THE DAILY EDGE: 13 JULY 2022

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CPI DAY

Out at 8:30 today: bls.gov

USD vs EURO: It’s not me, its you!

The WSJ Editorial Board: The Incredible Falling Euro Nears Dollar Parity Sharp movements in exchange rates create uncertainty and can lead to economic and financial instability.

Every month seems to find a different currency somewhere in the world in sharp decline, and the unlucky winner for July is the euro. The eurozone currency, shared by Germany, France, Italy and 16 others, is flirting with parity to the U.S. dollar for the first time since 2002.

This is a dramatic shift since the start of the year, when one euro bought about $1.14. Parity signals a 12% depreciation. (…)

Vladimir Putin’s invasion of Ukraine has created geopolitical uncertainty and is driving up energy prices. Monday’s shutdown of the Nord Stream 1 natural-gas pipeline into Germany, ostensibly for maintenance, contributed to the latest pressure on the euro.

But the most important cause is monetary policy. (…)

The European Central Bank is even less aggressive in fighting inflation. It stopped net asset purchases only last month and says it won’t start reducing its balance sheet until 2024. The short-term policy rate remains minus-0.5% with a quarter-point increase expected this month. Officials hint that maybe—maybe—a second increase in September will deliver a zero nominal rate. The growing chasm in yields between the U.S. and eurozone explains much of the exchange-rate swing.

Instead of fighting inflation, the ECB is focused on extending the monetary ease as long as possible at least for some eurozone members. Officials are busy trying to design a mechanism to avert “fragmentation,” by which they mean divergence between government bond yields of some countries and the German bund. The practical effect, if the scheme works, would be ongoing suppression of rates especially for Italy.

The risk is that if the lack of coordination among major central banks continues, Italy’s dysfunctional fisc could become the least of anyone’s problems. The dollar-euro exchange rate is the most important in the world, as the late Nobel economist Robert Mundell observed. When the rate starts to shift, companies must spend ever greater sums hedging against exchange risks, can be deterred from job-creating investments, and risk currency mismatches when they borrow. All of this weighs on financial stability, and on the Main Street economy.

Note how the conventional wisdom that a weak euro boosts European exports is already proving false. Euro weakness earlier this year boosted corporate profits in export-powerhouse Germany, mainly by allowing companies to book higher euro-denominated earnings on products made and sold abroad. But the good times appear to be ending as Germany reported its first monthly trade deficit since 1991. Energy imports are the main explanation. Energy markets mostly set prices in dollars, so the weaker euro is raising euro-denominated costs for German manufacturers.

Europeans have company in currency depreciation. The Japanese yen has tumbled this year, breaking through Tokyo’s red line of 125 yen to the dollar and now hovering near 137. After thinking a weaker yen might help the economy, Bank of Japan chief Haruhiko Kuroda and other officials are trying to talk the yen into stability. They’re having mixed success.

The die may be cast. Monetary authorities have decided that as they struggle to navigate an exit from their unprecedented policies of the last 15 years, they will each do it in their own ways. But this year’s exchange gyrations are a warning there is a price for this seeming independence—and that price is often paid in depreciating currencies.

The Telegraph’s Ambrose Evans-Pritchard: The magnificent euro is holding up remarkably well (for now)

(…) So for the sake of consistency, let me defend the magnificent euro. The European Central Bank’s trade-weighted euro index is currently near the top of its historical range.

It has fallen a little since reaching a 12-year peak just before the invasion of Ukraine but is not exhibiting signs of structural distress. Perhaps it should be looking more tattered, given what Vladimir Putin is preparing to dish out, but so far the euro is sailing through the worst geopolitical crisis in Europe since the Second World War with serene majesty. So, for that matter, is sterling.

This is almost entirely a dollar story. The dollar index (DXY) has gone mad as the US Federal Reserve engages in frenetic triple-decker rate rises, belatedly scrambling to contain the inflationary blow-off of its own monetary creation, and to rein in the greatest fiscal expansion since Roosevelt’s New Deal. Indeed, it may have been greater as a share of GDP.

