants looked ahead to key U.S. retail sales data and quarterly reports from more big banks.

In yesterday’s trading session, Wall Street’s main stock indexes closed higher, with the benchmark S&P 500 and blue-chip Dow posting new record highs. Trump Media & Technology Group soared over +31% after a failed assassination attempt on former President Donald Trump on Saturday evening potentially boosted his chances of winning the presidential election in November. Also, Apple  closed up more than +1% at a record high after Morgan Stanley named the stock as a “Top Pick” with a price target of $273. In addition, Goldman Sachs gained over +2% as upbeat Q2 results overshadowed plans to moderate the pace of buybacks. On the bearish side, Macy’s tumbled more than -11% after the department store chain announced that it had ended buyout discussions with Arkhouse Management and Brigade Capital Management.

Economic data on Monday showed that the Empire State manufacturing index fell to -6.60 in July, weaker than expectations of -5.50.

Federal Reserve Chair Jerome Powell said in an interview on Monday that second-quarter economic data has given policymakers greater confidence that inflation is trending towards the central bank’s 2% target, potentially setting the stage for near-term interest rate cuts. Powell also remarked that the labor market has shifted into better balance and that monetary lags imply the Fed can take action before achieving the 2% inflation target. At the same time, the Fed chief made clear that he would not send “any signals” regarding the timing of rate cuts. Separately, San Francisco Fed President Mary Daly remarked that inflation is decreasing in a manner that boosts confidence it is moving towards 2%. “Inflation is coming down and it’s doing so in a way that confidence is growing that we’re getting nearer a sustainable pace of getting inflation back down to 2%,” Daly said.

Meanwhile, U.S. rate futures have priced in an 8.6% chance of a 25 basis point rate cut at July’s monetary policy meeting and a 99.4% probability of at least a 25 basis point rate cut at the conclusion of the Fed’s September meeting.

On the earnings front, notable companies like UnitedHealth, Bank of America , Morgan Stanley, PNC Financial, and JB Hunt Transport  are set to report their quarterly figures today.

On the economic data front, all eyes are focused on U.S. Retail Sales data, set to be released in a couple of hours. Economists, on average, forecast that June Retail Sales will stand at -0.3% m/m, compared to last month’s figure of +0.1% m/m.

Also, investors will focus on U.S. Core Retail Sales data, which came in at -0.1% m/m in May. Economists foresee the June figure to be +0.1% m/m.

The U.S. Import Price Index for June will be reported today. Economists anticipate the import price index to be +0.2% m/m, compared to the previous figure of -0.4% m/m.

U.S. Business Inventories data will come in today as well. Economists foresee this figure to arrive at +0.4% m/m in May, compared to the previous number of +0.3% m/m.

In addition, market participants will be anticipating a speech from Fed Governor Adriana Kugler.

In the bond market, the yield on the benchmark 10-year U.S. Treasury note is at 4.176%, down -1.26%.

The Euro Stoxx 50 futures are down -0.60% this morning, extending the losses from the previous session as investors digested more corporate results and awaited the European Central Bank’s interest rate decision later this week. Mining and insurance stocks underperformed on Tuesday. Final data from the statistical office Istat showed Tuesday that Italy’s annual inflation rate remained unchanged at 0.8% in June, matching the preliminary reading. Separately, the ZEW Economic Research Institute reported Tuesday that German investor morale worsened in July. Meanwhile, market participants are anticipating the ECB’s interest rate decision on Thursday, with the central bank widely expected to maintain interest rates unchanged following its first rate cut in this cycle last month. In corporate news, Hugo Boss Ag  plunged over -8% after the German fashion house trimmed its full-year sales guidance. Also, Rio Tinto Plc RIO fell more than -2% after providing weaker-than-expected guidance on its copper operations.

Italy’s CPI, Germany’s ZEW Economic Sentiment Index, and Eurozone’s ZEW Economic Sentiment Index were released today.

