Turkey: Central Bank Decision Calms Investor Nerves, But a Sustained Policy Reorientation Needed

The Turkish central bank backed up words with action in last week’s monetary policy decision – raising the key repo rate 475bps to 15% from 10.25%. In addition, the central bank indicated that commercial banks will have access to financing exclusively via the one-week repo auction window, with the repo rate henceforth the “only” indicator of monetary policy.

This ends for now a phase of “backdoor”, unorthodox rate increases via alternative tools that the central bank had employed to avoid any unwanted attention from President Recep Tayyip Erdoğan – who prefers low interest rates – and which had failed to assuage market concerns of too-easy central bank policy.

The central bank’s rate increase, both in its scale and in the consolidation of various policy instruments, was intended to address investors’ immediate concerns, ease pressures on the lira and stem a full-blown currency crisis. This has eased some concerns that central bank policy would remain behind the curve under new governance.

Shift near term to a more market-friendly, conventional monetary policy

The sizeable 30% depreciation in lira this year before ex-Central Bank Governor Murat Uysal’s dismissal appears to have been the final straw that forced this month’s reset of economic governance and the shift, at least near-term, towards a more market-friendly, more conventional monetary policy framework under Governor Naci Ağbal.

With this rate hike, Ağbal demonstrated that he holds enough influence and sway with the Turkish president to convince him to tolerate higher rates near term to fight inflation. Turkey’s real policy rates were negative before Thursday’s policy change with an annual rate of inflation of 11.9% in October. Real policy rates have since flipped to +2.8%

Complacency quickly returned after rate hike initially calmed investors’ nerves in 2018

That said, we have been here before. In 2018, the central bank raised rates by 625bps and similarly consolidated multiple policy instruments to reverse a sharp lira sell-off, only for complacency to speedily re-emerge by the following year as the lira stabilised and inflation receded.

The Turkish government’s underlying bias in favour of looser monetary policy has not dissipated overnight. Nor has Turkey’s executive presidency, in place since 2018 and which overtly subverts central bank independence, changed.

Possibility of greater near-term lira stability, but longer-term governance risks remain

While any sustained return to conventional monetary policies amid this year’s crisis could support greater lira stability in the short run and possibly help begin a process of rebuilding depleted foreign-exchange reserves, longer-term risks remain that significant institutional and governance deficits of the past re-emerge once the immediate crisis is in the rear-view mirror.

An important upcoming task is using this forthcoming window to rebuild Turkey’s official reserves, which stood at USD 82.4bn on 15 November, compared with USD 105.7 at year-end 2019 and USD 134.6bn at a 2013 peak. Official reserves cover around 61% of short-term external debt. Net reserves excluding short-run swaps with domestic banks stood at all-time lows of negative USD 47.5bn in September, cut sharply from (positive) USD 18.5bn at end-2019.

The government needs to tackle external-sector weaknesses

The risk that a longer-standing structural depletion of Turkey’s foreign-currency reserves poses to the economy’s external sector stability remains real and calls upon the near-term shift in policy frameworks to not only be maintained but strengthened. This will require tighter, more sustainable monetary, fiscal and structural economic policies over a longer period both in crisis and outside of crisis – something that has been lacking in the past – which prioritise lower but more sustainable economic growth.

In addition, Turkey needs to strengthen its flexible exchange rate regime – a traditional credit strength – and reduce severe external sector vulnerabilities, such as structural current account deficits, economic vulnerabilities to capital outflows and high FX exposures.

Scope downgraded Turkey’s foreign-currency long-term issuer and senior unsecured debt ratings to B from B+ on 6 November, while affirming Turkey’s long-term issuer and senior unsecured debt ratings in local currency at B+. Scope revised the Outlooks on Turkey’s long-term ratings in both foreign and local currency to Negative from Stable. Scope will next review Turkey’s sovereign ratings and Outlooks in H1-2021.

For a look at all of today’s economic events, check out our economic calendar.

Dennis Shen is a Director in Sovereign and Public Sector ratings at Scope Ratings GmbH.

Germany, France, Italy, Spain: Sustained Growth Required to Heal Public Finances as EMU-4 Debt Soars

Countering the Covid-19 pandemic has required European governments to loosen fiscal policy and borrow heavily in 2020, raising concerns about how sovereign debt will evolve after the shock.

Scope Ratings’ analysis of fiscal targets under the Economic and Monetary Union (EMU)-4’s 2021 budgetary plans leads to two main conclusions.

First, the proposed budgets mirror the EU’s shifting paradigm towards counting on growth rather than austerity for achieving fiscal consolidation.

Secondly, official forecasts assume an effective and long-lasting fiscal impulse from stimulus packages despite challenges such as ageing populations and environment-related adjustment costs. However, we believe less buoyant growth even with expansionary fiscal policies will prevent the EMU-4’s governments from bringing down public debt ratios to pre-crisis levels over the foreseeable future.

Government debt to rise to record highs

Government debt is set to rise to record highs this year in the EMU-4 due to the Covid-19 crisis. Scope expects public debt to increase by between 9pp and 23pp in the four economies, adding up to a weighted aggregate 107% in 2020 from 90% of GDP at end-2019.

Budget deficits in the EMU-4 have widened by similar degrees amid fallout from the 2020 pandemic, but why they have increased differs markedly. The dominant role here of discretionary fiscal support in Germany contrasts with the impact of automatic stabilisers, such as lower tax revenues and increased spending on short-time work schemes, in France, Italy and Spain, induced by more severe recessions in the latter economies.

The substantial increase in public debt ratios in France, Italy and Spain, by more than 20 percentage points this year, reflects the double impact of a severe growth contraction and an automatic decline in the primary balance, being a lot more significant than the debt-creating effects of discretionary fiscal measures.

Governments to rely on growth, rather than austerity, to achieve future fiscal consolidation

The stabilisation and then reduction of debt ratios of the four governments under IMF forecasts hinge upon governments making swift budgetary adjustments despite less generous IMF estimates for future growth compared with national government forecasts. Governments themselves are counting on growth, rather than fast budget adjustments, for achieving fiscal consolidation, relying on optimistic scenarios for their economies’ longer-term growth potential, driven by assumed permanent growth impacts of fiscal stimulus.

The focus on fiscal stimulus is a landmark moment in euro area economic policymaking with a shift from the previous paradigm of fiscal restraint towards a more durable dependence on pro-growth policies. Seizing the opportunity to raise growth potential has to be weighed against risks that growth forecasts prove too optimistic, however.

Optimistic official forecasts in 2021 budgetary plans

The four governments expect a significant growth boost over the next years. Italian officials project an average growth rate of 2.7% in 2022-24 compared to 0.9% in three years before the crisis and the Spanish government has raised its growth forecast to above 4% by 2023 compared with 2% growth in 2019. Scope’s forecasts remain more conservative, with expected growth converging more rapidly to pre-crisis potential rates.

Spanish officials expect a doubling and Italian authorities even a tripling of growth over the next three years compared with pre-crisis growth rates. Uncertainties about fiscal multipliers, project implementation risks and structural challenges such as declining productivity growth and ageing societies present risks to official forecasts.

The EU’s massive stimulus package of EUR 750bn over 2021-26 will spur investment. At the same time, the fruits of infrastructure investments or higher spending on education will only be felt over the more distant future.

EU funds will support a faster green transition but achieving important long-term social objectives such as a more educated and skilled workforce will require a lot of staying power in terms of reform progress if it is to sustainably elevate growth.

Download the full report.

For a look at all of today’s economic events, check out our economic calendar.

Giulia Branz is Associate Analyst in Sovereign and Public Sector ratings at Scope Ratings GmbH.

Governments, Creditors Need DSSI+ Debt Relief Framework to Tackle Africa’s Solvency Crisis

We believe the Debt Service Suspension Initiative (DSSI) provides extra fiscal space in the near term to 29 participating African governments, but the programme can also accentuate medium-term debt distress by increasing future interest payments for some of the world’s most vulnerable sovereigns. African governments account for 38 of 73 countries eligible for the DSSI. Fine tuning the DSSI as well as the more recent Common Framework beyond the DSSI is essential to heading off future debt crises.

Download Scope Ratings’ full report on the need for a revamped debt relief framework for African countries.

Need for a DSSI+ architecture that differentiates between liquidity and solvency crises

A formal mechanism has been necessary to determine whether African countries face just a liquidity crisis or an underlying solvency issue given half of all sub-Saharan African sovereigns were at risk of or in debt distress at the start of 2020.

A framework that we call “DSSI+” is essential for enhancing the transparency and consistency of China’s participation under the programme, ensuring creditors are treated equally including mandating the participation of private-sector creditors, and, importantly, bringing to the fore debt forgiveness as an option to address solvency crises.

China’s involvement in DSSI has been crucial for the programme’s efficacy

China is the largest player in African infrastructure finance. Between 2000 and 2018, China lent USD 148bn to 50 African countries, contributing to a near doubling of the region’s external debt from 19% in 2008 to about 34% of GDP in 2018.

With almost a third of Africa’s sovereign external debt service over 2020-24 due to be paid to China, the country’s involvement in the G20’s DSSI has been crucial. With the extension of DSSI beyond 2020, Angola and Djibouti could see total debt-service savings on loans from China of above 4.5% of 2019 GDP over 2020-21. Potential savings under any case of their DSSI participation are estimated as well at over 1.5% of GDP for countries such as Mozambique, the Republic of the Congo, Kenya, Guinea and Zambia.

Debt-service suspension can address short-run liquidity shortages but could accentuate medium-term debt distress

Debt-service suspension is the right remedy for certain countries such as Burkina Faso, Central African Republic, and the Democratic Republic of the Congo with low debt and limited debt sustainability concerns. Suspension of debt service addresses a short-run liquidity shortfall and provides the required fiscal space. However, for countries such as Angola, Burundi or Ghana, a participation under existing DSSI terms could compound medium-run debt distress.

Angola, Djibouti and Mozambique could each see increases in their debt servicing requirements over 2022-24 of over 1% of GDP on average per year due to participation in debt-service suspension on existing programme terms, due to the shifting of payments to later years on NPV-neutral bases.

G20’s Common Framework beyond the DSSI does not go far enough to address solvency crises

In October, Paris Club creditors agreed on a “Common Framework for Debt Treatments beyond the DSSI”, approved at a 13 November extraordinary meeting of G20 Finance Ministers and Central Bank Governors.

While the Framework represents a positive step, the emphasis on reductions in short-run debt service and NPV reductions of debt risks not going far enough. According to the Framework, debt treatments will generally not be conducted in the form of debt write-off or cancellation except in the most difficult cases.

While the G20 Framework is a positive extension of DSSI’s core tenets with a progression from a principle of NPV neutrality in the direction of NPV haircuts in certain cases of solvency risk, the stated preference against outright principal haircuts even in more severe cases may not go far enough for vulnerable borrowers. In addition, the lack of a specified mechanism to compel equitable participation across creditor groups including from the private sector remains a weakness.

An evolution to a DSSI+ architecture could support stronger credit profiles for African issuers after a restructuring

The evolution of DSSI to a proposed DSSI+ architecture of orderly debt treatments could embed enhanced collective-action clauses in bonds, mandate rather than seek the involvement of private-sector creditors, ensure consistency in the adoption of debt measures across participating creditors, and provide the option of ambitious debt restructuring – including outright principal write-down were this needed. Such a proposed DSSI+ architecture could support stronger credit profiles for African issuers after any more comprehensive debt restructuring.

An evolution to a DSSI+ framework for sovereign debt restructuring could be similarly managed with debt sustainability analyses determining if a solvency issue exists. A hypothetical 25% principal write-down for only distressed African borrowers could alone bring targeted savings of nearly USD 29bn with the largest savings coming on bilateral loans from China (USD 11bn).

In this respect, clearly not all DSSI-eligible countries, however, would or should qualify for debt forgiveness under a suggested DSSI+ framework. In addition, the form and extent of any principal write-downs for a sovereign government with underlying solvency risks under such a mechanism need to be tailored to the specific debt sustainability situation of the borrower.

For a look at all of today’s economic events, check out our economic calendar.

Dennis Shen is a Director in Sovereign and Public Sector ratings at Scope Ratings GmbH. Thibault Vasse, Sovereign Ratings Analyst of Scope, co-authored this article.

Markets Remain Unsettled

Emerging market currencies and the majors that benefit from world growth outperformed the perceived safe-havens, like the yen and the Swiss franc. The euro rose above $1.19 briefly before selling off to trade below $1.18. Gold collapsed.

Yesterday’s violent moves may have been an overreaction, but today’s action is more consolidative than a reversal. Most Asia Pacific markets rallied, led by 3-4% gains in Singapore, Malaysia, and Thailand. China and Taiwan were exceptions with their losses. Europe’s Dow Jones Stoxx 600 is firm as it consolidating yesterday’s is nearly 4% gain. US shares are mixed with the tech-heavy NASDAQ looking at additional steep losses, while the S&P 500 is trading about 0.5% lower.

Australia and New Zealand saw big jumps (13-15 bp) in their 10-year yields as they catch-up to yesterday’s move in the US and Europe. Europe’s benchmark yields are firm, and the US is firm with the 10-year Treasury yield changed around 0.94%, having reached an eight-month high near 0.97% yesterday. The dollar is trading firmly against most of the major currencies, with sterling a notable exception.