The Fed is compounding the shock by draining global dollar liquidity at a net annual pace of $2 trillion, that is to say by switching almost overnight from $120bn a month of QE asset purchases to near mirror-image asset sales (QT).

Ferocious tightening by the world’s superpower central bank has turbo-charged a parallel development: America’s astonishing revival as the top global producer of oil and gas, a valuable thing to be in an energy crisis of broader scope even than the 1970s.

This has pushed the dollar index to levels not far shy of the Reagan dollar in the mid-1980s, when it was sterling’s turn to flirt with parity. (Britain was spared that indignity by the timely intervention of Sultan of Brunei, responding to a plea from Margaret Thatcher).

Yet still some chatter on about the end of dollar hegemony. Dream on, my friends.

What is true is that the euro is not as strong as it might be given that the ECB is finally about to abandon its invidious experiment with negative interest rates, which has been the nail in the coffin for Germany’s once vibrant cooperative and savings banks, the backbone of the Mittelstand family firms. A 50-point rate is expected this summer.

Markets do not fully believe that the ECB is capable of seeing through its plan for a series of staccato rate rises, or that it has the stomach to end bond purchases once and for all, given that QE has long since metamorphosed into a debt shield from insolvent sovereign states.

They doubt whether the ECB can devise a credible and legal ‘anti-fragmentation’ tool to prevent Italian and Club Med risk spreads from spiralling out of control once there is no longer a buyer-of-last resort for their ever-higher debts.

These doubts have crept into the currency, but bear in mind that the Japanese yen is even weaker. So is the Swedish krona.

The euro may indeed become unhinged over the next few months (that is not a prediction) as the energy crisis collides with the fundamental incoherence of an unfinished monetary union with no fiscal union to back it up.

Nomura expects a “non-linear” move to 0.95 against the US dollar by the end of August. It thinks Europe’s terms-of-trade have suffered such a large shock that European manufacturing industries now need an exchange rate of 0.65 for good health. That is a surreal thought to contemplate.

So yes, the euro may yet crash. It has not done so yet. You can make more or less the same argument for sterling. It is the dollar that is out of alignment.

• Dollar Looks Like a Winner as Markets Brace for Even Faster US Inflation

(…) Here are a selection of views from strategists and analysts:

BlackRock Investment Institute Asia Pacific investment strategist Ben Powell

• Markets are going through a paradigm shift from a fairly loose policy era with low inflation and low rates, to an inherently more volatile world shaped by supply, he said on Bloomberg Television
• It’s going to be a more challenging macro backdrop
• “We think investors of all types now have to be a bit more nimble, and I guess a bit more focused around selectivity, rather than just a broad buy-any-dip-that-we-see mentality. Fundamentally, central banks are not there for us in the way that they have been over much of the last several decades”
• The Fed will continue to stress its hawkishness to preserve credibility
• Dollar strength and equity weakness may persist for some time

AllianceBernstein Holding LP co-head of Asia Pacific fixed income Brad Gibson

• The market needs more than one CPI print to show it’s peaking out and rolling over, he said on Bloomberg Television. “We do expect that to occur in the later stage of this year”
  (…)

• There’s more room for the yield curve to invert further. With the rate differentials, real yields, there is probably room for the dollar to continue to appreciate (…)

Goldman Sachs: “We think EUR/USD could fall near 0.95 if European growth expectations move to our “severe downside” scenario.”

Google slows hiring citing ‘uncertain’ outlook as recession threat rises

And From Almost Daily Grant’s:

Right-sizing season is in full swing for the technology sector.  A Crunchbase News analysis last week found that upwards of 75 domestic firms conducted layoffs in June, following 35 such announcements in May. This made for the most active month in a year that has seen 143 tech companies lay off more than 24,000 staffers.

