Storms Ahead if Monetary Losses Turn Political

Economic

Summary:

Far-right rise exacerbates central banks communications problems.

The rise in Europe’s populist parties, underlined by this week’s far-right election win in the Netherlands, further exacerbates central banks’ political and public relations problems over their weakened balance sheets.

The far right’s surge, with anti-Islam, anti-euro Party for Freedom leader Geert Wilders favourite to become the next Dutch prime minister, makes life more difficult for central banks for several key reasons. It concentrates the spotlight on policy mistakes by largely independent central banks contributing to an unpopular mix of high (though now diminishing) inflation and high interest rates.

The rise of a new breed of politicians unstinting in their criticism of public sector technocrats will focus attention on central bank operating losses and measures taken to stem them. A landmark report from the International Monetary Fund in July found that losses throughout the euro system were ‘temporary and recoupable’. However, following the European Central Bank’s further interest rate rise in September, prospects for a medium-term easing of the central banks’ balance sheet plight have deteriorated further.

As the IMF wrote, quantitative easing – large-scale, across-the-board purchases of government bonds introduced in 2015 – removed duration risk from the private sector’s balance sheet, in an effort to support credit provision to the real economy. ‘In effect, the ECB executed a fixed-for-floating rate swap for public debt. This leaves the ECB and its shareholder national central banks with a large interest rate exposure in the current tightening cycle.’

Campaign to raise minimum reserve levels could hit bank lending

Deposit rates paid by central banks to commercial banks have increased sizeably in the past 18 months. These outlays hugely exceed the paltry interest rate return on the asset side of central banks’ balance sheets, heavily swollen by huge purchases of low- (sometimes negative-) yielding bonds during the past decade.

This imbalance – as well as some more mainstream monetary policy reasons – represents one reason why some euro area central banks have been campaigning to raise much further the volume of commercial banks’ non-remunerated minimum reserves held at Eurosystem central banks.

This aim is unlikely to be met, at least in the short term. Increasing minimum reserves might lower banks’ profitability and capacity to overpay staff, potentially garnering political applause. But bank executives argue it would impede lending at a sensitive time for European economies.

As the IMF wrote, major euro area central banks seem unlikely to turn to governments for recapitalisation or other forms of overt state support. But an end to a long cycle of paying profits to aid public finances is politically problematic. De Nederlandsche Bank is likely to pay no dividends to the government for the next 10 years. The Bundesbank is braced for a wider public debate over its finances in 2024-25. This will coincide with a probably stormy run-up to the next scheduled general election for Germany in autumn 2025.

QE criticism and appeal of populist parties

The Bundesbank will have used up nearly €20bn of provisions on its balance sheet in covering 2023 losses, to be announced in early 2024. These balance sheet problems, although soluble through accounting adjustments, will sharpen the debate about the drawbacks of large-scale QE. Many now believe this continued too long in the European Union and the UK. QE has been blamed for exacerbating wealth imbalances and undermining the solidity of public finances – both factors enhancing the appeal of populist parties.

The UK has a different mechanism to the euro area for dealing with central banks’ QE-induced losses. The prospective levy on UK taxpayers to stem losses through the Bank of England’s asset purchase facility is estimated to be as high as a cumulative £150bn by 2033.

The Bundesbank may see its sizeable gold reserves as an important buffer for its balance sheet strains. For political, legal and accounting reasons, it probably will not resort to direct use of its gold valuation reserves to plug its deficit. But it pointed out in its 2022 annual report that its balance sheet is underpinned by a gold revaluation reserve of €176bn, eight times larger than when the euro started in 1999.

A similar approach seems likely to be followed by De Nederlandsche Bank. Drawing on gold directly might have adverse side effects if politicians opined that the Bundesbank’s gold should be diverted to other channels. In view of the political and constitutional imbroglio over German public finances, such speculation would be anathema to the Bundesbank and to Chancellor Olaf Scholz’s embattled government.

Source: David Marsh

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Damon

Economic

Global GDP growth is seen at 2.5% in 2024 and growth in developed markets (DM) will average 0.7% versus 3.6% in Emerging Markets (EM) amid the prospects of a slow and fragmented world economy. These are the predictions of Amundi, a leading European asset manager.

Amundi expects global growth gradually weakening while inflation tempers but remains above central banks' targets, until the end of the year. Assuming the Middle East crisis remains contained, this weaker global economic outlook will be mainly driven by a slowdown in Developed Markets (DM).

"For 2025, we forecast global, DM, and EM real GDP growth at 2.7%, 1.5%, and 3.6% respectively," Amundi says.