It extended yesterday’s gains and traded around $1.3260, its best level since September 7. The JP Morgan’s Emerging Market Currency Index is snapping a five-day advance. The Turkish lira and South African rand are paring yesterday’s gains. Gold has steadied after yesterday’s 4.5% shellacking, its biggest loss in three months. The attempt to resurface $1900 was rebuffed. Oil prices are holding on to yesterday’s gains. The December WTI is around $40.65 a barrel in the European morning after reaching almost $41.35 yesterday. Recall that early last week, it hit a low near $33.65

Asia Pacific

While Pfizer‘s vaccine and Eli Lilly’s antibody therapy appear promising, Brazil’s testing of China’s Sinovac’s Coronavac was halted due to an “adverse event.” What needs to be kept in balance is that there are still many steps before a vaccine is available, and the most pressing health issue is the surge in the infection. Vigilance is still needed.

Falling pork prices saw Chinese CPI fall below 1% for the first time in three years in October. The 0.5% year-over-year CPI was lower than expected and follows a 1.7% gain in September. Pork prices fell by 7% in October. The 2.8% decline year-over-year is the first since February 2019. Food prices as a whole rose 2.2% year-over-year after 7.9% in September. Non-food prices were flat, and core prices were unchanged at 0.5% from a year ago. Producer prices remained 2.1% lower than a year ago, the same as in September. Economists had expected a little improvement. Chinese officials do not seem ready to respond, and deflationary pressures on consumer prices will likely continue.

Japan reported a smaller than expected September current account surplus of JPY1.66 trillion down from JPY2.11 trillion. On the other hand, Japan’s trade surplus grew, practically doubling month-over-month to JPY918 bln from JPY413 bln. In the past six months, Japan’s trade surplus has swung from a JPY929 bln deficit to the September surplus of nearly the same magnitude reported today. Separately, as has been well telegraphed, Prime Minister Suga ordered the compilation of a third supplemental budget.

The dollar soared against the Japanese yen yesterday, rising from around JPY103.20 to about JPY105.65. It is consolidating in the upper end of that range today (~JPY104.80-JPY105.45). There is an expiring option for $980 mln at JPY105.50 and a smaller option for JPY375 mln at JPY106 that also rolls off today. Initially, it looks like Tokyo sold into the dollar’s surge, but buyers returned, and the dollar was recording session highs in the European morning. The Australian dollar reached nearly two-month highs yesterday near $0.7340 and retreated to almost $0.7265.

It has been unable to distance itself much from those lows today and has held below $0.7300. A break of the $0.7250 area may signal a move toward $0.7200. The PBOC set the dollar’s reference rate at CNY6.5897, near what the bank models expected. The dollar is trading within yesterday’s range (~CNY6.5640-CNY6.6350)

Europe

Germany failed to convince the other EU members to postpone WTO-sanctioned tariffs on US goods in retaliation for improper subsidies for Boeing. The new EU tariffs on $4 bln of US goods will be formally announced today. While it is perfectly within its legal rights to do, the risk is that the US makes good on its threat to boost the levies that it was allowed to impose because of Europe’s improper subsidies for Airbus. Regardless of the election outcome, Trump is still the US President, and the office is still powerful. For example, new sanctions were announced on four more Chinese officials for the dissent crackdown in Hong Kong.

The UK employment report was weak. The unemployment rate jumped to 4.8% from 4.5%. It is the highest for a three-month period in four years. Employment has fallen by 164k in the three-month through September. The government’s extended furlough program was not announced in time to impact this time series. Separately, the House of Lords removed the most controversial clauses in the government’s Internal Market Bill, but it will be reinserted by the House of Commons.

There is some speculation the new US administration is considerably more skeptical of the merits of Brexit that it could impact the UK-EU negotiations, as the Irish foreign minister suggested. However, it seems like a stretch, and the deadline for the trade deal is less than a week away.

The euro briefly traded above $1.19 yesterday before selling off and dipping below $1.18. After struggling to sustain even modest upticks, it has been sold in the European morning to around $1.1780. The halfway point of the rally from the test on $1.16 last week to yesterday’s high is near $1.1760, and the next retracement (61.8%) is closer to $1.1725. There is an option for 1.5 bln euro at $1.18 that expires today and another for about 665 mln euros at $1.17. Sterling is the strongest of the major currencies.

While sterling was firm the Asia Pacific session, it pushed higher in the European morning. The next chart target is near $1.33. Sterling strength appears to be coming from the cross against the euro. The euro broke down yesterday, and the follow-through selling has driven the single currency below its 200-day moving average (~GBP0.8925) for the first time in six months. The next target may be the September low near GBP:0.8865.

America

The US quickly took credit for the Pfizer vaccine, but it got no funds from Operation Warp Speed for the trial, testing, and manufacturing. Pfizer’s partners, BioNTech SF, did receive almost $450 mln from Germany. What the US did was agreed to pay $2 bln for 100 mln vaccines and an option for another 500 mln doses. The US does get to decide who gets the vaccine first. Reports suggest Pfizer will handle the distribution directly and has designed reusable contained to keep the medicine at the cold temperature necessary. Moderna uses an approach similar to Pfizer’s, and the results are expected in the coming weeks.

While the JOLTS report is the economic data highlight, no fewer than five Fed officials will talk through the day today. Governor Brainard, who is seen as a possible candidate for Treasury Secretary, discusses the Community Reinvestment Act and could draw extra attention. Mexico and Canada also have light economic calendars today. Mexico’s slightly higher than expected headline inflation but slightly lower core inflation keeps the market favoring a rate cut late this weeks.

The US dollar was sold to new lows for the year yesterday against the Canadian dollar (~CAD1.2930), but the greenback recovered to close above CAD1.30, which is now support. It is firm today, having reached CAD1.3040 in the European morning. Yesterday’s high was near CAD1.3070. The greenback is was testing CAD1.34 at the end of October, and some near-term consolidation is likely. The US dollar fell to almost MXN20.00 yesterday after finishing last week near MXN20.60. It, too, is consolidating today. It is near the middle of today’s range in late morning dealings in Europe (~MXN20.35)

For a look at all of today’s economic events, check out our economic calendar.

This article was written by Marc Chandler, MarctoMarket.

US Elections: Political Polarisation, Governance, Fiscal Challenges Weigh on Credit Outlook

We rate the United States at a below-consensus AA credit rating. This rating level considers the country’s wealthy, competitive and diversified economy, its transparent and accountable institutional framework, as well as the dollar’s unparalleled global reserve currency status as credit strengths. The latter allows the country to run fiscal and current account deficits with limited concern regarding the sustainability of public debt.

In the near term, the most credit-relevant factor is the health of the country’s transparent and accountable institutional framework. While legal battles over results in tightly contested states are occurring, it would be credit negative if a judicial ruling on the outcome – should it be needed to determine the next US president – is not accepted by the losing party.

Reduced growth potential and rising debt are the biggest medium-term challenges

Over the medium term, the incoming administration’s economic, fiscal and social policies, and ability to implement them alongside a possibly split Congress, are the most relevant to the outlook. The US’ credit rating is constrained by two principal factors. First, the outlook for the economy’s long-run growth is worsening.

Secondly, public debt is high and rising after the current administration’s strongly procyclical fiscal policies before the Covid-19 shock in addition to the sizeable, albeit appropriate, fiscal stimulus this year and the federal government’s significant contingent liabilities from pension and healthcare-related obligations.

The economic impact of the Covid-19 pandemic, which led in the second quarter to the deepest recession in US post-war history, is being mitigated substantially by the Federal Reserve’s low interest rates and policies providing credit support to households and firms, alongside a government fiscal package totalling USD 2trn (9% of GDP) in direct spending and USD 860bn (4% of GDP) in liquidity support.

As a result of these forceful fiscal and monetary policy actions, the US is among G10 countries where economies will see the smallest contractions in 2020. The change in real GDP in 2020 is estimated at -4.3% by the IMF, versus -9.8% for the UK and France and a G10 average of -6.5%.

Troubling social outcomes constrain growth potential

Still, the US’ growth potential has been declining from about 3% in the previous decade to around 1.9% for the next decade. An incoming administration needs to adopt policies to raise growth by addressing troubling social outcomes. These include a persistently high share of the population depending on federal programmes for nutrition, healthcare, education and housing, the erosion of socio-economic mobility, stagnating incomes among many households, and widening income and wealth inequality.

These structural weaknesses are likely to constrain labour-force participation, diminish human capital formation, and suppress aggregate demand as well as future productivity growth, ultimately reducing potential output growth.

In addition, the US’ fiscal fundamentals are deteriorating and will remain structurally weaker over coming years, with the IMF projecting the public debt-to-GDP ratio rising to 131% in 2020 and further to 137% by 2025, almost 30pp above 2019 levels, and about 15pp above those of France and the UK.

The government’s failure to pass extra fiscal stimulus in the run-up to the November elections, due to disagreements between Democrats and Republicans over the design and intended beneficiaries of the package, highlights how political polarisation is impeding effective macroeconomic policy despite the urgency of addressing the pandemic.

In the short term, a Biden presidency would also likely face resistance in legislative negotiations of a potentially split Congress, potentially getting in the way of the timely implementation of a much-needed fiscal support package, thus reducing the stimulus’ overall positive economic impact.

Over the longer term, the declining ability of US politicians to achieve bipartisan political compromise raises doubts on the government’s ability to form and implement a fiscal consolidation strategy once the economy returns to full potential.

Overall, the US outlook depends on its governance framework in the short term as well as the ability to implement effective policies that address structural growth and fiscal challenges over the medium term.

For a look at all of today’s economic events, check out our economic calendar.

Alvise Lennkh is the Deputy Head of Sovereign and Public Sector ratings at Scope Ratings GmbH.

Spain: Covid-19 resurgence heightens risks to optimistic growth and fiscal forecasts in 2021 budget

The Spanish government’s projection of a downward trajectory for debt-to-GDP next year as outlined in the 2021 Draft Budgetary Plan (DBP) assumes a vigorous and sustained economic rebound supported by transfers from the Next Generation EU (NGEU) recovery fund.

We see significant downside risk to the government’s anticipated economic outlook, which also informs its fiscal and debt projections.

The Spanish government expects an economic recovery of 9.8% of GDP in 2021, which includes the positive impact of EU recovery funds, after a contraction of 11.2% this year. The government’s assumption is that the recovery fund will shift the trajectory of real GDP back to 2019 levels by the beginning of 2022. By 2023, the growth path would be the same as it would have been in the absence of the pandemic due to a permanent, positive impact from resulting investment, which is assumed to raise the country’s growth potential to 2% from current estimates of around 1.5%.

Covid-19, low investment, slow deployment of EU funds are risks to the economic outlook

We see three principal risks to the Spanish government’s economic forecasts.

First, the extended second wave of contagion is forcing Spain to reintroduce limits on economic activity, which will likely reverse the recovery in Q4, after the very robust growth in Q3 (16.7% QoQ). The fall in Q4 output and probably only a gradual recovery in early 2021 will result in lower growth next year.

Secondly, as the crisis persists, Spanish corporates and households will not shift their focus towards investments and expenditure as assumed under a V-shaped recovery, but rather focus on their own survival and savings, undermining private demand in the coming quarters.

Thirdly, EU resources, via grants from the recovery fund, need to be effectively channelled into public investment projects and support growth-friendly structural reforms. Spain has a weak track record of converting EU funds into fiscal stimulus.

To be sure, the Spanish government has strengthened the governance of EU recovery funds through centralisation within the Cabinet Office and by advancing reform plans to streamline administrative processes and public procurement. Still, the administrative capacity to utilise such a large amount of funds efficiently and in a timely fashion may represent a significant challenge for the Spanish public sector. In fact, at 39%, Spain has the second lowest cumulative 2014-20 absorption rate of European Structural and Investment Funds among the EU-27, in line with Italy’s but below that of Portugal (54%).

The budgetary outlook hinges critically on a large tranche of EU funds – about EUR 27bn, or around 2.2% of 2019 GDP – being effectively channelled into growth by next year. The government assumes that these funds, mostly allocated to productive investment expenditure, will raise Spain’s GDP growth by around 2.6pp, given their forecast of a 9.8% growth rate in 2021 compared with 7.2% in a no-policy-change scenario.

Scope forecasts wider fiscal deficits than the government does

For this year, the government expects a fiscal deficit of 11.3% of GDP, with improvement to 7.7% in 2021. This compares with our more conservative forecasts – also based on a less favourable growth outlook – of fiscal deficits at 13% of GDP in 2020 and 8.5% in 2021, broadly in line with the IMF’s forecasts of 14.1% and 7.5%.

Risks to the public debt trajectory but favourable funding conditions

Further risks from less robust economic recovery include the crystallisation of contingent liabilities on the public balance sheet. According to the DBP, the maximum amount of public guarantees on loans that can be taken up amounts to about EUR 160bn, or 13% of 2019 GDP. Under the government scenario, it expects stock-flow adjustments to contribute to increasing debt-to-GDP by 2.5pp in 2021.

Overall, we expect public debt-to-GDP to remain on a slightly increasing trajectory over the medium term, rising from 122% this year to 125% by 2025. This compares with government projections of 118.8% for this year and a short-term reduction to 117.4% in 2021. On the plus side, strong market access and favourable funding conditions continue to support the government’s fiscal response to the pandemic.

The Treasury has so far carried out about 90% of its 2020 funding programme. Via the ECB’s purchases programmes, the Eurosystem now holds over 23% of Spanish government debt, ensuring low funding costs, with the yield on 10-year government securities at around 0.1%.

Also, in view of favourable borrowing conditions, the government has so far requested only the grant portion of the NGEU package, in addition to the EUR 21.3bn loan requested under the unemployment scheme, SURE, of which EUR 6bn has been transferred, reducing the government’s borrowing needs.

We expect the government to pass a 2021 Budget under the emergency situation

Finally, due to recurring failures in securing parliamentary backing for government budgets, Spain is still operating under the 2018 budget. However, we expect the government this time around to pass its budget, even if the ruling minority coalition between the PSOE and Unidas Podemos will depend on external parties’ support to do so.