Certain subgroups within that industry have been hit particularly hard. Some 3,700 employees in the financial technology “space” received their walking papers during the second quarter per Layoffs.fyi, a tally that excludes crypto-focused firms. That compares to 8,700 such job cuts across the plague year of 2020, while last year’s financial bumper crop saw not a single layoff within fintech.

Rapid turns in fortune characterize the current state of play. Bloomberg relays this afternoon that grocery delivery outfit GoPuff will lay off some 1,500 staffers, equivalent to 10% of total headcount, following March job cuts that affected 3% of employees. All this comes a year after the nine-year-old startup raised capital from the likes of Guggenheim Investments, Hedosophia and SoftBank’s Vision Fund at a $15 billion valuation, equivalent to a 69% increase from its prior fundraising round in March 2021. GoPuff, which grew revenues to $2 billion last year from less than $1.2 billion in 2020, also detailed plans to close 76 warehouses, equivalent to 12% of its system.

Silicon Valley heavyweights are not immune. The Information reported Friday that Oracle is weighing a $1 billion cost-cutting regime that “could result in thousands of layoffs as soon as August.” Positions on the chopping block are concentrated in Europe and stateside, the tech publication added. Corporate headcount stood at roughly 143,000 as of May 31, with upwards of 20,000 set to join the payroll once Oracle’s acquisition of healthcare I.T. firm Cerner closes later this year. 

Citing internal communications, The Information reports that Meta Platforms’ head of engineering recently told managers to flag professional weak links so they could be ushered out the door. “Identify people who need support early, partner with our Employee Relations team to get them on track, and move to exit people who are unable to get on track,” Maher Saba instructed.  His memo follows CEO Mark Zuckerberg’s June proclamation that “realistically, there are a bunch of people at the company who shouldn’t be here.”

The Fed seeks to keep inflation expectations low. It also needs to keep employment expectations low enough to contain wage growth:

• Union Organizing Efforts Jump in First Half of Year Pandemic-related health and safety concerns, coupled with a tight labor market, have led more workers to organize.

In the first half of the year, workers at 1,411 U.S. workplaces filed petitions with the National Labor Relations Board, the first step in joining a union, according to a Wall Street Journal analysis of federal data. That represents a 69% increase from the same period in 2021 and the most of any year since 2015. (…)

A Gallup poll last year found that 68% of Americans approve of unions, the highest share since 1965. (…)

About 10.3% of American workers were union members last year, down from 29.3% in 1964, according to researchers from Georgia State University, Trinity University and the Urban Institute.

Of the 1,411 workplaces filing petitions so far this year, about 400, representing more than 21,000 workers, have already voted in favor of a union and around 150, representing almost 7,800 people, have voted against–a small slice of the 164 million in the U.S. labor force. The remaining petitions have either been withdrawn or are awaiting a vote. (…)

Private sector workers who are union members made almost 14% more last year than those who aren’t members, according to the Labor Department. Unionized bar, restaurant and coffee shop workers made about 17% more than their nonunion counterparts. (…)

DEMAND DESTRUCTION UNDERWAY

• Global Oil-Supply Crisis Shows Signs of Easing The worst oil-supply crisis in decades is showing tentative signs of easing as flagging economic growth weighs on demand for crude while sanctions on Russia are having less impact on oil production than expected, the International Energy Agency said.

The Paris-based agency cut its forecasts for oil demand for this year and next. (…) Meanwhile, U.S. and Canadian producers were leading an increase in global output, while sanctions on Russia’s oil industry were having less of an effect on its production levels than initially expected. (…)

The agency cut its demand forecast for the year by 240,000 barrels a day to 99.2 million barrels a day. Demand in 2023 will also be 280,000 barrels a day less than earlier forecasts at 101.3 million barrels a day, it said. (…)

The agency raised its supply forecast for the year by 300,000 barrels a day to 100.1 million barrels a day. The IEA raised its forecast for Russian crude output this year by 240,000 barrels a day to 10.6 million barrels a day.