Quality sovereign & corporate bonds

Vincent Mortier, Group CIO of Amundi, said: "Investing in 2024 will be all about quality sovereign & corporate bonds, and seeking growth through Asian equities, as this region should benefit from better economic prospects than the others. Investors should also seek opportunities through companies positioned on promising long-term themes such as the energy transition or supply chain relocations. Nevertheless, investors will have to wait until the second half of the year to consider European stocks."

Monica Defend, Head of Amundi Investment Institute, added: "Turning tides in growth, inflation, and monetary policy will generate opportunities for investors to add on risk assets during the year."

Slowing and fragmented growth

The growth differential between Developed and Emerging Markets should reach a five-year high. The US will face a mild recession in the first half of 2024, while Eurozone growth will remain mildly positive and Japan should somewhat moderate. Emerging Markets remain more resilient but show higher fragmentation, with Asia standing out as a clear beneficiary of investment flows.

"We expect that the US will face a mild recession in the first half of 2024, as tight financial conditions begin to impact consumers and businesses. In H2, growth should stabilise below potential and inflation move closer to target. Our forecast is a 0.6% growth rate in 2024 and 1.6% in 2025."

Growth in the Eurozone should remain low, with mixed dynamics across countries, as fiscal policy becomes more restrictive on top of already tight monetary policy. Amundi expects both the Eurozone and the UK to grow by 0.5% in 2024, and by 1.2% and 1.3% in 2025, respectively.

Emerging Markets downturn

Emerging Markets are heading towards a cyclical downturn amid weak global demand. In China, additional fiscal stimulus will not reverse the trend towards lower growth (3.9% in 2024 and 3.4% in 2025). India emerges as a new power offering bright economic prospects amid strong domestic demand and investments (6.0% growth in 2024 and 5.2% in 2025).

Finally, countries at the centre of new supply chain routes in Asia or rich in natural resources in Latin America should do better.

Central banks: assessing the time for a dovish turn

With weaker demand, inflation should converge towards Central Banks' targets by the end of 2024. Risks for higher inflation remain in an era of disorderly energy transition and global realignment, that could drive a surge in energy and food prices. These risks could halt or reverse the process in place.

Amundi expects DM Central Banks to remain on a hawkish pause over H1, until inflation appears further under control. Inflation in the US will influence the Fed's response, thus determining the depth of the recession. The asset manager expects the Fed and the ECB to bring interest rates down by an overall 150 and 125 basis points respectively in 2024. In Emerging Markets, disinflation is ongoing and Central Banks have some room to cut rates but little room for error in re-anchoring inflation.

Investment implications

In 2024, investors will need to navigate a fragmented economic outlook. The high disparity in valuations and the drying up of excess liquidity will lead to higher equity volatility. Lower growth and inflation may favour a return to a negative bond-equity correlation, which is good news for diversification and multi-asset portfolios.

Real and alternative assets (such as macro and fixed income hedge funds) may further add to traditional diversification. Gold can provide protection from geopolitical risk and some commodities can hedge against inflation.

Fixed income is king amid peaking rates: Quality bonds (sovereign or corporate) are the favoured asset class entering 2024. Gradually add duration and focus on investment grade credit, EM debt in hard currencies and Euro high yield short-term. Add more EM local currency debt after the Fed starts cutting rates and the US dollar weakens. US high yield may be pressured by high refinancing costs in H1 and could come back when financial conditions ease in H2.

Resilience in Equities: Entering 2024, stay defensive and focused on dividend sustainability, quality, and low volatility. Favour value in the US and Japan. When the Fed starts cutting rates, turn to more cyclical markets and sectors, such as Europe, Emerging Markets, and small caps. Themes to watch in equity will be the energy transition, healthcare, and artificial intelligence.

Emerging Markets are a key performance engine: At the start of the year, favour fixed income hard currency debt, then add local currency debt when the Fed pivots. EM Equity should benefit from a rebound in earnings, particularly in Asia. Throughout the year, look at long-term (India) and nearshoring stories, as well as winners in the energy transition (commodity exporters like Brazil) and technological advances (China).

Source: ZAWYA

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Owen Li

Energy

In the intricate world of global oil trade, a profound transformation is unfolding, challenging the longstanding dominance of the U.S. dollar. Recent geopolitical tensions surrounding the Ukraine conflict have intensified this shift, leading to a clash between Russia and India over oil payments.