The emergency situation has triggered a State of Alarm, which temporarily strengthens government powers and increases the political price of being perceived as placing party interests above those of the state.

The failed attempt from far-right party Vox to pass a no-confidence motion in the government shows how the majority of opposition parties is likely not to risk jeopardising the country’s prospects of receiving EU recovery funds, which depend on passing the budget. Failure to pass the budget would be credit negative as highlighted in Scope’s rating action on Spain in August, when the Outlook on the A- sovereign rating was revised to Negative.

For a look at all of today’s economic events, check out our economic calendar.

Alvise Lennkh is the Deputy Head of Sovereign and Public Sector ratings at Scope Ratings GmbH.

Italy’s Debt Sustainability Remains a Challenge, Despite Low Interest Costs and Pro-Growth Agenda

Scope Ratings believes Prime Minister Giuseppe Conte’s coalition government has an opportunity to raise Italy’s rate of recovery exiting this Covid-19 crisis with its pro-growth agenda. However, given the Italian economy’s historically low-growth potential with modest inflation expectations (of 0.8% 12-months ahead according to the latest Banca d’Italia survey), public debt is unlikely to be curtailed significantly post-crisis – even recognising the boon from near-record-low borrowing rates as well as support from the EU’s EUR 750bn recovery fund.

The government’s latest budgetary plan contained in the Documento di Economia e Finanza (NADEF) envisages discretionary measures in 2021 amounting to a fiscal expansion of 1.4% of GDP, including measures for southern regions, business support and funding for ministries. This proposed fiscal stimulus will support growth, but longer-term plans premised on a compilation of reforms to ensure elevated growth medium term, to return the public debt ratio to pre-crisis levels by 2031, face challenges, including in policy implementation.

Government projections for public debt trajectory seem optimistic

We consider Italian Ministry of Finance projections for a reduction in Italy’s public debt ratio of more than 23pps over the next decade as optimistic. The forecasts assume significant primary surpluses equivalent to 2.5% of GDP by 2026, representing a very significant consolidation from the primary deficit of 7.2% of GDP we estimate in 2020. In addition, the government does assume a significant hike in trend growth, averaging 1.6% by 2024-26. This compares with our estimate of the economy’s medium-term growth potential of 0.7%, and pre-crisis output growth that averaged just 0.2% over 2010-19.

In view of the current fiscal stimulus to tackle the economic and public health consequences of the pandemic, alongside still accommodative financial conditions supported by the extraordinary interventions of the ECB, we do not consider the government being able to achieve pre-crisis levels of primary surpluses of near 1.5% of GDP over forthcoming years of recovery as a given. On that basis, achievement of a higher primary surplus of 2.5% of GDP seems optimistic.

Yields nonetheless hit record lows, also fostering risk of budgetary moral hazard longer term

Nevertheless, the yield on the 10-year Italian BTP touched an all-time low of just above 0.6% last week compared with 2.4% at crisis peaks of March, underpinned by a declining disparity in borrowing costs between European nations. Ten-year BTPs have been trading around a spread of only 130bps above German Bunds. Earlier this month, Italy issued a three-year BTP with a zero coupon – the first such issuance on record – which was priced with a negative yield. Over recent months, unlike during past crises, as debt and deficits have risen, yields have declined. There is a risk of moral hazard, nonetheless, linked to this in governments’ spending behaviours longer term even if, short term, counter-cyclical spending amid the crisis is appropriate.

Italy has exercised, however, greater fiscal restraint during this crisis than many other economies of the region such as Germany or the United Kingdom, and authorities are targeting an ambitious longer-term consolidation.

Italy’s debt ratio seen to be on a structurally rising long-term trajectory

Nevertheless, instead of a sustained declining trajectory of public debt beginning in 2021 as assumed under the government or the latest IMF projections, we expect a comparatively flat trajectory of public debt in the years immediately after this crisis, currently projected around a 160% of GDP level, with this ratio potentially displaying a short-run moderate decline during initial 2021 recovery phases. Similar to our opinion before this crisis, we consider Italy’s debt ratio long term to be on a structurally rising trajectory, displaying modest changes during years of positive economic growth but seeing large increases during years of recession such as in 2020.

This pattern had seen Italy’s public debt ratio steadily increase entering this crisis, across multiple business cycles, from 104% of GDP as of end-2001, reaching 135% by end-2019, and around 160% in 2020 under Scope baseline expectations. As we move ahead in this decade, there remains the likelihood of additional adverse shocks that could impact the debt trajectory abruptly. This questions long-run debt sustainability.

Scope’s baseline is for a Q4 economic contraction amid fresh economic restrictions

Scope’s baseline scenario, which assumes a fresh round of economic restrictions in Q4 amid a significant second wave of coronavirus and a return to negative Q/Q growth in Q4 but with a second recovery phase beginning by the spring of 2021, foresees the Italian economy will contract by around 9% in 2020 before rebounding with growth of 6.1% in 2021. The fiscal deficit widens to 10.9% of GDP in 2020 from 1.6% in 2019, before easing to a nonetheless elevated 6.9% of GDP next year.

Alternatively, under a stressed scenario of a return to full national lockdown of the same scale of that of spring 2020 alongside an uneven 2021 recovery due to virus relapses, Scope estimates growth of -13.7% in 2020 before +4.3% in 2021. This stressed scenario could see not only higher explicit public debt but greater risk of crystallisation of contingent liabilities that impact the government balance sheet.

Unprecedented EU institutional support continues to support low-cost refinancing, although poor record of EU fund absorption a risk for sustained recovery

Nevertheless, Italy and other euro area economies are set to receive unprecedented support from EU institutions, including the recovery fund’s EUR 77bn in grants and EUR 128bn in loans to Italy over 2021-26. Italy’s poor record of absorption of EU investment funds poses the risk, however, that Italy’s fiscal response tied to EU funds may not be effective in supporting recovery longer term.

Favourable funding conditions due to ECB interventions have also been critical considering Italy’s elevated gross financing needs (GFNs). In 2020, Scope projects GFNs of about 33% of GDP, well above an IMF threshold of 20%, above which a mature economy is considered by the IMF as being under “high scrutiny”, with GFNs remaining well above a 20% of GDP level through 2025.

We estimate the share of Italy’s government debt held by the Eurosystem to rise to about 25% by end-year, and about 30% in 2021. As such, the nominal stock of public debt held by the private sector will indeed decrease by 2021 compared with 2019 levels even despite the significant debt accumulated in this crisis. This is credit positive near term.

Scope revised the Outlook on Italy’s BBB+ sovereign ratings from Stable to Negative in May.

For a look at all of today’s economic events, check out our economic calendar.

Dennis Shen is a Director in Sovereign and Public Sector ratings at Scope Ratings GmbH.

 

Central & Eastern Europe Sovereign Update: Full Economic Recovery to be Gradual and Uneven

Download Scope Ratings’ Central and Eastern European macroeconomic update.

Lingering uncertainties over the duration of the Covid-19 pandemic are the main downside risks to the CEE region’s growth prospects in Q4 2020 and 2021 which are also tied to the uneven and slowing economic rebound in western Europe – assuming that governments impose restrictions to contain the renewed wave of Covid-19 infections that are less economically damaging than they were in March and April.

We acknowledge that daily coronavirus cases and fatalities have reached record levels in many countries of the region, which will inevitably have an adverse impact on economic recovery.

That said, this year’s slump in GDP in Central and Easter Europe may not be as bad as it looked several months ago due to less severe declines in Q2 output and a stronger Q3 rebound that we expected at the time of our previous forecasts in July.

Decisive monetary-policy action by the region’s central banks and fiscal stimulus from governments have spared the region from a possibly markedly larger economic contraction this year.

Keep expectations in check of a rapid and uniform economic recovery in Q4 2020, 2021

However, we would caution against expectations of a rapid and uniform economic comeback in 2020. The regional recovery, after significant interruptions, will remain vulnerable to setbacks in 2021 even if we expect gradual economic normalisation to resume by early next year.

Scope has marginally improved its 2020 forecast for Poland (A+/Stable) to a 3.9% decline in output from 4.2% forecast three months ago, reflecting the economy’s relatively modest exposure to international tourism and global supply chains, both badly disrupted by the pandemic.

Economic prospects in Turkey (B+/Stable) remain finely balanced, given the tense geopolitical situation in the eastern Mediterranean and the Caucasus and ebbing foreign investor confidence in Ankara’s domestic economic policy, reflected in declining foreign-exchange reserves and a weakening currency. Scope forecasts Turkey’s output to fall 1.4% this year, revised from -4.2% in July forecasts.

We have also moderated our forecast for the scale of the 2020 recession in Russia (BBB/Stable) as well to -5.5% from a previous expectation of -6.8%. Russia’s sizeable fiscal and FX reserves enable an extensive policy response in support of its economy, but uncertainty over oil prices, upcoming fiscal consolidation and sluggish private-sector demand may impede recovery.

Recessions this year could also be milder than previously expected in the Czech Republic (AA/Stable) at -7% compared with -7.5% in July, Romania (BBB-/Negative) -5.5% vs -6.3%, Slovenia (A/Stable) -7% vs -7.6% and Bulgaria (BBB+/Stable) -5% vs -7%. Scope’s forecasts for a deep contraction in GDP are unchanged in Hungary (BBB+/Stable) at -6%, Slovakia (A+/Negative) at -8.1%, and Croatia (BBB-/Stable) at -8.9%.

The economic outlook is less gloomy in the Baltics this year. We forecast a fall in GDP in Lithuania (A-/Positive) of -1.5%, revised from a previous forecast of -7.6%, after surprisingly resilient economic activity in the second quarter; Estonia (AA-/Stable) revised to -5.5% from -7.7%; Latvia (A-/Stable) to -5.5% from -8%/. Georgia (BB/Negative) faces a steep recession this year equivalent to a 5% drop in GDP.

Monetary policy to remain unchanged, supporting the economy through this crisis

For CEE euro area member states, the ECB’s asset purchase programmes underpin low borrowing rates, bolstered by the euro’s reserve-currency status. We don’t expect monetary tightening by most non-euro-area CEE central banks near term, as they remain focused on providing accommodative financial conditions in support of weakened economies. The Turkish central bank is one exception, with pressures for tighter monetary policy stemming from rising inflationary pressure linked to the Turkish lira’s loss in value this year.

The strength of recovery across CEE depends in part on labour markets. Governments’ short-time work schemes have forestalled sharp rises in unemployment. The possible extension of support programmes assisted by the EU’s SURE loans will prove crucial in containing future rises in jobless rates.

Much is also riding on the efficient deployment of the recently agreed EU budget, including the EUR 750bn recovery fund, which should support recovery in EU member states of the region and facilitate needed medium-term investment.

Scope expects a rebound in growth for most economies in the region next year, ranging from 3.5% in Russia to 7.2% growth in Turkey under its baseline scenario which assumes that pre-crisis output levels are reached in most country cases by early 2022.

For a look at all of today’s economic events, check out our economic calendar.

Levon Kameryan is a Sovereign and Public Sector analyst at Scope Ratings GmbH.

Global Economic Outlook: Gradual, Uneven Recovery Runs into Virus-Containment Challenge in Q4

Scope Ratings presents its updated economic forecasts

 

Download Scope Ratings’ Q4 macroeconomic update.

Scope Ratings’ baseline forecast is for a contraction in the global economy of around 4% in 2020, compared with its July forecast of a 4.5% slump, with growth rebounding by 6% in 2021, compared with a previous forecast of 5.8%. The 2020 forecast represents the sharpest global contraction of the post-war era.

However, under a stressed scenario, Scope expects a deeper global contraction of 6.5% this year and only 4.8% growth in 2021 assuming that, in the months ahead, governments reimpose lockdowns on a similar scale to those in early 2020 under this alternative scenario.

We have expected that the economic recovery would become more uneven and subject to interruption by this stage in 2020 after the sharp recoveries mid-year when governments ended lockdowns in Europe and North America. The re-imposition of restrictions to contain the resurgence in Covid-19 will inevitably have an impact in curtailing economic activity.

While the trajectory of Covid-19 remains uncertain, our baseline scenario remains for a severe contraction in output in 2020 even though, as governments and public health sectors are better prepared than in March and April, we don’t generally expect a return in the coming months to the same scale of drastic restrictions of earlier this year.

However, under any scenario, the return to more normal levels of economic activity will take time and there will be setbacks as we are now experiencing.

Second coronavirus wave has slowed or even temporarily reversed national recoveries

Second waves of Covid-19 have slowed or even temporarily reversed national economic recoveries. The latest measures to contain the pandemic will slow down the recovery particularly in more hard-hit countries such as the US, the UK, Spain and France. After moderate interruptions to economic recoveries in Q4, including outright contractions in Q4 GDP expected in multiple cases, recovery should regain momentum by the spring of 2021.

An important possible exception to significant renewed economic restrictions in Q4 is China, with a sustained recovery since the first quarter as authorities have mostly contained the transmission of Covid-19 over recent months. We forecast growth in China of 1.3% this year – the weakest since 1976 – accelerating to 9% in 2021 (revised upward 2.6pps from July forecasts). The revision to 2021 China growth expectations drives a higher 2021 baseline global growth forecast.

Emergency financial measures to protect households, workers, and businesses – including around EUR 700bn in fiscal stimulus in the euro area – amid the lockdowns and other healthcare-related restrictions have led to rapidly rising government borrowing. Higher debt ratios weaken general government balance sheets. In addition, putting fiscal consolidation on hold as central banks ensure easy financing conditions creates moral hazard. These are credit concerns – though ratings implications will vary country by country.