The Italian June CPI has been reported at +0.1% m/m and +0.8% y/y, in line with expectations.

The German July ZEW Economic Sentiment Index came in at 41.8, stronger than expectations of 41.2.

Eurozone July ZEW Economic Sentiment Index arrived at 43.7, weaker than expectations of 48.1.

Asian stock markets today settled in the green. China’s Shanghai Composite Index (SHCOMP) closed up +0.08%, and Japan’s Nikkei 225 Stock Index (NIK) closed up +0.20%.

China’s Shanghai Composite Index closed slightly higher today. Gains in semiconductor and software stocks led the overall market higher on Tuesday. China reported slower-than-expected growth in the second quarter on Monday amid an extended downturn in the property market and concerns over employment, prompting several major banks to lower their full-year GDP forecasts. Barclays revised its 2024 China GDP forecast down to 4.8% from 5%, Goldman Sachs adjusted its forecast to 4.9% from 5%, and JPMorgan downgraded its forecast to 4.7% from 5.2%. Also, the increased likelihood of a second Donald Trump presidency in the U.S. is viewed as a negative development for China. According to new research from UBS Group AG, new tariffs of 60% on all Chinese exports to the U.S. would reduce China’s annual growth rate by more than half. Meanwhile, the closely watched Third Plenum will outline efforts to promote advanced manufacturing, reform the tax system to mitigate debt risks, manage a significant property crisis, stimulate domestic consumption, and revitalize the private sector. The details are expected to be released on Thursday. In other news, the People’s Bank of China injected a net 674 billion yuan ($93 billion) in liquidity into the banking system through reverse repurchase operations on Tuesday, the largest amount since January. In corporate news, Ping An Insurance slumped over -5% in Hong Kong after the insurer said it had raised $3.5 billion via convertible bonds.

Japan’s Nikkei 225 Stock Index closed slightly higher today, tracking overnight gains on Wall Street as expectations for a second Donald Trump presidency increased following the assassination attempt. Defense and financial stocks led the gains on Tuesday. Export-oriented stocks also advanced as the Japanese yen weakened against the dollar on bets that the currency would remain weak during Trump’s second term. Meanwhile, Japanese Chief Cabinet Secretary Yoshimasa Hayashi said on Tuesday that authorities are prepared to take all possible measures in the currency market, emphasizing the undesirability of excessively volatile movements. Japan’s 10-year government bond yield fell to its lowest level in nearly three weeks, mirroring a decline in U.S. Treasury yields after Fed Chair Jerome Powell remarked that recent data “add somewhat to confidence” that inflation is returning to the central bank’s 2% target. In corporate news, Metaplanet surged over +9% after announcing the acquisition of 21.877 Bitcoin for 200 million yen. Also, Mitsubishi Heavy Industries climbed over +5% as speculation of a Trump win spurred so-called “Trump trades” among Japanese stocks. The Nikkei Volatility, which takes into account the implied volatility of Nikkei 225 options, closed down -2.50% to 17.91.

The Japanese May Tertiary Industry Activity Index stood at -0.4% m/m, weaker than expectations of +0.1% m/m.

Match Group climbed more than +8% in pre-market trading after activist investor Starboard Value disclosed a stake of around 6.6% in the dating app company and advocated for a turnaround or potential sale.

Kyverna Therapeutics  surged over +7% in pre-market trading after announcing that the U.S. Food and Drug Administration has designated its drug candidate, KYV-101, as a Regenerative Medicine Advanced Therapy for treating patients with refractory stiff-person syndrome.

EPAM Systems  gained more than +1% in pre-market trading after Jefferies upgraded the stock to Buy from Hold with a price target of $237.

Dollar Tree fell over -2% in pre-market trading after Piper Sandler downgraded the stock to Neutral from Overweight.

Huge debt piles among the world's biggest economies are starting to unnerve financial markets again, as elections cloud the fiscal outlook.