The Petro-Dollar era unravelled

The U.S. dollar has been the undisputed currency in international oil transactions for decades. However, as Western sanctions gripped Russia in response to the Ukraine conflict, Moscow began steering away from the dollar and euro. Currently, less than 10 per cent of Russia's daily oil output is sold in these dominant currencies. The Russian central bank, restricted by sanctions, faces challenges in dollar operations, prompting a strategic shift in how Russia engages in global trade.

Pivot to India

Amid this shift, India emerged as a pivotal player, becoming Russia's largest buyer of seaborne oil. In a bold move, India insisted on paying for oil in rupees, disrupting established norms. However, this stance faced resistance, as the Russian central bank provided informal guidance against accepting the Indian currency. The resulting standoff almost derailed crucial trading activities, revealing the complexities that arise when traditional powers navigate new and assertive players.

Seeking alternatives amid sanctions

As Moscow faces limited access to the international banking system due to sanctions, Russian oil executives sought alternative currencies to facilitate transactions. The challenge lies in finding a viable substitute for the dollar, a quest that has implications not only for Russia and India but also for other key players such as buyers in Africa, China, and Turkey – all significant purchasers of Russian oil.

The Yuan factor and diplomatic sensitivities

Russian officials and oil executives, pressed by the limitations on the dollar, advocated for transactions in the Chinese yuan. While advantageous for Russia, this proposition faced resistance from India, given the sensitive nature of using the currency of a regional rival. The complexity deepened as Indian state refiners turned to the UAE dirham, introducing additional clearing requirements amidst Washington's tightened stance on enforcing price caps.

The story takes a dramatic turn as at least two major Russian oil companies threatened to redirect tankers carrying millions of tonnes of oil away from India. This move underscored the severity of the clash and the challenges in finding swift solutions. With Washington imposing sanctions on owners of tankers carrying Russian oil, the situation escalates, leaving a cloud of uncertainty over the future dynamics of global oil trade.

Bottomline

This exploration into the clash between Russia and India over oil payments unveils a narrative that goes beyond economic transactions. It reflects geopolitical shifts, the impact of sanctions, and the delicate dance between established and emerging players in the ever-evolving global trade landscape. As we witness the consequences of this clash reverberating across markets, one thing becomes clear – the tides of the global oil trade are shifting, and the implications are profound.

Source: Wionews

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Economic

Central Bank

Investors fully price in a 25bps Fed cut in June

The US dollar continued trading on the back foot against its major peers on Thursday, losing the most ground against the yen, the aussie, and the kiwi, in that order. It seems that expectations of several cuts by the Fed next year continue to weigh on the greenback, with the weaker-than-expected new home sales data yesterday corroborating investors' view.

According to Fed funds futures, market participants are penciling in around 90bps worth of rate cuts for next year, assigning a 50% chance for the first 25bps reduction to be delivered in May and fully pricing it for June.

Traders are now likely awaiting the core PCE index on Thursday, the Fed's favorite inflation metric, where a further slowdown could increase the probability for a May cut and perhaps push the dollar even lower. However, investors will have the opportunity to listen to several Fed officials before the numbers are out, with Chicago President Goolsbee and Board Governors Waller and Bowman stepping onto the rostrum today.

It will be interesting to see whether they will push back against rate cut expectations, but also whether the market will pay attention to such comments. Recent market moves suggest that investors prefer to focus more on data rather than Fed rhetoric and thus, even if policymakers decide to pour cold water on rate cut expectations, any rebound in the dollar due to their remarks could remain limited and short lived.

Yen extends recovery on Japanese media reports

The yen took the most advantage of the dollar's weakness yesterday, extending its recovery today after Japanese media carried a report expressing confidence that the end of the BoJ's negative interest rate policy is approaching. Raising interest rates at a time when other central banks are expected to start cutting rates could narrow the gap between Japanese government bond (JGB) yields and yields elsewhere, thereby allowing the yen to stage a solid comeback against most of its major peers.

What may have also helped the Japanese currency is separate news that Japan's top business lobby, Keidanren, is planning to hold discussions on the negative impact of the yen's slide on the economy at its December meeting. In the past, the lobby has favored a weaker yen as it makes exports more competitive overseas, and thus, the shift to discuss negative implications highlights the severity of the impact of the currency's latest fall on the economy.

Aussie and kiwi also take advantage of dollar slide, RBNZ meets

The aussie was the second winner in line yesterday, as the divergence in policy expectations between the RBA and the Fed is adding fuel to its engines. Today, RBA governor Bullock said that they have to be a “little bit careful” with using interest rates to tame inflation without lifting unemployment, but she added that demand is being propped up by immigration, which has contributed to second round effects of cost rises, and that service inflation is sticky. This allowed investors to continue pricing in around a 60% probability for another quarter-point hike by May.