Forceful policy responses have placed a floor beneath economies, protected jobs market

At the same time, the forceful monetary and fiscal policy responses to this crisis have moderated the degree of deterioration in sovereign creditworthiness near term. Countermeasures have put a floor beneath the economy, maintained low interest rates for many public sector borrowers and transferred significant sovereign debt from private sector balance sheets to central banks, in addition to forestalling sovereign liquidity crises. This explains the only modest downward rating actions we have taken so far in this crisis.

In the euro area, we have revised the Outlook on ratings for Italy (BBB+), Slovakia (A+) and Spain (A-) to Negative. Turkey lost its BB- ratings in July, when it was downgraded to B+.

The modest upward revision to Scope’s 2020 global baseline forecast to -4% mostly reflects somewhat more optimistic assessments of activity in the US (+1.5pps to -6%) and the euro area (+0.6pps to -8.5). Spain (-12%), France (-10.1%) and Italy (-9%) will nonetheless experience deep recessions this year, compared with a less drastic slump in Germany (-5.6%). Euro area unemployment has, however, not increased in line with the depth of output losses due to the exceptional policy action undertaken.

Outside the EU, the UK faces among the world’s deepest recessions with a contraction of 10.8% in 2020, including continued anticipation of a quarter-on-quarter contraction in Q4, though the UK could also see one of the sharpest recoveries next year, with growth of 8%. Scope expects milder recessions in Turkey (-1.4%) and Russia (-5.5%) this year than previously forecast.

For a look at all of today’s economic events, check out our economic calendar.

Giacomo Barisone is Managing Director of Sovereign and Public Sector ratings at Scope Ratings GmbH.

Gold, NDX and the US Dollar Index Forecast

Central Banks of the largest economies already announced that further stimulus will be required to keep the economy stable and adhere the positive inflation rates.

US is ready to pump into the economy with the new Heroes Act, a $2.2 trillion stimulus pack. While House Speaker Pelosi and Treasury Secretary Mnuchin continue to negotiate, Covid-19-infected president Trump has asked to sign the Act and provide stimulus to the economy, tweeting on his Twitter: “OUR GREAT USA WANTS & NEEDS STIMULUS. WORK TOGETHER AND GET IT DONE. Thank you!” The urgency of signing the bill is not only flanked by the contagion of the President but the Presidential election which is less than a month away.

Trump is still behind the democrat opponent Joe Biden, and if Biden is elected, the economy might face further difficulties as Biden’s tax plans will most likely to stifle business as the US presidential nominee is planning to increase the business tax.

Biden-proposed business tax changes:

  • Increases the corporate income tax rate from 21 percent to 28 percent.
  • Creates a minimum tax on corporations with book profits of $100 million or higher. The minimum tax is structured as an alternative minimum tax—corporations will pay the greater of their regular corporate income tax or the 15 percent minimum tax while still allowing for net operating loss (NOL) and foreign tax credits.
  • Doubles the tax rate on Global Intangible Low Tax Income (GILTI) earned by foreign subsidiaries of US firms from 10.5 percent to 21 percent.
  • In addition to doubling the tax rate assessed on GILTI, Biden proposes to assess GILTI on a country-by-country basis and eliminate GILTI’s exemption for deemed returns under 10 percent of qualified business asset investment (QBAI).
  • Establishes a Manufacturing Communities Tax Credit to reduce the tax liability of businesses that experience workforce layoffs or a major government institution closure
  • Expands the New Markets Tax Credit and makes it permanent.
  • Offers tax credits to small business for adopting workplace retirement savings plans.
  • Expands several renewable-energy-related tax credits, including tax credits for carbon capture, use, and storage as well as credits for residential energy efficiency, and a restoration of the Energy Investment Tax Credit (ITC) and the Electric Vehicle Tax Credit. The Biden plan would also end tax subsidies for fossil fuels.

Increasing the tax charges might hit hard on returns of the Nasdaq-listed corporations, which in other hands may proceed with labor layoffs and wage cuts to maintain the positive return. Hence, post-election drop in the US Indices is very possible.

US Indices are probably going to show positive signs today amid Trump recovery hopes, though mid-term shows that the indices are about to show deeper correction.

Nasdaq-100 on a daily chart might continue the drop towards 10800 to test the dynamic resistance and a neckline of the Head and Shoulders pattern, and proceed towards 10100 if below the neckline.

Chart by TradingView

Even if the US indices drop, the US Dollar index might continue the uptrend as increased CIT will pump money back to the treasury, though investors will closely monitor the core US data and if the FOMC plan on economic recovery continues to proceed as planned under Biden. Undoubtedly, during the pre-election and election days the market will be highly volatile and the Dollar Index might as well test the resistance at 95 or drop to 92.80 if breaks the 93.60 support.

Chart by TradingView

The closer gets the election, the more pressure is on the commodities market. Gold investors are looking for any signal from the USA to proceed with their next move. Further Covid-19 prevention measures and stimulus bills might nudge the Gold’s surge. Yet XAU / USD is still locked in a downtrend channel and in order to continue the uptrend, Gold should breakout from the downtrend channel with a strong impulse.

Gold price on Overbit

Currently Gold is traded at $1899, Gold quote on Overbit, retraced on October 2 after testing of the MA100 and a resistance of September 22 at $1917 and was able to keep above the mid-line of the Pitchfork – an important support and resistance zone, bringing new hopes of the further surge.

Gold price on Overbit

If XAU / USD remains above the mid-line and is able to break the $1906 resistance, it will proceed towards $1928 to test the dynamic resistance (upper edge of the channel) and the MA200. Closing above $1928 and $1930 might bring another stimulus for investors to pump the price higher to $1950 and $1966.

For a look at all of today’s economic events, check out our economic calendar.

Coronavirus, Job Market and Brexit Stresses Darken the Outlook for the British Economic Recovery

The United Kingdom faces a challenging fourth quarter with crises that stretch from fresh corona lockdowns to an expectation of sharply higher unemployment to prolonged negotiations still to come before a Brexit year-end deadline.

“We anticipated renewed partial lockdown and more intensive restrictions in the United Kingdom to arrive by Q3 and Q4 under our baseline scenario in July’s Q3 2020 Sovereign Update,” says Dennis Shen, primary analyst for the UK at Scope. “Here, we anticipated a deceleration in the UK’s recovery in the 2H 2020 with moderate economic contraction by Q4 GDP relative to Q3 in following the rapid economic gains between April and July.”

“As economies reopen, coronavirus cases rearise, and fresh restrictions follow – even though governments and public health sectors are considerably better prepared during this second wave.”

Scope currently projects for the UK an economic contraction of 10.4% in 2020 before recovery growth of 8.8% in 2021.

“Lockdown lite” thus far in response to a significant second wave

Although mortality ratios are lower during the second wave, UK daily confirmed cases have now reached record rates. Most concerningly, confirmed cases have been spreading to older demographics ahead of the winter.

So far, the UK is trying to contain the breakout with “lockdown lite” actions taken at sectoral and local levels such as limiting the number of people in a social group, as well as stricter local measures in virus hotspots.

Transition out of furlough scheme to abet market-based adjustment but raise unemployment

Rules that restrict economic activity – most critically within the UK services sector – and thus adversely impact demand and labour markets are occurring while the UK is phasing out current furlough wage support policies by end-October to be replaced with a six-month “Job Support Scheme” to subsidise wages for short-time work.

“The premise to this change in policies to abet market-based economic adjustment and arrest the sharp increase in public debt is understandable given many of the jobs may not come back and in view of a public debt ratio we see rising past 110% of GDP in 2020, after 85% in 2019,” says Shen. “However, there will be, in following, a significant increase in unemployment due to this policy transition, with the effects to reverberate across the economy in the fourth quarter and into 2021 as lost subsidised income and resulting curtailed private final demand interact with economic losses from renewed economic and social restriction.”

A year-end no-deal Brexit is unlikely; an agreement of some kind late in the year more probable

The public health and unemployment crises gather as Brexit negotiations enter a critical three-month stretch, including this week’s nominal final round of formal negotiation, before the transition state ends in December.

“We have considered a year-end no-deal Brexit as unlikely, especially amid a global health emergency that’s elevated the need for just-in-time supply chains and given political sensitivities of any Brexit disorder around the end-year Christmas period,” says Shen. “Instead, a last-minute agreement late in the year of some kind that avoids no-deal, announces progress made since March in free trade talks and gives the UK and the EU potentially additional time by extending standstill conditions for most if not all goods trade temporarily into 2021 to allow continued negotiation, give any time needed for Treaty ratification and/or support necessary preparations around customs infrastructure appears more likely.”

“No-deal remains unlikely from multiple vantage points – whether due to the significant economic, financial market, social and political dislocations that’d ensue – including probable loss of life amid the pandemic, the succour no-deal could give nationalists in Scotland surrounding independence, the frictions to trade no-deal facilitates within the UK itself between Great Britain and Northern Ireland or between the county of Kent and the rest of England in travel to Dover, the fact the UK is unprepared currently to replace arrangements with many global trading partners it benefits from preferential trade within the EU customs union, or the damage a no-deal scenario could deal to EU-UK relations longer term for both counterparties in key strategic areas.”

Things on Brexit could get worse before they get better

“The Internal Market Bill detailed earlier this month was likely designed to add pressure in trade negotiations – similar to the tactical use of parliamentary prorogation in 2019 – with the intention that such pressure could force the EU to back down on some negotiation red lines,” adds Shen.

“As such, things on Brexit could easily still get worse before they get better – with uncertainty looming around how much progress will have been made before a self-imposed 15-16 October European Council deadline. However, we maintain the view that even were the UK to agree on terms with the EU ultimately, there’s an ongoing cost of Brexit uncertainties as future relationship negotiations drag on into 2021. Entering 2020, we estimated this Brexit cumulative cost in lost output had already totalled to over 1.5% of UK GDP.”

“With protests against coronavirus restriction, higher short-run unemployment and banks relocating operations to Europe, economic output is foreseen contracting in the fourth quarter and the robust recovery foreseen in 2021 will take some hit,” says Shen. “This holds important credit implications for the United Kingdom’s AA/Negative ratings were economic uncertainty and rising public debt to not be firmly addressed.”

For a look at all of today’s economic events, check out our economic calendar.

Dennis Shen is a Director in Sovereign and Public Sector ratings at Scope Ratings GmbH.

Hungary Faces Tougher Public Finance Challenges in the Era of Covid-19

Scope Ratings says improvements in Hungary’s debt structure and the expected timely return of the economy to pre-Trisis growth mitigate an increased vulnerability of the country’s public finances to future shocks.

“An important absorption measure would be the further extension of public debt maturities,” says Giulia Branz, analyst at Scope. “Doing so could reinforce Hungary’s fiscal resilience by reducing high gross annual financing needs, although a critical issue remains the capacity of domestic investors to absorb higher volumes of government bonds issued by the Hungarian State Treasury – especially at longer durations.”

Scope draws five main conclusions from its latest analysis of Hungary, illustrated by five charts in a new report, available here.

Upward revisions to public deficit and debt, but significant improvements in debt profile

“We have made an upward revision in our deficit forecast to 10% of GDP in 2020 after higher spending in response to the pandemic, expected further extension of fiscal support, and a deep recession,” says Branz.

Nevertheless, a robust recovery in nominal output is foreseen in the years ahead, which should ensure the gradual decrease of debt back toward 75% of GDP by 2024.

A significant improvement in Hungary’s debt profile over the past decade, including a substantially lowered share of foreign-currency denominated debt, has reduced external sector risks and helped to advance Hungary’s domestic capital market liquidity, especially via the issuance of retail bonds.

Constraints from low average debt maturity and domestic sector’s limited debt absorption capacity

At the same time, Hungary still faces a relatively low average public debt maturity – only 4.4 years for HUF-denominated debt – resulting in high yearly gross financing needs relative to other countries’ in Central and Eastern Europe.

“The fact that domestic debt holders have a limited capacity to absorb longer-dated government bond issuance compared to the tolerance of international investors may pose a constraint on the government’s objective of extending debt maturities,” says Branz.

The benefits of fairly benign market conditions

Hungary benefits from fairly stable market conditions over recent months, with current 10-year yields around 70bps above pre-crisis levels. Hungary’s international capital market access was also successfully tested through the placement of a EUR 500m bond denominated in Japanese Yen (Samurai Bond) this month.

“The mix of lower interest rates and the quantitative easing of the Magyar Nemzeti Bank (MNB) have provided robust support for Hungary’s debt management agency, ÁKK, to complete a large share of its funding needs for 2020, including 100% of the planned foreign-currency debt issuance,” she says.

For a look at all of today’s economic events, check out our economic calendar.

Giulia Branz is Associate Analyst in Sovereign and Public Sector ratings at Scope Ratings GmbH.

Gold, Dollar and Rates: A Correlated Story

Mining production? No. China’s consumer demand? No. The main drivers of gold prices are, as I’ve repeated many times, the U.S. dollar and real interest rates. You don’t believe it? You don’t have to – just look at the charts below.

The first one displays the greenback and the dollar-denominated price of gold. Because other series start much later, I used here the Trade Weighted U.S. Dollar Index against major currencies that circulate widely outside the country of issuance. Although the correlation is not perfect, the inverse relationship is quite strong and bull and bear markets in gold coincide with the bear and bull trends in the U.S. dollar.

The second chart presents the U.S. real interest rates and the price of gold (London Gold Fix). As the data series for the yields of inflation-indexed Treasuries (which I treat a proxy for real rates) start only in 2003, I use here nominal bond yields adjusted for the CPI. Again, the negative relationship between displayed variables is far from being perfect (actually it is only -0.31), but it is clear that gold rallied the most when the real interest rates were negative.

