Novum Alpha - Daily Analysis 3 June 2021 (12-Minute Read)
Markets appear to be hitting exit velocity - that sweet spot for investors where the same set of data can mean whatever it likes to whomsoever it pleases.
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A terrific Thursday to you with markets in the green!
In brief (TL:DR)
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In today's issue...
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Market OverviewMarkets appear to be hitting exit velocity - that sweet spot for investors where the same set of data can mean whatever it likes to whomsoever it pleases.
Fed officials hinting at the prospect of vacating the market albeit very slowly? Whatever.
Prices surging on many consumer indices? Been there done that, bought the T-shirt.
Not only have investors pushed equities higher, bonds rose as well - in a clear indifference to what would otherwise have resulted in some pullbacks.
At this stage, it's unclear what happens next, but clearly everyone can't be right or can they?
Could markets have finally hit peak insanity where they can continue to march higher, even as borrowing costs are low and nobody seems to care about inflation?
Yes, but only if investors keep a keen eye on the money supply and jobs - those are the two metrics that matter.
If U.S. nonfarm payrolls hit it out of the park on Friday, then watch out for comments from the Fed for tapering - that could hit markets in the immediate term.
And if jobs miss the mark, then expect the status quo and more upside for equities.
What about bonds? Only the U.S. Treasury matters and insofar as Biden is looking to rebuild America again bridge by brick, road and rail, then the government's long term borrowing costs need to stay low and therein lies the key.
Because everyone else's borrowing costs take dressing from how much it costs Washington to borrow, as long as money is cheap then the bets are free flowing.
And that's why markets are all up, even in pandemic-mired Asia where Tokyo's Nikkei 225 (+0.57%), Seoul's Kospi Index (+0.65%), Sydney’s ASX 200 (+0.84%) and Hong Kong's Hang Seng Index (+0.16%) all saw gains on Thursday's morning session.
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1. The Fed is Cleaning Up its Balance Sheet
As millions of Americans gathered at Memorial Day barbecues and headed out for a picnic or to the beach, enjoying a respite from months of hibernation because of the coronavirus pandemic, the U.S. Federal Reserve is also taking the opportunity to stretch its legs.
When the pandemic first hit American soil, the Fed was quick to shore up the financial system by scooping up corporate bonds and exchange traded funds through an emergency lending vehicle.
Known as the Secondary Market Corporate Credit Facility (try saying that really fast) or SMCCF (not all acronyms make things easier), the Fed acted as an implicit backstop for the debt of companies from Whirlpool (-0.44%) to Visa (+1.34%), and ETFs like Vanguard’s Short-Term Corporate Bond ETF.
But the SMCCF’s role in shoring up market confidence was more a matter of optics than operational necessity, with its holdings peaking at US$14.2 billion sometime last year, a drop in the ocean when combined with the holdings of the Primary Market Corporate Credit Facility of US$750 billion.
The Fed will soon begin selling off the corporate bonds and ETFs under SMCCF, but has been quick to point out that the sales, which are expected to be completed by the end of this year, are unrelated to monetary policy.
In a statement on Wednesday, the Fed said that it plans to sell the bonds and ETFs under the SMCCF in an orderly way that seeks to minimize “the potential for any adverse impact on market functioning” (translation: manic market panic and selloff in equities).
And while the SMCCF’s corporate debt holdings are distinct from the US$7.3 trillion worth of U.S. Treasuries and mortgage-backed securities that the Fed has on its balance sheet, investors will no doubt be carefully scrutinizing the SMCCF sale for signs that the Fed will eventually taper its larger asset purchases.
Investors however don’t need to worry too much about the SMCCF sales.
For starters, the SMCCF isn’t all that big and the corporate debt that it’s selling off are for blue-chip American companies that have weathered the pandemic well and are likely to do even better as America reopens, including retailers like Walmart (-0.22%) and payment companies like Visa.
Against that backdrop, it makes sense to start paring holdings of some of that debt, but continue to keep long term borrowing costs of the government low, especially if the Biden administration is looking to roll out even more ambitious infrastructure programs which will need to be funded.
What investors will need to pay attention to is if the U.S. economy starts overheating, and inflation appears to be getting out of control, the Fed may need to taper its bigger assets purchases, which could see Treasury yields soar and hurt all of the high-flying growth stocks that have done so well throughout the pandemic.
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2. How much brighter can gold shine?
Last year, both Goldman Sachs (+0.26%) and Citibank (+0.13%) forecast a US$2,300 price for gold this year, against a backdrop of inflation and on bets that a vaccination drive in the U.S. would help to reopen its economy.
Those forecasts are now starting to look prescient as the precious metal pushes on a five-month high and investors try to discern the subtext in statements from the U.S. Federal Reserve which may hint at a potential time frame for tapering stimulus.