The kiwi was also among yesterday's top gainers, despite bets of around 40bps worth of rate cuts by the RBNZ next year. The Bank meets tonight, during the Asian session Wednesday, and expectations are for no action. Ergo, the focus is likely to turn to the accompanying statement and the updated macroeconomic projections, on signs about the future path of interest rates.

Although recent data out of New Zealand came in on the soft side, inflation remains well above the RBNZ's 1-3% target range, with inflation expectations suggesting that inflation is not likely to return within that range in the coming year. What's more, New Zealand's governing coalition is likely to be led by the National Party, which promised tax cuts, an inflationary policy, and suggested the adoption of a stricter inflation target by the RBNZ. This means that if the Bank switches to a 2% objective like other major central banks, policy may need to stay restrictive for longer than previously estimated to achieve that target.

Therefore, officials are unlikely to affirm market expectations of rate reductions. They will probably continue to predict that interest rates will finish 2024 at the current 5.5% level, which could prove positive for the kiwi.

Gold rises above $2,010 on dollar dip, oil unfazed by OPEC headlines

Gold continued drifting north, closing the day above the high of October 27 at around $2,010, as sliding yields and a weaker dollar continue to reduce the opportunity cost of holding the non-yielding metal.

Oil prices remained under pressure yesterday, even after news that the OPEC+ alliance is looking at deepening oil production cuts despite earlier disagreement that led to the postponement of their gathering from Sunday to this Thursday. That said, black gold is staging a recovery today.

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Devin

Economic

Poverty has forced most Europeans to skip meals during the past three years, according to a survey conducted by Ipsos on behalf of the charity French Secours Populaire, which advocates for people on low incomes.

The survey of 10,000 Europeans in 10 nations asked whether money worries had worsened or improved during the preceding three years.

More than half said their situation had worsened, with 29 percent saying they were so short of money that a single unexpected expense would plunge them into difficulty.

The results, published on Monday in the charity's European Barometer on Poverty and Precariousness, found 38 percent of Europeans were no longer able to eat three meals a day on a regular basis. And 21 percent of parents had skipped meals so they could feed their children.

The survey quizzed people living in France, Germany, Greece, Italy, Moldova, Poland, Portugal, Romania, Serbia, and the United Kingdom.

The pollsters found the main reason for the poor financial situation in many European households was the fast-rising cost of goods and services, with price inflation having tripling during 2022 and the cost of housing, water, and fuel rising by 18 percent during the course of a year. At the same time wages remained relatively stagnant.

Financial worries

The survey followed other recent worrying assessments of increasing levels of poverty throughout Europe, with Eurostat, the European Union's statistics agency reporting 17 percent of the population of the 27-nation bloc was "at risk of poverty" and that only 15 percent of Europeans had enough money not to have financial worries.

Another survey, conducted by the Joseph Rowntree Foundation in June, found the UK had 5.7 million low-income households that were so lacking in money they had insufficient access to food.

And another survey, by the Equality Trust, found the gulf between rich and poor in the UK was actually being exacerbated by the government, which, it concluded, was spending more money than any other European nation on subsidizing the rich through structural inequality.

Priya Sahni-Nicholas, the co-executive director of the Equality Trust, told The Guardian newspaper the growing chasm between rich and poor was "causing huge damage" to the economy.

As a result, she said: "We have shorter healthy working lives, poorer education systems, more crime, and less happy societies."

The survey released this week for French Secours Populaire found money worries among Europe's population now mean a significant number of people have turned off heaters, avoided treatment for medical problems, and borrowed as a result.

The survey found one person in 12 in Italy is in "absolute poverty "and relies on discounted food and food banks. And the situation was even worse in Greece and Moldova, which had more people at risk from poverty than any other European nation.

Source: ChinaDaily

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ING

Forex

USD: Excessive weakness

The dollar has stayed under pressure at the start of this week as markets remained bullish on Treasuries across the curve on the back of growing dovish Federal Reserve expectations. The Fed Funds future curve currently prices in the first rate cut in June 2024. Yesterday, soft US home sales data helped consolidate the dollar's bearish momentum and now endorses the narrative that higher rates are having a more tangible impact on the economy.

Expect the dollar to remain very sensitive to US data, including today's Conference Board Consumer Confidence index, which is expected to have mildly declined. We'll also take a look at the Richmond Fed manufacturing index today. On the Fed side, there are a number of speakers to monitor: Austan Goolsbee, Christopher Waller, Michelle Bowman and Michael Barr. The central bank will almost surely keep rates on hold in December, but the softening in its hawkish stance in November was due to the tightening of financial conditions – and the recent drop in rates significantly increases the chances of pushbacks against rates cut speculations, which can help the dollar rebound.