Now, let’s zoom in and use more recent data. The chart below shows the price of gold and Trade Weighted U.S. Dollar Index against the broad basket of currencies. As the two lines looks like their mirror images, the inverse relationship between the yellow metal and greenback becomes even clearer now.

Or… does it really? The correlation coefficient is 0.26, so the relationship was positive in the analyzed period! Never trust your eyes, only numbers are real! As one can see in the chart below, the 100-day rolling correlation between gold and the U.S. dollar is quite volatile. Which is not so surprising, when we realize that both the yellow metal and the greenback can serve as safe-haven assets during economic crises. However, the correlation has become more negative recently.

Similarly, the next chart zooms in on the relationship between gold and real interest rates, using more recent data and yields of TIPS. Again, the inverse, mirror relationship between both variables becomes more than clear. It is obvious at first sight, without any quantitative analyses.

But never stop at the first impression! The correlation coefficient is -0.85, so it is indeed very strong negative correlation. And in the past 100 days, it was even stronger (-0.95), as the chart below shows. As one can see, correlation is not fixed but it is constantly changing. And gold has become recently even more sensitive to changes in the real interest rates.

What does it all mean for the gold market? Well, as I have repeated many times, the strong relationships with U.S. dollar and real interest rates stem from the fact that gold is not merely a commodity, but it is a monetary asset. Of course, the international price of gold is quoted in the dollar, so when the value of the greenback increases (decreases) relative to other currencies around the world, the price of gold tends to fall (rise) in the U.S. dollar. However, there is something more to the story. Gold is seen as another currency, or a bet against the greenback and other fiat currencies, so during times of fear, the price of the yellow metal tends to rise as confidence in the Fed (and other central banks), the U.S. government and the current monetary system fails.

The real interest rates are connected, of course, with the exchange rates. The lower the rates, the weaker the currency is. So, low interest rates tend to weaken the greenback, which also supports gold. Moreover, because the yellow metal does not bear any yield, the low rates reduce the opportunity costs of holding gold compared to other assets. And TIPS are used as protection against inflation, just as gold, so they move together.

Question: what about when the rates are low, or even negative? When either inflation is high, or when nominal interest rates are close to zero. Both cases mean that economic situation is grave or even that central banks have lost control, which drives investors toward gold.

Now, the real interest rates are at very low level, so there is a risk of a rebound. However, they were even lower during the 1970s, so the reversal is not certain, especially that the Fed is not even thinking about thinking about hiking the federal funds rate. So, although the U.S. central bank distanced itself somewhat from the idea of yield curve control, the interest rates are likely to remain ultra low for the foreseeable future. Which is great news for gold.

When it comes to the U.S. dollar, we see that it has peaked recently. It can go, of course, further north, but the current environment of the dovish Fed, negative real interest rates, narrowing divergence between monetary policies conducted by the U.S. and other countries, and soaring fiscal deficits and federal debt are important headwinds for the greenback. We know that other central banks and governments are not much better than their American counterparts, but it seems that more and more people are starting to worry about the soundness of the U.S. dollar (although the greenback, together with gold, still behaves like the safe haven during economic crises). So, more investors could be interested in buying gold, the ultimate currency.

Thank you for reading today’s free analysis. We hope you enjoyed it. If so, we would like to invite you to sign up for our free gold newsletter. Once you sign up, you’ll also get 7-day no-obligation trial of all our premium gold services, including our Gold & Silver Trading Alerts. Sign up today!

For a look at all of today’s economic events, check out our economic calendar.

Arkadiusz Sieron, PhD
Sunshine Profits: Analysis. Care. Profits.

Gold Bull Markets: History and Prospects Ahead

 

Demographics Squeeze Advanced Economies’ Long-Term Growth Potential; Big Test for Italy & Japan

Scope Ratings has examined the impact of demographic trends on long-term economic growth in major economies, assuming productivity growth and employment rates remain constant.

“We show that GDP growth rates are likely to decrease in all countries in the coming decades, but large differences exist between advanced economies. Comparing the best and worst performers – the US on the one side and Italy and Japan on the other – over time highlights the magnitude of the problem: by 2050, US GDP could be significantly higher compared to its 2020 level in real terms, while, in the absence of significant productivity and employment gains, Japan and Italy would likely have lower real GDP levels than potential GDP today,” says Giulia Branz, analyst at Scope Ratings.

At the same time, countries can enhance productivity to maintain positive long-term growth and implement policies to address adverse demographic trends and employment trends – two key variables that are captured in the ESG-risk pillar in Scope’s forthcoming update to its sovereign rating methodology.

Demographics explain a large part of structural downward trends in growth

Demographic factors explain a large part of the downward trend in advanced economies’ recent economic growth rates and are likely to remain important over the coming decades according to Scope’s study of the 1960-2050 period, focusing on working-age populations, productivity, and employment rates.

“Our model holds productivity and employment rates constant at 2014-19 levels – which we recognize is a bold assumption as these can change significantly as a result of government policies – but this allows us to estimate a country’s growth prospects based only on its demographic trends that are less likely to fluctuate as significantly,” says Branz.

Significant differences in growth prospects between countries

Growth prospects are structurally declining in all advanced economies, but significant differences exist across selected countries:

  • The US, UK, and France are likely to continue to grow over the long term thanks to relatively favorable demographic trends.
  • Germany and Spain are likely to see GDP stagnate over the coming decades. Adverse demographic trends are likely to offset some of the expected gains in productivity and employment (assuming the latter are sustained over the coming period).
  • Japan and especially Italy would likely experience a marked decline in GDP levels over the next decades based only on adverse demographic trends were such trends not offset with productivity and employment gains that have been distinctly lacking over recent years.

“Our findings have important implications for public debt dynamics and, as a result, sovereign ratings,” says Branz. “Policies that improve countries’ productivity levels, demographic trends, and employment rates are critical to ensuring the long-term sustainability of public debt.”

Download the full report from Scope Ratings.

For a look at all of today’s economic events, check out our economic calendar.

Giulia Branz is Associate Analyst in Sovereign and Public Sector ratings at Scope Ratings GmbH.

A Depression For The 21st Century

The Depression Of The 21st Century will likely end up being the new singular event of discussion and comparison for all financial and economic catastrophes. Questions of how much worse and how long it will last are difficult to answer. Predictions about the type and strength of potential recovery could be premature.

THE GREAT DEPRESSION

After the stock market crash in October 1929, the situation was bleak. Formerly wealthy investors literally lost everything. Unemployment surged, especially with the layoffs on Wall Street.

The onset of the new year, 1930, brought new-found optimism. Banks and brokerage firms began hiring again, confidence increased and stocks recovered a majority portion of their previous losses.

Unfortunately, things didn’t get better. The new-found optimism was lost, stocks collapsed again, and the layoffs continued. Over the next two years, stock prices declined by more than ninety percent.

What if something like that happened today? A similar percentage drop in the Dow Jones Industrial Average would take it from 29,000 to 2900. There is not much allowance for confidence to reassert itself in the face of stocks dropping to a level last seen in November 1991. A nearly 30-year period of higher and higher stock price gains would be wiped out in two short years.

Taking only two years to find a bottom might be the best news. It took the stock market (DJIA) twenty-three more years (twenty-five years in all) to regain its all-time price peak from August 1929. That is in nominal terms. In inflation-adjusted terms, the stock market did not regain and exceed its previous all-time high until May 1959 – thirty years after the crash.

As bad as the stock market numbers sound, other events and circumstances reflect a clearer picture of the financial and economic turmoil which followed the crash.

The ranks of unemployed grew to more than twenty-five percent, then declined to approximately twenty percent and remained at that level until dropping sharply with the concurrent rise in manufacturing and industrial activity associated with the United States involvement in World War II.

Homeless people on the streets, long lines at soup kitchens, beggars, and tent cities were obvious indications of the depressed state of the economy. Week after week, month after month, year after year, the Great Depression lingered on.

The conditions accompanying the bleak economic environment were exacerbated by bank failures. People who thought they had some money safely deposited at their local building and loan institution or commercial bank saw their hopes and dreams dashed. Bank failures became an almost common threat to financial stability.

How much more difficult would it be for us today to deal with similar events and circumstances? Probably much more difficult. We might not be able to cope with it.

As a society today, we are far removed in experience and memory from hard times. We have become accustomed to being taken care of. Part of that coddled feeling is due to the extreme level of government guarantees and our expectations that ‘Big Brother’ will always be there to do something.

Investors and consumers like guarantees; and they want to see evidence that a guarantee is more than just an empty promise.

During the 1930s, with the alarming numbers of bank failures and the Great Depression at its full-blown worst, confidence was almost nonexistent. Bank runs and depressed stock prices had created an atmosphere of financial panic.

President Roosevelt’s answer was a bank “holiday”. Not too long afterwards, Congressional legislation authorized the formation of the Federal Deposit Insurance Corporation (FDIC) and the Federal Savings And Loan Insurance Corporation (FSLIC).

Use of the terms ‘federal’ and ‘insurance’ in the names of the new institutions was meant to help restore lost confidence and maintain it. Apparently it worked. Confidence in the banks improved.

The money wasn’t really there to back up the guarantees. It was an empty promise, but people felt better; and that seemed to be good enough. Fragile as the banking system was – and still is – people preferred having their money in the bank.

That preference did not in any way, shape, or form, translate to investor participation in the stock market. Still reeling from the collapse in stocks, people would sooner lend or give money to family members. If someone had any money to invest they usually bought bonds. It took almost two generations for stocks to become fashionable again.

NO RESERVATIONS FOR TODAY’S STOCK INVESTORS

The almost casual attitude towards selloffs in the stock market that exists in this century is the result of assuming that the market will right itself and go right back up in short order. Or, if things are serious enough, the Federal Reserve Cavalry will ride to the rescue – every time.

The expectation that the Fed will always bail out the banks and the financial markets has muted the word ‘caution’ when it comes to investing. Some people seem to fancy themselves as smart investors because they bought stocks this past spring and are now feeling the euphoria from the effects of the Fed’s injection of the money drug into their financial veins.

We seem to have forgotten how difficult it was to extricate ourselves from a similar mess little more than a decade ago. The financial markets may have recovered more quickly this time but the economic backdrop is more characteristic of a patient that is “terminally ill but resting (un)comfortably”.

The Fed is very aware of how precarious the situation is. They have pulled out all the stops in their quest to “bring back inflation”. They are fighting an uphill battle. The chart below shows the declining effects of the inflation created by the Fed over the last half-century…

Capacity Utilization Rate – 50 Year Historical Chart

This chart shows capacity utilization back to 1967. Capacity utilization is the percentage of resources used by corporations and factories to produce finished goods.

As you can see in the chart, the capacity utilization rate has been trending down in regular stair-step fashion for more than fifty years. A possible reason could be an increase in the efficient use of the available resources. Rather, though, the declining capacity utilization rate is more reflective of an ongoing decline in the demand for finished goods.

Neither of those reasons are consistent with the expectations from ongoing inflation that the Fed creates. The actual results are indicative of a multi-decade decline in the demand for finished goods; a long-term slowdown in economic activity.

Here is another chart. This one shows the relationship of gold’s price to the monetary base…

Gold’s Price To The Monetary Base – 100 Year Historical Chart

In the chart immediately above, we see that the ratio of gold’s price to the monetary base is in a long-term decline that has lasted for over one hundred years. This seems somewhat contradictory when compared to what some think they know about gold.

Gold’s higher price over time is a reflection of the ongoing decline of the U.S. dollar. The decline (loss of purchasing power) in the value of the U.S. dollar is the result of the inflation created by the government and the Federal Reserve.

The increase in the monetary base is an indicator of the extent to which the government and the Fed have debased the money supply. The continual expansion of the supply of money and credit leads to the loss in purchasing power of the dollar.

Some gold analysts and investors believe that increases in the monetary base lead to similarly proportionate increases in gold’s price. But that is not what is happening.

Gold’s price increase for the past one hundred years does not correlate with the increase in the monetary base. The price of gold reflects the actual loss in purchasing power of the U.S. dollar.

Inflation created by the Fed is losing its intended effect. It’s resulting effects on the economy are similar to those of drug addiction. Over time, each subsequent fix yields less and less of the desired results.

THE FED KEEPS TRYING

Jerome Powell’s announcement of a ‘major policy shift’ is borne out of fear and frustration. The intention of moving towards “average inflation targeting” while allowing inflation to run higher than the standard 2% target is meaningless.

If you continually fall short of your original 2% target, how can you possibly “allow inflation to run higher”? That is like saying that your car will only go forty mph but you want it to go fifty mph. Nothing you have done so far has been successful in getting your car to go fifty mph. As a result, you announce that you are going to allow you car to go sixty mph for awhile. Huh?

Mr. Powell’s statement is an admission that the Fed has lost control. This does not mean that they necessarily had much control over things in the past, either; but the Fed definitely can influence the financial markets. For example…

“…as the Fed slashed interest rates to nearly record lows from 2001 until mid-2004, housing prices climbed far faster than inflation or household income year after year. By 2004, a growing number of economists were warning that a speculative bubble in home prices and home construction was under way, which posed the risk of a housing bust.” (source)

Fed Chairman Alan Greenspan’s response to the potential threat of a housing bust was that housing prices had never endured a nationwide decline and that a bust was highly unlikely.

Even after the fact, during his testimony before the House Committee on Oversight and Government Reform, Greenspan referred to his own reaction to the credit crisis and its economic destruction as one of “shocked disbelief”. The former Fed chairman is blamed by some for the credit crisis of 2007-08.

