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Novum Alpha - Weekend Edition 20-21 March 2021 (10-Minute Read)

Investors turned back to tech, helping to recover the Nasdaq Composite as U.S. Treasury yields retreated from the highest levels of the day as investors weighed the risk of inflation versus the pace of economic growth accelerating. 

A wonderful weekend to you! 


In brief (TL:DR)

  • U.S. stocks were a mixed bag headed into the weekend as the S&P 500 (-0.06%) and blue-chip Dow Jones Industrial Average (-0.71%) were lower while the tech-centric Nasdaq Composite (+0.76%) was higher as Treasury yields retreated. 

  • The U.S. 10-year Treasury yield retreated from fresh highs and fell to 1.726% allowing for familiar pandemic trades to resurge. 

  • The dollar was little changed. 

  • Oil recovered with April 2021 contracts for WTI Crude Oil (Nymex) (+2.37%) at US$61.42 on the back of a reflation trade. 

  • Gold rose with April 2021 contracts for Gold (Comex) (+0.54%) at US$1,743.90 on expectations of a slipping dollar. 

  • Bitcoin (+0.32%) recovered to US$59,370 at the middle of the weekend and may look set to rise sharply before Monday's institutional traders return to their desks as inflows slowed against outflows from exchanges (outflows suggest that investors are looking to hold Bitcoin in anticipation of rising prices).

In today's issue...