Month-end flows may get in the mix and delay a dollar recovery, but we remain of the view that it is too early to chase the dollar bear trend. There is still some resilience in US data into year-end that can prop up the high-yielding dollar.

EUR: PEPP discussions kick off

ECB President Christine Lagarde fuelled expectations that the central bank will reshape its bond reinvestment strategy soon yesterday during her EU Parliament hearing. The current indications by the ECB are that its pandemic emergency purchase programme (PEPP) will be in the reinvestment phase until the end of 2024, but there has been growing pressure inside the Governing Council to accelerate quantitative tightening.

Tighter financial conditions are generally positive for a currency, but this specific discussion around PEPP reinvestment could have unwelcome spillover into the euro area peripheral spreads. The Italian BTP-bund 10-year spread is more than 25bp below the 200bp pain threshold, but 2024 carries risks for Italian bonds as EU fiscal rules are reinstated and the economy slows. We currently identify Italian bond spreads as one key risk for the euro next year, even if it is not our base case that they will sustainably widen to concerning levels.

Today, the eurozone calendar is quiet, but there are few ECB speakers to watch. Lagarde will deliver a pre-recorded message, and Pablo Hernández de Cos, Joachim Nagel and Philip Lane are also scheduled to speak. The impact on the euro of ECB members' remarks has been rather muted and EUR/USD should remain almost solely a function of USD moves and Fed rate expectations. We are not convinced the pair has enough backing on the rates side to trade sustainably above 1.10 and favour instead a correction below 1.0900 in the coming days.

GBP: Bearish momentum in EUR/GBP may not last

We had called for a break below 0.8700 in EUR/GBP as sterling benefitted from the better risk environment more than the euro, and above all, the fiscal support in the UK was a clear-cut GBP-positive. We suspect the pair may be reaching the bottom of its recent downtrend, as risk sentiment may start to soften into key US data and the UK fiscal event's impact on markets wears off.

We expect increasing support for the pair around 0.8650 and at the 0.8640 100-day MA. When it comes to Cable, our view is very similar to that of EUR/USD; the probability of a correction from these levels appears rather high.

The UK calendar is empty today, but we'll hear from the Bank of England's Jonathan Haskel this afternoon. Yesterday, Governor Andrew Bailey pushed back against rate cuts while acknowledging the encouraging news on inflation.

NZD: RBNZ may focus on pushing back against rate cuts

The Reserve Bank of New Zealand (RBNZ) announces monetary policy overnight and will almost certainly keep rates on hold again. Since the October meeting, inflation, employment and wage growth have all slowed more than expected. Still, the Bank has to operate with the most lagging inflation data (only quarterly) in the G10 space and will probably focus on keeping its stance broadly hawkish against rising rate cut speculations.

Markets currently price in a first rate cut in New Zealand around this summer, while current rate projections by the RBNZ (published in August) signal rates will be kept at the 5.50% peak at least until the end of 2024. We think the Bank will try to discourage further rate cut expectations by signalling rates will be held at 5.50% or cut only by 25bp in the whole of 2024.

That can help NZD get some further support, although the very good performance of the Kiwi dollar of late remains almost solely a function of external factors. Domestically, it's worth keeping an eye on the expected change in the RBNZ remit by the newly installed government, which plans to remove the dual mandate to focus on inflation only. In our view, that is a long-term NZD-positive.

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Commodity

Gold prices are extending their bullish rally towards a fresh six-month high of 2,018, holding well above the simple moving averages (SMAs) in the daily timeframe.

Technically, the MACD oscillator is strengthening its bullish structure above its trigger and zero lines; however, the stochastic oscillator is showing overbought conditions as it is holding above the 80 level, so a bearish correction may be a possible scenario for the next few sessions.

If the market continues to the upside, then it may target the 2,050 resistance level ahead of the record high of 2,079.29, achieved on May 4.

On the other hand, if the bears take control, the yellow metal could move towards the 20-day SMA at 1,978 and the 23.6% Fibonacci retracement level of the upward wave from 1,810 to 2,018 at 1,969. Underneath these lines, the 50- and the 200-day SMAs at 1,952 and 1,942, respectively could come in focus before meeting the 38.2% Fibonacci of 1,938.

All in all, gold is looking strongly bullish in the short-term so the worries may rise for a bearish retracement, according to the stochastic oscillator, before heading higher again.