The Federal Reserve has a history of implication regarding causes of financial and economic disaster; and, on occasion, they have admitted their part:

“Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”…Remarks by Governor Ben S. Bernanke (At the Conference to Honor Milton Friedman, University of Chicago -Chicago, Illinois November 8, 2002)

Three years later, Mr. Bernanke had succeeded Mr. Greenspan and was at the helm as Chairman of the Federal Reserve when storm-tossed seas amid waves of financial debt threatened to destroy the ship completely – again.

I wonder if Mr. Bernanke regrets his public admission in behalf of the Federal Reserve; he seemed to be in a hurry to leave his post at the end of his initial term as Chairman.

As The Depression Of The 21st Century unfolds, here are some charts of various economic indicators that bear watching…

Continued Jobless Claims Historical Chart

The chart above shows that the current level of continued jobless claims is twice as high as it was at its peak in June 2009; and that is after declining forty percent from its peak earlier this year in April.

Housing Starts Historical Chart

The above chart of Historical Housing Starts puts into perspective the action and attention in today’s market for new homes. It is true that housing starts are nearly back to their peak from just before economic fallout from the Covid-19 response. Nevertheless, they are still thirty percent lower than their peak in 2006 prior to the mortgage crisis associated with the Great Recession. In addition, the activity level of new housing starts for the past decade is lower than any decade as far back as the 1960s.

Durable Goods Orders – Historical Chart

As the above chart shows even at their post-pandemic recovery highs, durable goods orders are still lower than at any other point dating back to the early 1990s (the exception being the brief spike downwards in 2009).

5 Year 5 Year Forward Inflation Expectation

The chart above measures the expected average inflation rate over the five-year period that begins five years from today. Expectations for the future rate of inflation continue to decline and reached their lowest point since December 2008, and lower than any other point in this century.

Expectations for lower rates of inflation are consistent with the trend of actual rates of inflation shown on the chart below…

Historical Inflation Rate by Year

Inflation rates in this century are lower than any comparable period of time going back to the 1950s-60s.

We spoke earlier in this article about declining demand for finished goods. Raw goods have been affected by lack of demand, too. One of these is crude oil.

Below is a chart showing the phenomenal increase in oil reserves that has occurred over the first two decades of the 21st Century…

U.S. Crude Oil Reserves – 110 Year Historical Chart

The huge increase in crude oil reserves depicted above (May 2008 – current) corresponds perfectly with the huge decrease in the price of oil over that same time period.

In May 2008, crude oil peaked at $145 bbl. In March of this year, it posted a low price of $11 bbl. There are reports that the immediate spot price for crude oil on tankers and ready for delivery actually approached zero. However, $11 bbl still represents a decline in its price of ninety-two percent.

Demand in luxury goods markets has suffered, too. The World Gold Council announced that jewelry demand in the U.S. fell 34%, compared to the second quarter of 2019; and for the first six months of the year jewelry demand fell 21% to an eight-year low.

The World Gold Council said that jewelry demand also fell to historic lows in European markets, dropping 42% in the second quarter and for the first half of 2020 was down 29%.

CONCLUSION

The upshot of all this is that the effects of inflation are growing more muted over time. More and more stimulus has less and less impact.

Also, the demand for money is increasing. People need money – not more credit. Inflating the prices of financial assets might make it look like things are getting better, but the reality of it all is that while financial asset prices recover and go to new highs, the economy never regains its full health.

The relative difference between stocks at all-time highs and the current state of the economy is growing larger. Some might think that higher stock prices are an indication of expectations for the eventual full recovery of the economy; but that is not the pattern of the economic cycle this century.

For the past twenty years, and longer according to some of the charts above, economic activity is stagnating and weakening. Each bout with financial catastrophe leaves the economy weaker overall, and it never fully recovers. It just continues to muddle along.

Wall Street, the banks, and some investors seem to do well enough; but the comfort and overall good feelings associated with a rising stock market seem disproportionate to the disappointing level of well-being and optimism emanating from the general public and small businesses.

At this time, the economy is a better indicator than stocks and bonds (house prices, too) of our financial health. We are currently in poor financial health and before we can get better, we will experience a healing crisis of immense proportion. (also see Supply And Demand For Money – The End Of Inflation?)

Kelsey Williams is the author of two books: INFLATION, WHAT IT IS, WHAT IT ISN’T, AND WHO’S RESPONSIBLE FOR IT and INFLATION, WHAT IT IS, WHAT IT ISN’T, AND WHO’S RESPONSIBLE FOR IT

Multilateral Fiscal Support for African Governments Addresses Liquidity More than Solvency Risk

Download Scope Ratings’ full report on Africa’s debt crisis and multilateral initiatives.

Fiscal vulnerabilities among African sovereigns were building in the years even before this year’s pandemic. This reflected challenging economic conditions, unfavourable exchange-rate and commodity-price changes, alongside significant new borrowing – including loans from Africa’s largest bilateral lender, China, and increased bond issuance.

Covid-19 has pushed most African economies into recession, driven, among other factors, by lost tourism revenues, falls in commodity prices and a decline in remittances. Real GDP in 2020 is set to contract by 2.3% on average across the continent, tax revenues will shrink and pressures to increase expenditure have risen.

An emphatic policy response needed in Africa, however fiscal constraints prevail

“This calls for an emphatic policy response,” says Dennis Shen, director at Scope. “Reinforcing public health systems, providing emergency food where necessary, offering income relief to vulnerable persons and supporting strategic economic sectors and small and medium-sized enterprises are short-term priorities alongside the long-term need to bolster economic development.”

However, in addition to overcoming weak governance structures and administrative capacities for the policies’ effective implementation, such measures also come with considerable price tags. Many African governments lack the fiscal space to implement such relief programmes without jeopardising the sustainability of their public debt.

African countries’ average public debt ratio increased from a 2011 low of 38.5% of GDP to 62.3% in 2019, while debt ratios more than doubled in that period in one third of the 53 economies on which there’s data. The burden of servicing debt has risen in parallel: regional average interest payments doubled from 5% to just under 10% of government revenues over the same period.

Multilateral institutions have increased emergency lending and debt service suspension

Multilateral organisations have ramped up emergency support in the form of loans and grants of around 0.6% of Africa’s 2019 GDP to-date, while the G20 has agreed on a Debt Service Suspension Initiative (DSSI) with average savings of 0.6% of 2019 GDP.

“International initiatives can support African sovereign creditworthiness, though, critically, DSSI debt relief has led to suspension rather than outright debt forgiveness,” according to Shen. “The international support programmes primarily address short-run liquidity rather than long-run solvency issues.”

“In addition, any private sector involvement in DSSI could be tied to a temporary (selective) default credit rating – potentially restricting market access near-term,” Shen says. “However, such a default credit rating in a scenario of private sector involvement would likely be transitory and, longer term, involvement of private sector creditors in debt relief could be viewed as positive for creditworthiness especially were underlying solvency issues addressed.”

DSSI elements such as enhanced debt transparency, multilateral monitoring and borrowing ceilings are considered by the rating agency as positive for the region’s sovereign ratings.

Governments will need to independently weigh the benefits vs costs of debt suspension participation

“Governments will need to judge the benefits of participation in DSSI – especially of any element of private debt bail-in – against the costs,” Shen says. “If a suspension of 2020 bond coupon and principal payments leads to a significant debt service hump in future years, this could be considered a significant risk even after a debt suspension – given potential for renewed debt distress over future years.”

“Conversely, if an economy’s debt sustainability is adequately enhanced by momentary suspension of debt payments to official and/or private sector lenders and repayment schedules are subsequently smoothened, this could support stronger market access and lower borrowing rates long term, and with this, bring a potentially stronger sovereign credit rating long term.”

The ongoing shift in African governments’ funding source in the direction of markets and China

Rising public debt burdens have coincided with a shift in African governments’ reliance on multilateral institutions and bilateral lenders towards capital markets. There has been a parallel longer-term shift to non-Paris Club bilateral creditors, predominantly China. The proportion of private funding has risen, up at almost 40% of public and publicly guaranteed debt in 2018.

Increased issuance of sovereign bonds can diversify a country’s investor base and subject a government to market discipline especially in crises, but it comes with higher borrowing costs than concessional multilateral and bilateral loans and increases exposure to volatility in investor sentiment.

Multilateral and bilateral financial support alongside debt relief initiatives, such as the DSSI, support African governments’ capacities to cope with the economic and public-health crises – they mitigate economic and financial damage, ease immediate liquidity risk, and can improve sovereign creditworthiness over time.

For a look at all of today’s economic events, check out our economic calendar.

Dennis Shen is a Director in Sovereign and Public Sector ratings at Scope Ratings GmbH. Thibault Vasse, Sovereign Ratings Analyst of Scope, co-authored this article.

September Monthly

New lows for the year against the euro, Swiss franc, the British pound, Swedish krona, and the Australian dollar were recorded in recent weeks. The Dollar Index (DXY), which is heavily weighted toward Europe, fell by over 4% in July, the largest monthly decline in a decade, and another 1.25% in August. In fact, the Dollar Index has not risen on a monthly basis since March. The surge in gold (reached a record high near around $1975 an ounce) was also seen in some quarters as an expression of dollar bearish sentiment.

The interest rate support for the dollar has fallen. Of course, with around $14.5 trillion of negative-yielding bonds, mostly in Europe and Japan, the US still offers a premium, but the premium has narrowed, and when hedging costs are included, it has disappeared. Growth differentials also had favored the dollar, but it is not so clear anymore. The eurozone’s August Purchasing Managers Survey disappointed, and as the month ended, the virus appears to be growing faster in Europe than the US. Yet, as with the interest rate differentials, growth differentials are simply less dollar supportive, and that is the takeaway.

It is not as if all things were equal. The relevant pre-existing conditions in this context were two-fold. First, after trending higher for several years, by various metrics economists use, the dollar was over-valued prior to the pandemic. At the end of last year, according to the OECD’s measure of purchasing power parity (a rough approximation of value in a world of currencies that are no longer backed by gold), the dollar was terribly rich against most of the major currencies.

The euro was estimated to be a little more than 26% undervalued against the US dollar Sterling was next, nearly 11% undervalued. The Canadian dollar was almost 9% undervalued, and the Japanese yen was 7% cheap to the greenback. As of June, the Economist’s “Big-Mac” model of purchasing power parity had the euro more than 16% undervalued, and sterling was 25% undervalued.

The second pre-existing condition was that growth and interest rate differentials attracted significant portfolio flows into the US. US stocks have outpeformed European shares handily over the past 3, 5, and 10-years. The narrowing of yield differentials means that US Treasuries have outpeformed German, British, and Japanese bonds over the past couple of years. This suggests that many asset managers are overweight US exposure. One estimate (13D Global Strategy and Research) suggested is that there has been “nearly $10 trillion of global capital concentration into US assets in less than a decade.”

Still, European stocks (Dow Jones Stoxx 600) outperformed US shares (S&P 500) on the downside in the first three months of the year and has underperformed in the recovery. June was the only month so far this year in which the Stoxx 600 outperformed the S&P 500 (~2.8% to 1.8%). In August, the S&P 500 gained around 7.2%, more than twice the Dow Jones Stoxx 600 3% gain. Year-to-date, the S&P 500 is the only G7 equity market index positive for the year.

Equity portfolio investment tends to carry low currency hedge ratios, and the greenback’s decline adds a tailwind for dollar-based investors in European markets. The Swedish stock market, for example, performed marginally better for unhedged dollar-based investors than the S&P 500 so far this year (~8.6% vs. 8.2%).

In a nutshell, the dollar’s main supports have weakened, it was overvalued, and it was a crowded trade. The adjustment has been nearly relentless. The euro has fallen in only five weeks since the end of April (19 weeks). Speculators in the futures market have amassed record net and gross long euro positions, and still, the biggest pullback has been limited to about 2.5-cents.

Most of the major central banks did not meet in August, and their September meetings will draw attention. Several central banks, including the Federal Reserve, the European Central Bank, and the Bank of Japan, will update their economic forecasts. The Federal Reserve may be the most likely to adjust policy as a follow-up to its formal decision to target the average rate of inflation.

Still, on balance, it might not be prepared to move quite yet to cap interest rates or boost it bond-buying, even though Congress has been unable to provide fresh fiscal stimulus. The Fed has not achieved its 2% inflation target since 2012. As of August 25, the Fed’s balance sheet was nearly $180 bln (~2.5%) below its peak in mid-June.

Many emergency measures were initially for six months or so, and governments and central banks will face some difficult choices. Most of the Fed’s facilities, though used less than anticipated, have been extended until the end of the year. The ECB has extended its Pandemic Emergency Purchase Program. The thrust of monetary policy is shifting from its initial efforts to ensure orderly markets to supporting the recovery.

Without a vaccine, a partial and uneven recovery may be the best that can be expected over the coming months. This means that elevated unemployment levels will prevail, even if partially hidden or socialized through furlough and short-time schemes. Canada has announced both a four-week extension of its emergency income program (through mid-September) before modifying initiatives to put them on a more sustainable basis. It has also extended its loan program for businesses.

In Germany, Finance Minister Scholz, who will be the Social Democrat candidate for chancellor next year, has pushed through an extension of its short-term work program (~government picks up about 2/3 of the wages for households with children) for 24 months from 12. France is preparing a large stimulus effort. UK Chancellor Sunak is under increasing pressure to extend funding for the furlough program that is supporting around four million people, but parts of Her Majesty’s Treasury is pressing for some funding through new taxation.

That said, with numerous vaccines in various stages of development, optimism is running high. Many governments are relaxing some of the procedures around creating vaccines to expedite the process. Until a vaccine is available of which people can be confident, flare-ups may be unavoidable, but they can be minimized and limited in scope. That will be the challenge in September. As the US flare-up appears to be being brought under control in late August, the contagion is rising in the Asia Pacific region and parts of Europe.