  1. Fed's Largesse Fueling Bets on Market's Weakest Members

  2. Treasury Yields Spiking? Count on the Fed

  3. Who Needs a Digital Dollar Anyway?

Market Overview
Investors turned back to tech, helping to recover the Nasdaq Composite as U.S. Treasury yields retreated from the highest levels of the day as investors weighed the risk of inflation versus the pace of economic growth accelerating. 
There is growing expectation that should Treasury yields continue to run ahead unabated, the Fed will need to intervene. 
In Asia, indices which are more sensitive to yields saw sharp pullbacks heading into the weekend with Tokyo's Nikkei 225 (-1.41%), Hong Kong's Hang Seng Index (-1.41%), Seoul's Kospi Index (-0.86%) and Sydney’s ASX 200 (-0.56%) all lower. 
1. Fed's Largesse Fueling Bets on Market's Weakest Members
  • U.S. Federal Reserve's loose monetary policy is fueling bets on some of the more sketchy parts of the markets, on firms with shaky finances and iffy business models 
  • Investors are betting that Fed's support has allowed these companies to survive and an economic recovery will allow them to restart and flourish 
Shaky finances, questionable business model and speculative prospects? No problem. The Fed has your back.
For proof that the Fed’s largesse is fueling some of the more dicey corners of the stock market, companies with weaker balance sheets are beating stalwarts by at least a fifth, according to data compiled by Goldman Sachs (-1.09%) and Bloomberg – the biggest gap since just before the last financial crisis.
The usual suspects populate this list of shaky firms, with airlines and cruise operators at the head of the table, including Alaska Air Group (+0.27%) and Carnival (+2.44%), with online travel agency Expedia (-0.45%) rounding off the theme.
But as coronavirus vaccines ripple through the population and the U.S. economy opens, the Fed’s rock-bottom rates and consistent monthly asset buying, support that the central bank appears determined to keep in place for a long time, are providing opportunities for investors to take riskier bets.
Throw in another US$1.9 trillion from the Biden administration and markets already flush with cash are now drowning in money.
No profit? No problem.
A Goldman Sachs basket of tech firms that spend more money than they make is up almost 2% since the beginning of this year, while Russell 3000 loss-makers have surged 25% this quarter alone, around five times the performance of the index itself.
Part of the reason of course is excess liquidity, but the other is retail investors and reflation.
Inspired by the quick cash generated from the GameStop (-0.73%) and AMC Entertainment (-0.50%) trades, retail investors, armed with US$1,400 stimulus checks are now wading into the markets and searching out its more speculative small-caps based on information from Reddit and Twitter (-0.73%), in the hopes of getting in early on the next GameStop.
Another reason of course is the so-called reflation trade, with a rotation into value stocks as Treasury yields have spiked, and investors are no longer willing to pay the high premiums that these doyens of the market once commanded.
There is some method to the madness of course – as the economy opens and starts to recover, those firms with shaky finances and which came under the most pandemic pressure, but have somehow survived, are in the best position to make good on their potential. 
And it's entirely possible that with vaccinations, many of the businesses that require face-to-face interaction or travel can restart again in earnest. 
2. Treasury Yields Spiking? Count on the Fed
  • Good chance that Fed will intervene should U.S. Treasury yields spike to excessive levels 
  • Central bank is no doubt monitoring how Treasury yields are faring and will have to intervene at some point to keep borrowing costs low at risk of undermining the nascent economic recovery 
Investors expecting that the U.S. Federal Reserve would step in to tame the recent spike in benchmark Treasury yields last week were disappointed when the central bank demonstrated no inclination to step in and reign in Washington’s borrowing costs.
Instead, markets were treated to pretty much more of the same, with the Fed sticking to its tolerance of low rates, even if inflation should creep up, as well as maintaining the status quo with respect to asset purchases.
But as more bond sales occur because of the Biden administration’s US$1.9 trillion fiscal stimulus package, the supply side problem for Treasuries and the upward pressure on yields will only exacerbate.
A recent Treasury auction saw some of the lowest levels of liquidity ever, and the benchmark U.S. 10-year Treasury yield, which sets the rate for everything from student loans to mortgages has hit its highest level in a year.
The Fed’s low interest rates mean nothing if the U.S. government has to pay a premium to borrow.
And that’s why billionaire hedge fund investor Ray Dalio believes that the Fed will eventually have to step in.
Speaking at the annual China Development Forum on Saturday, Dalio noted that a prolonged period of elevated yields will “prompt the Federal Reserve to have to buy more, which will exhibit downward pressure on the dollar.”
But more than that, Fed intervention to crank up its asset purchase of Treasuries, which should bring yields down, will also fuel many of the trades taken during the pandemic that have been unraveling – including for tech and growth stocks, as well as cryptocurrencies.
Noting that the world is “very overweighted (sic) in bonds” that are yielding negative real returns, Dalio is concerned that “not only might there be not enough demand, but it’s possible that we start to see the selling of these bonds.”
Beyond being bearish for the dollar (investors need dollars to buy U.S. Treasuries, which are considered a safe security around the world), it will provide a boost for dollar-denominated assets, including equities and commodities.
U.S. Federal Reserve Chairman Jerome Powell said last week that the central bank’s current monetary policy was appropriate and there was no reason to push back against the recent surge in Treasury yields, but you can bet that the Fed is monitoring the situation closely.
As Dalio notes, the Fed can’t afford to stand back and do nothing if the spike in Treasury yields starts eating into its low-rate policy and starts undermining the nascent economic recovery.
And that in and of itself should provide some comfort to investors wondering if now would be a good time to consider getting back into the growth stocks that had slipped through the cracks as valuations reached eye-watering levels. 
3. Who Needs a Digital Dollar Anyway?
  • Stablecoins make up the bulk of transaction volume amongst other cryptocurrencies 
  • Lack of clear regulatory treatment and difficulty in policing dollar-based stablecoins is actually a feature, and not a flaw in Tether - ultimately it doesn't matter if Tether is indeed backed by dollars at all, as long as someone else will accept them 
Even as the U.S. Federal Reserve dithers on a central bank-issued digital currency, USDT or Tether, the world’s first dollar-based stablecoin (nobody really knows if it’s actually fully backed and even fewer seem to care), has a circulation even greater than Bitcoin’s.
For all the headlines that Bitcoin grabs, it’s Tether that does the business.
Just take a 24-hour volume window from last week for Tether, which was estimated by CoinGecko to be US$94 billion, to Bitcoin’s US$56 billion.
And data provider CryptoCompare estimates that over half of all Bitcoin purchases are now completed using Tether.
But the rapid rise of stablecoins, regulated and unregulated alike, might open up questions over what authorities intend to do about them, if and when central banks themselves start dishing out their own digital currencies.
Despite years of controversy surrounding Tether, it still remains the stablecoin of choice among the crypto-faithful, in large part because of its liquidity.
Whether you’re a trader looking to exit a long position or holding on to dry powder to cash in on the next DeFi token, Tether provides that almost instant access.
And that Tether now rides on the world’s largest cryptocurrency exchange by volume, Binance’s smart chain, suggests that the cryptocurrency powers that be, don’t see it going anywhere anytime soon.
Despite years of legal challenges, failing to produce an audit of backing each Tether with a dollar in the bank, Tether still trades at parity to its underlying asset.
And even if central banks do decide to issue their own digital currencies, including the Fed, the operation of Tether, much like how billions of actual U.S. dollars are used offshore, will continue in earnest, far away from the long arm of American regulators.
Best of all, because Tether exists outside of U.S. regulations, it doesn’t require onramps or access points to the Federal Reserve’s payment system – it’s almost like the Liberia of stablecoins if you will, flying the American-ish flag in an entirely parallel system.
And that ability to skirt around chokepoints like the New York banking system or international sanctions, means that regardless of one’s view about Tether, there are plenty of others who see its value. 
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Mar 20, 2021

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