In perhaps the most telling language, President of the Philadelphia Federal Reserve Patrick Harker said on Wednesday that it was appropriate “to slowly, carefully move back,” which seems to suggest that the Fed’s retreat from the market is a given, it’s just the pace of that retrograde step.
But if the SMCCF sale of corporate debt and ETFs is anything to go by, that pace ought to be glacial at best.
And Fed officials have repeatedly said that they’ll only begin scaling back asset purchases when the economy has made “substantial further progress” towards their goals, a condition which many Fed soothsayers believe will be met later this year.
One of the key platforms of the Biden administration is that of providing jobs, and good quality, well-paid jobs at that.
But while the U.S. economy is reopening in earnest, job growth simply hasn’t kept up.
Last month, the U.S. added just 266,000 jobs, well off economist forecasts of 1 million, with some suggesting that the job support schemes have made it more economically worthwhile for Americans to stay home, than to seek out jobs.
The Biden administration has hit back by suggesting that companies could get those workers if they just paid more.
And some are doing just that and it is that upward pressure on wages which is leading some to take a bet on rising costs being passed on to consumers in the form of rising prices.
Which is why gold has been stabilizing around US$1,900 an ounce and demand has been growing for what many investors are increasingly viewing as a haven asset.
If Bitcoin was the “gold” of the first quarter, the second quarter, which saw volatility in the cryptocurrency and wild swings in both directions, saw funds flow back into gold, which became the, well, "gold" of the second quarter.
Goldbugs will now be eyeing Friday’s all-important U.S. nonfarm payrolls report for May, for further clues on the strength of the labor market and whether growth will spur inflation that could prompt governments and central banks to begin thinking about beginning to reduce stimulus.
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3. A Crypto Tax Upon Your House
Let’s face it, cryptocurrency doesn’t have the most spotless reputation.
Despite just 0.34% of cryptocurrency transactions in 2020 being linked to nefarious activity, according to blockchain analytics firm Chainalysis, the use of digital assets to launder money and to evade taxes is usually top of the list of beefs that authorities have with the nascent asset class.
But what if there was a way for governments to tax cryptocurrencies? Would lawmakers be more open to embracing digital assets so long as they demanded and were paid their pound of flesh?
That’s precisely what the Biden administration appears prepared to do.
Hot on the heels of Biden’s financial regulators announcing that they would be working together to carve up issues of jurisdiction when it comes to cryptocurrencies, officials are now proposing the collection of data on foreign cryptocurrency investors active in the U.S.
The move is aimed at bolstering international cooperation to help in a broader crackdown against tax evasion.
Last Friday, the U.S. Treasury Department revealed in its “Greenbook” of revenue proposals a requirement for cryptocurrency brokers, exchanges such as Coinbase Global (+0.65%) and hosted-wallet providers, to provide information to the Internal Revenue Service or IRS on foreign individuals indirectly holding accounts with them.
The Biden administration is hoping that by providing that information to foreign governments, in exchange it can demand information on any U.S. individuals concealing cryptocurrency assets and dodging their U.S. tax liabilities by using offshore exchanges and wallet providers.
Part of a campaign by the Biden administration to strengthen tax enforcement to help fund the trillions of dollars of proposed longer-term spending programs, the proposal will still require congressional approval to be passed into law.
Biden officials have said that cryptocurrencies have served as a significant contributor to the growing tax gap – the difference between taxes owed and actually paid on time – an amount that IRS Commissioner Charles Rettig estimates may exceed US$1 trillion a year.
But Biden’s move to tax cryptocurrencies may only increase their allure, with no shortage of offshore locations more than willing to look the other way when it comes to assisting Americans in their tax planning goals.
By gathering information about foreign citizens trading in cryptocurrencies in the U.S. and using that as a carrot to entice offshore jurisdictions which thrive on customer privacy may provide little impetus to reciprocate, especially countries which are tax havens and have little to gain from receiving information about their own citizens who aren’t subject to tax anyway.
And much of the gains made from cryptocurrencies are capital gains, for which there are plenty of countries such taxes do not apply.
Where it may of course be valuable is where a foreign criminal uses U.S.-based cryptocurrency facilities to launder their ill-gotten gains, but why would anyone (criminal or otherwise) do that?
If nothing else, the offshore exchanges are also the most liquid, with the greatest volume of trading and the deepest markets, Americans looking to trade offshore would use those, or better yet, decentralized exchanges which are governed entirely by smart contracts, and brook no AML or KYC.
Despite the gaps in Biden’s approach to tax cryptocurrencies, the move should still be welcome, because nothing quite says legitimacy and recognition like a tax upon your house, after all, that's how the Feds got Al Capone.
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Jun 03, 2021