The US-Chinese relationship has deteriorated on many fronts, two issues that had been flashpoints, trade, and currency, have become less so. China has stepped up its imports of US agriculture goods, and with 19 tankers carrying a combined 37 mln barrels of oil from the US (~$1.55 bln), its energy imports will surge in September. Although many observers have emphasized that China is far behind its numerical commitments, top US officials (including Navarro, Lighthizer, and Kudlow) all publicly stated that the agreement was intact, and China was adhering to the deal.

A year ago, the US was citing China as a currency manipulator as the dollar rose above CN7.0. However, the link between the geopolitical competition and the yuan has loosened. The yuan traded at seven-month highs against the dollar at the end of August. Its nearly 2% gain makes it the strongest in the region last month. The JP Morgan Emerging Market Currency Index fell a little more than 0.5% in August, paring July’s roughly 2.4% rise. Regionally, South America underperformed, alongside the Turkish lira, which fell to new record lows in August (~-5.2%). After the lira, the next three emerging market currencies were Brazil real (~-4.7%), Argentine peso (-2.5%), and the Chilean peso (~-2.2%).

Dollar:

After trending lower since March, the dollar traded weakened broadly in the second half of August. Sentiment remains bearish as growth and interest rate differentials supports have been undermined. Although there has been some impact of the loss of the $600 a week in federal unemployment insurance and the fading effect of other fiscal efforts, the economic data have been mostly better than expected. Estimates for Q3 GDP around a little above 20% at an annualized rate. That said, there is concern that a quarter or more of the jobs there were lost temporarily will turn into permanent losses.

The Federal Reserve meets on September 16. The steepening of the yield curve through a relative increase in long-term yields cannot come as a surprise to Fed officials after adopting the average inflation rate target. Yet, on balance, it does not seem quite ready to move to cap rates either through yield curve control or through increased bond buying. The political campaigns get into full swing after Labor Day (September 7). It has yet to become much of a market factor except that investors appear to be buying options for protection, and this is seeing the volatility curve steepen.

Euro

The euro has not been the best performing major currency this year, this quarter, or last month. Its 6.6% advance through the first eight months puts in fourth place within the top ten major currencies against the US dollar. Most of those gains were registered here in Q3, where it is in fifth place. It was appreciated by a little less than 1.5% in August. Speculators have amassed a record net and gross long euro positions in the futures market.

The ECB meets on September 10 and is not expected to take new action. The economy has generally performed in line with the staff forecasts last updated in June when it forecast an 8.3% expansion here in Q3. The WTO may announce its preliminary ruling on EU charges that Boeing received illegal government assistance and could be a new flashpoint in the evolution of the trade relationship. In late August, the EU ended its controversial tariff on US lobster in exchange for reduced levies on around $200 mln of EU consumer goods.

(end of March indicative prices, previous in parentheses)

Spot: $1.1935 ($1.1780)
Median Bloomberg One-month Forecast $1.1905 ($1.1570)
One-month forward $1.1945 ($1.1785) One-month implied vol 7.9% (7.8%)

Yen

The dollar traded between JPY104 and JPY108 in July and a narrower JPY105-JPY107 range in August. On a purely directional view, the yen tends to weaken when US yields rise and/or when the S&P rally. The three-quarter contraction that began in Q4 19 with the sales tax increase and typhoon appears to be ending here in Q3.

Prime Minister Abe will step down due to health reasons around the middle of September when the LDP picks his successor. The situation is still fluid, and Cabinet Secretary Suga seems may get the not, which would underscore the continuity we see as the most likely outcome. The Diet’s term is up in a year, but the LDP may want a sooner election.

While there may be an alternative to Abe, there may not be for Abenomics, which is arguably the traditional policy thrust of the Liberal Democrat Party of loose monetary policy, deficit spending, and raise the consumption tax. A supplemental budget for the second half of the fiscal year (begins October 1) seems more likely that fresh initiatives from the Bank of Japan, which meets on September 17. BOJ Governor Kuroda is seen likely to fulfill his current term, which ended April 2023.

Spot: JPY105.90 (JPY105.85)      
Median Bloomberg One-month Forecast JPY105.95 (JPY106.50)     
One-month forward JPY105.90  (JPY105.90)    One-month implied vol  7.4% (7.3%)

Sterling

The pound fell by about 6.5% in H1 20 and rebounded by about 7.8% through the first two months of Q3.  Sterling made a new marginal high for the year in late August, a little below $1.34 on the back of a softer US dollar. The UK economy shrank by a fifth in Q2, the most in the G7, but appears to be gaining traction, though there is still pressure to extend the employee furlough program.  There has been little progress in trade negotiations with the EU.
A break-through is needed in the coming weeks in time for the mid-October EU summit and allow members sufficient time to ratify the agreement. This continues to seem unlikely. The potential disruption may already be a factor underpinning implied volatility.  Yet, August was the second consecutive month that sterling rose against the euro, and is near its best level in two-and-a-half months at the start of September.
Spot: $1.3370 ($1.3085)   
Median Bloomberg One-month Forecast $1.3285 ($1.2820) 
One-month forward $1.3370 ($1.3090)   One-month implied vol 8.7% (8.6%)

Canadian Dollar

The Canadian dollar was one of the strongest major currencies in August, appreciating about 2.9% against the US dollar.  Rising equities speaks to the elevated risk appetites that are correlated with the Canadian dollar. Rising commodity prices (CRB Index rose about 6.8% in August, its fourth consecutive monthly gain and now is above its 200-day moving average for the first time since January) have also been supportive.
Since the middle of March, the US dollar has fallen by about 11.3% against the Canadian dollar, but speculators in the futures market continue to carry a net short futures position. The Canadian dollar is the only major currency that is depreciated against the US dollar this year.  A scandal over favoritism and a dispute over fiscal policy led to the resignation of Finance Minister Morneau, but it did not derail the Canadian dollar’s recovery.
Canada has been more cautious than the US in lifting containment measures while seeing a slightly higher percentage of returning workers. The Bank of Canada meets on September 9 and is not expected to change policy. New fiscal initiatives are likely to be outlined on September 23, when the new session of parliament begins.  Ottawa’s decision about Huawei, on the one hand, and how to respond to the new US tariffs on Canada’s aluminum, on the other hand, risks escalating tensions with both Beijing and Washington.
Spot: CAD1.3045  (CAD 1.3410)
Median Bloomberg One-month Forecast  CAD1.3100 (CAD1.3515)
One-month forward  CAD1.3000  (CAD1.3415)    One-month implied vol  6.5%  (6.3%) 

Australian Dollar

The recovery of the Australian economy seemed to lag behind others even before the flare-up that led to the lockdown in Victoria.  Australia lost about 375k full-time positions between February and June and only gained 43.5k back in July (~11%).  However, the government has reduced the JobKeeper and JobSeeker payments.  Still, in the fiscal year that began July 1, the government anticipates a boost in spending and a reduction of tax revenues of around A$185 bln.

The Australian dollar gained about 3.3% in August, its fifth consecutive monthly increase, and is up about 5.1% for the year.  Reserve Bank Governor Lowe admitted to preferring a weaker currency, but suggest intervention would only be effective if there was a valuation misalignment. The OECD’s model of Purchasing Power Parity puts fair value at closer to $0.6950 (~5.7% over-valued), which represents a relatively modest deviation.

Spot:  $0.7375 ($0.7145)       
Median Bloomberg One-Month Forecast $0.70315 ($0.7035) 
One-month forward  $0.7380  ($0.7150)     One-month implied vol 9.8%  (10.4%)   

Mexican Peso:

The peso gained about 1.8% against the dollar in August, making it among the strongest of the emerging market currencies. The peso is off around 13% year-to-date, and the substantial depreciation that could still feed through to domestic prices.  Consumer prices have firmed in recent weeks and are now at the upper-end of 2%-4% target range.  After cutting the overnight rate by 50 bp at the past five meetings to 4.5%, Banxico sees itself with limited scope for additional easing.
The next meeting is on September 24, and it will likely standpat.  Outside of the auto sector, Mexico’s economy is still reeling from the virus and the limited policy response.  A new corruption scandal in President AMLO’s family may complicate next year’s local and state elections, but had little impact on the Mexican peso.

The dollar has been trading between MXN21.85 and MXN23.00 since the middle of June.  It edged lower to MXN21.74 into the end of the month before bouncing back to nearly MXN22.00 where it finished the month.  In the low interest-rate environment, the 4.5% available on short-term Mexican bills (cetes) is attractive and keeps the peso stronger than the macroeconomic considerations would suggest.

Spot: MXN21.89 (MXN22.27)  
Median Bloomberg One-Month Forecast  MXN21.92 (MXN22.12) 
One-month forward  MXN21.96 (MXN22.37)     One-month implied vol 13.4% (14.7%)

Chinese Yuan

The recovery of the world’s second-largest economy is being stymied by floods and weak domestic demand. The floods are disrupting food supplies and elevating prices.  By late August, and estimated $26 bln of damage has been inflicted and four million people displaced.
Agriculture imports have been boosted to meet the shortage of domestic supply.   Many expect the PBOC to continue to ease policy in a targeted way while holding back from the asset purchases that other major central banks are undertaking.  Since late May, the dollar has depreciated by around 4.7% against the Chinese yuan.   Chinese officials have allowed the yuan’s exchange rate to become decoupled from the ongoing political tension.
The yuan strengthened in seven of the nine weeks of Q3 through the end of August to finish near seven-month highs.  We suspect there is a limit to how much Beijing will allow the US to depreciate the dollar, but the 1.7% depreciation thus far this year is modest by any measure, and still fits the official rhetoric about the yuan’s stability.
Spot: CNY6.8485 (CNY6.9750)
Median Bloomberg One-month Forecast  CNY6.8815 (CNY7.0165)
One-month forward CNY6.9050  (CNY7.0795)    One-month implied vol  4.9% (4.4%)
For a look at all of today’s economic events, check out our economic calendar.

This article was written by Marc Chandler, MarctoMarket.

The Federal Reserve vs. Judy Shelton And Gold

A letter published and signed by former Federal Reserve officials and staffers called on the Senate to reject her nomination, stating that “Ms. Shelton’s views are so extreme and ill-considered as to be an unnecessary distraction from the tasks at hand…”

Her “extreme” views were referred to in a general statement of condemnation:

Ms. Shelton has a decades-long record of writings and statements that call into question her fitness for a spot on the Fed’s Board of Governors”. This was followed by a citation of the specific issues:

“She has advocated for a return to the gold standard; she has questioned the need for federal deposit insurance; she has even questioned the need for a central bank at all.” 

FED CONDEMNATION OF SHELTON IS MOTIVATED BY FEAR

Would these specific views have been considered extreme a century ago? No. Are they extreme now? No. Then why all the fuss?

The statement by former Fed officials has been published openly and is prompted out of fear. Fear of discovery and exposure; and fear of a possible end to the biggest Ponzi scheme of all time.

If someone with Ms. Shelton’s views were to be sitting on the Federal Reserve Board of Governors, that individual would have a platform to call attention to the facts at hand. More public recognition of those facts could change measurably the current perception of the Fed. In addition, it might also signal the possible end of the central bank.

It was established in 1913 by congressional vote. It is, ostensibly, an institution that is responsible for, and actively pursues management of the economy. The goal is economic stability.

PURPOSE OF FEDERAL RESERVE

But that is not its true purpose. The Federal Reserve is a “banker’s bank”. As such it facilitates and orchestrates a financial environment that allows banks to do what they do best – loan money.

On a retail basis, this “power” to create and loan money is best illustrated by the system of fractional-reserve banking. The system of fractional-reserve banking fosters an unending expansion of the money supply via loans. That is what banks do: create money, loan it to others, and collect interest. (see: Origin And Danger Of Fractional-Reserve Banking)

The Fed’s expansion of the supply of money and credit, along with additional creation of money in the form of loans granted via fractional-reserve banking, is inflation. The loss of purchasing power of the US dollar and the higher prices you pay overtime for all goods and services are the effects of inflation that has already been created by governments and central banks.

If Judy Shelton was confirmed as a member of the Federal Reserve Board, maybe she would say more about this publicly in her new role. Or maybe she would become silent.

More than forty years ago, a former Fed chairman, who at the time was an economist and private consultant, received some similar attention because of some not entirely dissimilar viewpoints, particularly about gold and the gold standard. After his appointment as Chairman of the Federal Reserve Board of Governors in 1987, Alan Greenspan said very little about gold.

As a board member, Ms. Shelton will not be in control; but she might be a disruption to ‘business as usual’ at the Fed. Maybe this is what is meant by the reference to Ms. Shelton’s views as “an unnecessary distraction from the tasks at hand”.

Probably the most blatant condemnation of Judy Shelton comes in an article by Steven Rattner, titled “God Help Us If Judy Shelton Joins The Fed”.

For some people, it might make more sense to say “God Help Us If Judy Shelton’s Nomination Is Not Confirmed”. On the other hand, it might not make any difference.

Mr. Rattner said that “The Federal Reserve is an indispensable player in managing our economy”. That cannot even scarcely be considered a true statement when the facts are known and acknowledged.

The truth is that the Federal Reserve has been mismanaging the economy for over one hundred years. The effects of their infinite money creation have destroyed the value of the US dollar which is now worth only $.01 cent compared to $1.00 when the Fed assumed command.

Since the effects of inflation are volatile and unpredictable, the Federal Reserve spends most of its time now trying to manage the ill effects and unintended consequences of its own actions.

GREAT DEPRESSION – FED MADE THINGS WORSE

Regarding Ms. Shelton’s views on gold, Mr. Rattner referred to the gold standard as “a significant culprit in deepening the Great Depression” which is not true.