In June, global oil supply jumped by 690,000 barrels a day to 99.5 million barrels a day, largely due to better-than-expected Russian output.

Sanctions have weighed heavily on Russian oil exports but higher prices for oil meant Moscow was still earning significantly more than before the war, the IEA data showed. Russia’s oil exports fell to their lowest level since August 2021 in June, but its oil export revenues rose by $700 million to $20.4 billion, 40% more than the 2021 average. (…)

Global oil demand growth would slow to 2.7 million barrels a day from 3.4 million barrels a day in 2022, OPEC said.

• Biden to Visit a Saudi Arabia That Is Closer to Russia Than Ever As President Biden prepares to visit Saudi Arabia, the oil-rich kingdom is closer than ever to Russia and has no plans to help Washington by pumping more crude, Saudi officials said.

Knapp-Track reports that casual dining SSS rose 0.7% in June (inflation was +7.4%) with traffic down 5.9%, decelerating throughout the month with the last week of June seeing traffic down 1.1%. Wealthier Americans reduced their visits to high-end steakhouses by 3.7% with the last week of the month also weak (-1.9%)

THIS ACCIDENT NO LONGER HAPPENING IN SLOW MO:

Chinese Homebuyers Across 22 Cities Refuse to Pay Mortgages Across China, homebuyers are refusing to pay mortgages as property developers drag on construction projects, escalating the country’s real estate crisis and risks of bad debt for banks.

(…) The payment refusals underscore how the storm engulfing China’s property sector is now affecting the country’s middle class, posing a threat to social stability. Chinese banks already grappling with challenges from liquidity stress among developers now also have to brace for homebuyer defaults. (…)

A drop in home values hasn’t helped. Average selling prices of properties in nearby projects in 2022 were on average 15% lower than purchase costs in the past three years, according to Citigroup’s research.

The contagion is spreading to banks. Non-performing loans triggered by the wave of mortgage payment snubs could reach as much as 561 billion yuan ($83 billion), about 1.4% of the outstanding mortgage balance, according to Chan. (…)

The latest development comes at a time when renewed risks of Covid restrictions also pose a threat to the industry. A key real estate index fell for a third day Wednesday, heading for the lowest level since March.

A Bloomberg index of China’s high-yield dollar bonds fell to the lowest in a decade as of Tuesday. Domestic bonds of large property developers, including Gemdale Corp. and Country Garden Holdings Co., also slumped to record lows.

China’s exports pick up speed, but global risks darken trade outlook

China’s exports rose at their fastest pace in five months in June as factories revved up after the lifting of COVID lockowns, but a slowdown in imports, fresh virus flare-ups and a darkening global backdrop pointed to a bumpy road ahead for the economy. (…)

Outbound shipments in June rose 17.9% from a year earlier, the fastest growth since January, official customs data showed on Wednesday, compared with a 16.9% gain seen in May and much more than analysts’ expectations for a 12.0% rise. (…)

June imports inched up just 1.0% from a year earlier, slowing from May’s 4.1% gain, weighed down by the lockdown-induced slackening in commodity imports and subdued domestic consumption. Analysts had forecast a 3.9% rise.

Evans-Pritchard noted that import volumes dived to a three-year low last month, indicating continued weakness in China’s construction sector, usually a significant growth driver.

Almost all of China’s commodity imports were notably weaker. Daily crude oil imports in June fell 11% from a year earlier to their lowest since July 2018, while coal imports fell 33%.

Soybean imports also fell 23% from a year earlier as high global prices curbed demand for the oilseed. (…)

As of Monday, 31 cities – making up 17.5% of China’s population and 25.5% of GDP – have implemented full or partial lockdowns or some control measures at district level, Nomura analysts said in a note.

Sohn 2022 | An Investment Idea from David Einhorn

Click on headline to listen to Einhorn’s inflation prospects. Not peaking just yet!