French bonds took a beating after a surprise election and hefty spending plans caused alarm. U.S. debt dynamics are in focus ahead of a November presidential election.

A debt crisis is not the base case, but investors are alert to the risk of looser purse strings sparking market stress.

"Deficits are back in focus," said Guy Miller, chief market strategist at Zurich Insurance Group.

"There needs to be more attention placed on not just the debt, but how to generate a growth dynamic – particularly in Europe," he added.

Here's a look at five big developed economies on the worry list:

A surprise election was a rude awakening to investors who had previously looked past France's creaking public finances. With a budget gap at 5.5% of output last year, France faces European Union disciplinary measures.

France's bond risk premium over Germany briefly surged last month to the highest since 2012's debt crisis as the far right pushed ahead in the election race.

A leftist alliance ultimately won and a hung parliament may limit its spending plans but could also hamper any action to strengthen France's finances.

France's national audit office chief said on Monday there was no room for manoeuvre on the budget and debt must be reduced.

Even before a new government, the EU expected debt at around 139% of output, opens new tab by 2034, from 111% currently. France's risk premium has eased, but remains relatively high.

"There's going to be a permanent fiscal premium embedded in the price," said David Arnaud, fund manager at Canada Life Asset Management.

The U.S is not far behind. The Congressional Budget Office reckons public debt will rise from 97% to 122% of output by 2034 - more than twice the average since 1994.

Growing expectations that Donald Trump will win November's presidential election have lifted Treasury yields recently as investors have priced in the risk of larger budget deficits and higher inflation. Some investors reckon the worst outcome for bond markets would be a Trump presidency with a Republican-led House of Representatives and Senate.

That would mean "we can get another round of fiscal stimulus... from a starting point in which the deficit is 6% of GDP," said Legal & General Asset Management's head of macro strategy Chris Jeffery.

While U.S. Treasuries are buffered by their safe-haven status, the yield curve is near its widest since January, reflecting the pressure facing longer-term borrowing costs.

Investors have praised nationalist Prime Minister Giorgia Meloni as market friendly. Yet last year's 7.4% budget deficit was the highest in the EU. So Italy also faces EU disciplinary measures that will test market optimism.

Italian bonds have outperformed their peers. But the risk premium on Italy's bonds briefly hit a four-month high in June, as French bonds sold off, reflecting how quickly jitters can spread.

Rome aims to lower the deficit to 4.3% this year, but has a dismal track record recently for meeting fiscal goals.

Home renovation incentives costing over 200 billion euros since 2020 will put upward pressure on Italian debt for years. The EU executive projects debt rising to 168% of output by 2034 from 137% now.

"You're not getting rewarded for the risk that you're running in Italy," said Christian Kopf, head of fixed income and FX at Union Investment.

Britain has gone down the worry list since 2022, when unfunded tax cuts by the then-Conservative government routed government bonds and sterling, forcing central bank intervention to stabilise markets and a policy U-turn.

A new Labour government, which has pledged to grow the economy while keeping spending tight, faces challenges, with public debt near 100% of GDP.

It could surge to more than 300% of economic output by the 2070s, Britain's budget forecasters said last year, with an ageing society, climate change and geopolitical tensions posing big fiscal risks.

Stronger economic growth is key to stabilising debt, says S&P Global.

Japan's public debt stands at more than twice its economy, by far the biggest among industrialised economies.

That's not an immediate worry, because the bulk of Japanese debt is domestically owned, meaning those investors are less likely to flee at the first signs of stress. Overseas investors hold just about 6.5% of the country's government bonds.

Fitch Ratings reckons price increases and higher interest rates could benefit Japan's credit profile by inflating debt away.

There are still some reasons for concern.

Japan faces more than a two-fold increase in annual interest payments on government debt to 24.8 trillion yen ($169 billion) over the next decade, government estimates suggest.

So any sudden jump in Japanese bond yields as monetary policy normalises is worth watching. At just over 1%, 10-year yields are near their highest since 2011.