The length and depths of the Great Depression were the results of government attempts to fight the necessary purging that was taking place. If it had been allowed to run its course without public works programs, wage supports, and a national government who tried to “spend” us into recovery and wellness, the Great Depression would have been over much sooner

Under a gold standard, accompanied by convertibility, gold acts as a restraint on a free-spending government. The reason all nations have abandoned a gold standard is that they do not want to be limited in their desire to create limitless amounts of fiat money. (see Gold, US Dollar And Inflation)

As it appears now, Judy Shelton brings a refreshingly different perspective to central banking; and offers the potential for positive change – from the inside.

If that were not the case, it is doubtful that so many of those with influence within that domain would be so open in their attempts to stop her.

Kelsey Williams is the author of two books: INFLATION, WHAT IT IS, WHAT IT ISN’T, AND WHO’S RESPONSIBLE FOR IT and ALL HAIL THE FED!

A Look at the Price Action

Make no mistake about it. After a wobble, the dollar fell. It recorded new lows for the year against the British pound, Australian dollar, and Swedish krona ahead of the weekend. New lows for the month recorded against the Canadian dollar and Norwegian krone. The euro and yen flirted with the edges but remained within their well-worn ranges.

It is the interest rate markets that saw a more nuanced response. The implied yield of the December 2022 Eurodollar futures contract rose 1.5 bp last week. The five-year yield also rose (less than a basis point), as the Fed signaled it would be more accepting of an inflation overshoot as a type of forward guidance meant to underscore its commitment to keep rates low for the foreseeable future.

The long-end of the curve backed up, with the 10-year yield rising 10 bp, and the 30-year yield increased 13 bp. However, the upside momentum was unsustainable, and yields pulled back from their best levels ahead of the weekend despite stronger than expected income, consumption, and deflator numbers.

Dollar Index

Ahead of the weekend, the Dollar Index approached the two-year low set in the middle of the month near 92.00. There was no meaningful bounce, and the broad sideways movement seen in the past few weeks has alleviated the over-extended momentum indicators.

A break of 92.00 would set the stage to test the 91.00 area, which has more technical significance. It is also the initial (38.2%) retracement of the rally in the Dollar Index from the historic lows in 2009 (~70.70). A move above 93.50 is needed to neutralize the negative technical tone.

Euro

Here in August, the euro has traded above $1.19 in six sessions and closed above it exactly twice and once was before the weekend. Perhaps it is a question of market positioning, where speculators in the futures market had amassed a record-long gross and net position and extended it further in the week ending August 25.

The broad, sideways movement in recent weeks ($1.17-$1.19) has seen the momentum indicators trend lower, but the firmer tone in recent days has steadied the MACD and Slow Stochastic, which now appear poised to turn higher. The upper Bollinger Band will begin the new week near $1.1925. A close above $1.20, is probably needed to signal a breakout. Support appears to have been carved around $1.1755-$1.1760 area.

Japanese Yen

The combination of the FOMC and Abe’s resignation saw the dollar transverse nearly its entire month’s range (~JPY105-JPY107) ahead of the weekend. Momentum traders have been whipsawed. The outside up day on August 27 was followed by an outside down day on August 28. The momentum indicators are not particularly helpful now. The dollar spiked to about JPY104.20 at the end of July, which was a four-month low and that is the obvious target on a break of JPY105.00, but the measuring objective of the chart pattern may be closer to JPY103.00.

British Pound

Sterling motored to new highs for the year ahead of the weekend a little above $1.3350. It has not ended a month above $1.33 since April 2018. The strong close leaves it in good shape to continue its run (three consecutive weeks and it has only fallen in two weeks here in Q3). While the MACD is uninspiring, the Slow Stochastic is turning higher after correcting from over-extended levels. The next important technical area is near $1.35. A caveat is it closed well above its upper Bollinger Band (~$1.3280).

Canadian Dollar

Nothing has been able to derail the greenback’s steady decline against the Canadian dollar, which has now been stretched into the seventh consecutive week. It has risen in one week here in Q3 and that was by about 0.3%. The US dollar pushed through CAD1.3050 briefly to fall to its lowest level since January, but it recovered a traced out a possible bullish hammer candlestick.

The long downtrend has left the momentum indicators stretched and do not appear to have confirmed the pre-weekend low. The downtrend line from March’s high will begin the new month near CAD1.3215. Only a break of this trend line is noteworthy, while CAD1.3000 has psychological significance and about CAD1.2985 is $0.7700. The lower Bollinger Band begins next week near CAD1.3080.

Australian Dollar

The Aussie was nearly flat coming into the start of last week and it gained almost 2.6% in the five-day rally that lifted it to almost $0.7360. It has not been at such levels since mid-December 2018. The next important technical objective is near $0.7500. It has fallen in only one week of the past 10 and that was by less than 0.2%. The Slow Stochastic corrected and is now turning higher. The MACD appears to be turning higher from its lowest level in a couple of months. On the other hand, the Australian dollar closed well above it upper Bollinger Band (~$0.7290), which also looks to be initial chart support.

Mexican Peso

The dollar appeared to have staged a key upside reversal on August 27 in the aftermath of the Fed’s statement. However, as cooler heads prevailed, the prospect of a faster-growing US economy and a softer inflation target by the Fed was understood to be good for emerging market currencies in general.

The JP Morgan Emerging Market Currency Index rallied a little more than 1% before the weekend, the most in a month. Its 1.5% gain for the week was the largest in nearly three months. The dollar lost about 1.4% against the peso ahead of the weekend to ensure its third consecutive weekly decline. The next target is the June low near MXN21.4650, around where the 200-day moving average is also found. The technical indicators offer little insight. Resistance is seen near MXN22.20.

Chinese Yuan

The dollar fell nearly 0.8% against the Chinese yuan last week. It has fallen in all but one week here in Q3. We had thought Chinese officials would have resisted more strongly the persistent demand for the yuan, which is at its strongest level since January. The dollar closed a gap left on the charts from the higher opening on January 21 near CNY6.8670.

The low for the year was set the previous day near CNY6.84. Technically, the CNY6.80-CNY6.82 would appear to offer support. It represents a retracement objective of the rally from the March 2018 low around CNY6.24 and the 200-day moving average.

Gold

The pre-weekend rally of about 1.3% prevented gold from falling for the third consecutive week. After testing $1900 in the middle of the week, gold rebounded initially in response to the Fed’s statement. It made it to almost $1977 before dramatically reversing back to $1910 before catching the bid ahead of the weekend that carried to nearly $1974. In the waning hours of activity, support was found ahead of $1960. Both the Slow Stochastic and MACD have corrected lower and now appear poised to turn higher. Initial resistance is in the $1995-$2000 range and then $2015.

Oil

The price of October WTI continues to trade broadly sideways in the $42-$43.50 range. It has progressed sufficiently for the contract to flirt with its 200-day moving average (~$43.15) without the kind of momentum that would usually signal a further advance. That said, October crude oil prices rose by about 1.5% to post the fourth consecutive weekly increase. A year ago, oil was a fifth higher.

US Rates

The US 10-year yields pulled back a couple of basis points ahead of the weekend to stop the four-day increase. Still, on the week, the 10-year yield rose 10 bp to around 73 bp, having traded a little above 78 bp. The 30-year yield edged up before the weekend to complete the fifth session higher. It reached 1.57%, the highest in a couple of months before settling back a little above 1.51%.

The September futures note tested the (50%) retracement of the rally from the June low around 138-22 at the end of last week and bounced off it. Are long-term interest rates on the rise? The technicals suggest otherwise. That said, the 10-year breakeven (spread between the conventional and inflation-linked bonds) rose to 1.77 bp, the most since April. Other market-based measures of inflation expectations are also elevated. The University of Michigan’s survey for 5-10-year inflation was confirmed at 2.7% in August, matching the high for the year.

S&P 500

The S&P 500 gapped higher to start the week and never looked back. The benchmark rose every day last week to bring its streak to seven sessions. The 3.1% rally was the biggest weekly rally of the month. As we have seen with some of the currencies, the S&P 500 has only fallen in one week over the past two months.

It began the week gapping above 3400 and finished the week poking above 3500 for the first time, which is just above the upper Bollinger Band. The trendline off the secondary low in March begins next week near 3400, which is also the bottom of the gap created by Monday’s higher opening.

This article was written by Marc Chandler, MarctoMarket.

Blame it on The Nasdaq

US data announced this week showed a significant recovery in building permits and housing, building permits (MoM) for July surged to 18.8% compared to the previous 3.5%, Housing Starts data revealed 22.6% which is 5.1% higher than the previous month, existing-home sales data were as well positive reported beyond expectations.

Despite the negative Jobless claims and Philadelphia Fed Manufacturing PMI reported on August 20, Manufacturing PMI and Services PMI demonstrated a significant improvement, which led major US Indices to surge whereas S&P500 and Nasdaq100 reached the all-time high.

US stocks continue hitting records, Tesla surged by 24.19% breaking the significant $2000 per share value, and is now worth more than $382 billion surpassing Walmart by nearly $10B. Nasdaq’s top company by market cap – Apple gained 8.23% hitting the $2127B in capitalization. Tesla and Apple remain the top popular shares last week based on Robinhood data.

S&P500 closed above the all-time high, some might think that there is a possible double top pattern, economic recovery of the US indicates that the index may continue the run towards $3500.

Nasdaq owes its gains not only to Tesla and Apple, but there are also other tech companies that surged last week and during the pandemic, such as NVIDIA, AMD, Qualcomm, Microchip Tech, Texas Instruments.

An hourly chart demonstrates that the correction is most likely will happen as the price touched the dynamic resistance and the fifth wave of an ending diagonal is about to complete at 11600. Ending diagonal is a trend reversal pattern, which usually demonstrates exhaustion of bulls, note the evening star doji, though the closing is above the previous close, it still shows uncertainty and exhaustion.

NDX chart by TradingView

How is it related to cryptocurrencies and Bitcoin?

Bitcoin and Ethereum price actions are considered as cryptocurrency market movers. Since Bitcoin is nowadays considered as the digital Gold and Ethereum as a digital Silver, their price action now is correlated to US data which effect Gold. Gold was ever since used as a safe-haven to hedge funds during the uncertain times and inflation, so is Bitcoin now.

An hourly chart of Bitcoin indicates that the price could decline further to towards $11200 – $11160 to complete the Head and Shoulders pattern, another pattern to watch is an ending diagonal which is yet to be completed as well. Bitcoin remains below the major resistance level of $11700 an in order to show another bull run it must break the dynamic resistance (ending diagonals upper edge) and close above the 11700, however testing 11200 might bring another stimulus for bulls.

BTCUSD price on Overbit

Ethereum plummeted to $380 after reaching the year’s maximum at $446.67, loosing 9.7% this week only. Digital Silver price is following a similar ending diagonal pattern, and if the upper dynamic resistance and a static resistance of 397 is not overpassed, ETH might continue the drop towards a major support at $380, and if that support is broken, towards $370 – 369.

ETHUSD price on Overbit

Unlike Bitcoin, Gold lost only 0.20% in price for the week. A significant drop was on Wednesday August 19 ahead of US data announcements, where the precious metal lost 3.67% after gaining 2.97% on Monday and Tuesday.

Head and shoulders pattern is identified on an hourly chart of Gold and the price might continue the drop down to $1881.60 – 1880, where if the support laid on those level withheld the price might retrace towards 2014 and if above towards 2046, where the bearish pattern will be completed.

Gold price on Overbit

Since Gold and Silver prices demonstrate similarities in their price action, the same Head and Shoulders is visible on an hourly chart of XAGUSD. The price is below the dynamic support of August 12 which might signal to a further decline down to $25.30.

Silver price on Overbit

The price continues the short-term downtrend move inside a descending channel, which in other had forms another controversial to the H&S pattern of Bullish Flag.

Silver price on Overbit

If bulls are able to push the price above the dynamic support and if the dynamic resistance is overtaken at $27, the bullish run might proceed towards $28 – 28.50.

Key takeaways for the upcoming week would be announcements from Eurozone, Great Britain, China and the US.

Important announcements to watch:

Tuesday, August 25, 2020

German GDP (YoY) as per Second quarter data is expected to be -11.7%, 9.8% lower than the previous -1.9%

German GDP (QoQ) as per Second quarter data is expected to be -10.1%, 7.9% lower than the previous -2.2

US CB Consumer Confidence (August) is expected to be 93, 0.4 points higher than the previous 92.6

US New Home Sales (July) is expected to be 786K, 10K higher than the previous 776K

Wednesday, August 26, 2020

US Core Durable Orders is expected to be 2.1%, 1.5% lower than the previous 3.6%

Thursday, August 27, 2020

US GDP (QoQ) as per 2nd Quarter is expected to be -32.6%, 0.3% higher than the previous -32.9%

US Initial Jobless Claims is expected to be 1,000K, 106K lower than the previous 1,106K

US Pending Home Sales (MoM) as per July is expected to be 4.5%, 12.1% points higher than the previous 16.6%

Asides from the data to be announced, there are other important events to trace.

Republican National Convention, which will be held on Monday, in which delegates will determine the nominees for the upcoming presidential elections. Markets will be watching this event closely as during the current campaign Democrats are having an edge over republicans.

Source: Yahoo Finance

Another major event would be an annual Jackson Hole conference this Thursday, August 27, where FED Chairman Jerome Powell will speak about current economic situation, inflation targets and possibly share preliminary focus on interest rate change.

The economic state and inflation in the US once again are an important constituent of the Global economy and global markets, all these events will be decisive for the mid-term price movements for the US Indices, commodities and cryptocurrencies.