Novum Alpha - Daily Analysis 22 June 2021 (10-Minute Read)
It's normal to overreact, especially in markets that are susceptible to even the most subtle shifts in sentiment.
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A terrific Tuesday to you as markets take a turn for the better!
In brief (TL:DR)
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In today's issue...
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Market OverviewIt's normal to overreact, especially in markets that are susceptible to even the most subtle shifts in sentiment.
And so last week, investors headed for the hills, sending equities and other risk assets dramatically lower in a bloodbath that extended to commodities and even cryptocurrencies, all on the prospect of Fed policy tightening.
Yet none of this is a surprise other than the timeline.
For months, the Fed had been saying that it would only begin to think about raising rates in 2023, even based on the current rate hike timetable, the two 25 basis point hikes are only due in 2023, albeit slightly earlier in the year.
And tapering of asset purchases was always a topic up for discussion, that doesn't necessarily mean that the central bank is going to yank the cord.
Having learned the hard lessons from then-U.S. Federal Reserve Chairman Ben Bernanke's taper tantrum episode of 2013, the Fed of Jerome Powell has been far more communicative and transparent with markets.
And that's why Monday saw a return to reason as investors and bargain hunters snapped up stocks.
But longer term, now that concerns over inflation have ebbed somewhat, demand for bonds is likely to return in force again, putting pressure on yields and making it a perfect time for the Biden administration to roll out ambitious fiscal projects (provided it can get the political backing to do so).
Asian markets which had suffered hard on Monday saw a terrific turn on Tuesday with Tokyo's Nikkei 225 (+2.41%), Sydney’s ASX 200 (+1.37%) and Seoul's Kospi Index (+0.59%), all rebounding sharply, while Hong Kong's Hang Seng (-0.33%) was down slightly as Beijing extended its crackdown on other speculative segments of the economy.
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1. Can Inflation Ebb & Flow Like the Tide?
With markets roiled following signs of the U.S. Federal Reserve’s impending hawkishness, policymakers showed investors who’s boss, and now that they have flexed their muscles, providing assurance to investors that inflation is something they can control, markets have recovered.
Testifying before the House Select Subcommittee on the Coronavirus Crisis, U.S. Federal Reserve Chairman Jerome Powell noted that while inflation had picked up, it would move back towards the central bank target of 2% once supply imbalances were resolved,
“As these transitory supply effects abate, inflation is expected to drop back toward our longer-run goal.”
Policymakers stunned markets last week when their forecasts brought forward the timing for interest rate hikes, from their current near-zero level, while also kicking off a discussion on when to taper the Fed's US$120 billion-a-month asset purchases the central bank currently supports.
But perhaps more important is the Fed’s views on employment – one of the stated goals of the central bank prior to withdrawing support, and to that end, Powell was sanguine,
“Job gains should pick up in coming months as vaccinations rise, easing some of the pandemic-related factors currently weighing them down.”
And while the U.S. consumer price index rose 5% in May, from a year ago, policymakers predicted that their preferred price measure, the personal consumption expenditures price index, would rise just 3.4% this year, decelerating to 2.1% and 2.2% over the next two years.
The choice of indicator that the Fed uses to measure inflation is important, because while the markets may monitor other sources, the Fed’s internal measures of how to respond will more closely align with what they view as relevant feedback.
That the U.S. central bank only forecasts some 3.4% inflation this year suggests that any hikes are likely to be on the horizon and not in the here and now.
And while job conditions in the U.S. are improving, unemployment in May was still at 5.8% according to the U.S. Department of Labor.
According to economists, full employment in the U.S. is in the region of around 3.5% and although much progress has been made, it’s also important to account for seasonal fluctuations.
Part of the difficulty with interpreting current data is that some unemployment programs are making it more logical for American workers to stay off payroll at a time coincident with the peak summer hiring season.
The longer-term damage from the pandemic however will only be evident after the summer season – where typically labor-intensive industries such as food service as well as hospitality and entertainment sectors start scaling back on their hiring.
And that may be why the Fed is still adopting a “wait-and-see” approach, while bracing markets to eventually face the inevitable, tapering and rate hikes, but providing sufficient room to preserve current stimulus measures for now.
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2. China Cracks Down on Iron Ore Bets
Not content to crack down on cryptocurrency which poses a threat to China’s monetary sovereignty, Beijing is now moving to clamp down on what it’s termed “malicious speculation” on iron ore, which poses a threat to its economic security.
While it’s no secret that China has spent the past year hoovering up commodities from all the four corners of the globe, its presence in the market to stockpile key industrial resources, coupled with bets on inflation have sent raw material prices soaring.
Beijing is now launching a review into record prices for iron ore, a key ingredient for making steel, and attempting to suppress record-high commodity prices.
Yesterday, China’s National Development and Reform Commission, the country’s top economic planning agency, said that it would investigate and “severely punish” any wrongdoing in the iron ore market.
Chinese policymakers are struggling to reign in commodity prices, which have pushed up factory gate prices to their highest since the 2008 Financial Crisis, and threaten to squeeze industry profits.
China is the world’s largest steel producer, accounting for over half of all global production, but relies heavily on imports of iron ore, particularly from Australia, and absorbs more than 70% of global production by sea.
Beijing’s move to reign in speculation on iron ore saw prices tumble on major commodity exchanges.
In the physical market, where miners and steel mills buy and sell the commodity, iron ore was at US$206.55 yesterday, according to data from S&P Global Platts, down from a high of over US$230 as recently as May.
Chinese authorities have grown increasingly frustrated at the high cost of the key industrial feedstock, with the National Development and Reform Commission saying in a statement that it will,
“Closely scrutinize changes to spot prices, swiftly investigate irregular transactions and malicious speculation, and severely punish and publicly expose acts such as monopolistic behavior, spreading around information about price increases, driving up prices and hoarding.”
China’s economy is facing headwinds on multiple fronts.
Slowing consumer consumption, despite the majority of pandemic restrictions being lifted, coupled with high commodity prices are putting a damper on the ability of Beijing to deliver the economic goodies to its citizens which legitimize the Chinese Communist Party.
Making matters worse, while China has delivered the highest absolute number of vaccine doses globally, there is some evidence to suggest that it may not be as effective as the mRNA versions being used in the west.
Fresh coronavirus outbreaks at key port cities like Shenzhen and Guangzhou are also providing new challenges for crucial export industries.
It’s unclear what Chinese authorities seek to achieve by launching the investigation or even if there is any evidence of manipulative behavior in the iron ore market.
A shift to a more hawkish tone by the U.S. Federal Reserve last week was all it took to send industrial metal prices plummeting and China’s tightening of credit conditions had already helped to pull back some of the most recent increases in the price of iron ore as well as other commodities.
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3. Another Week, Another Bitcoin Death Cross
Two weeks ago, Bitcoin’s “death cross” formed – when its 50-day moving average fell below that of its 200-day moving average, a formation on price charts used by technical analysts to indicate a sharp bearish move downwards.
And had traders used that signal to short Bitcoin, they would have been burned badly – as Bitcoin never quite threatened to fall below the US$30,000 level of resistance, rebounded sharply and rallied hard to US$41,000.
But with Chinese provinces all moving in unison to clamp down on cryptocurrency mining activities, markets have been flooded by sellers, and Bitcoin is once again forming a “death cross” – will bears get it right this time?
The trouble with technical indicators is that when it comes to a market as volatile and speculative as Bitcoin, they can lure traders into a false sense of certainty in a nascent asset class where there is nothing but uncertainty.
In March 2020, Bitcoin’s “death cross” posed no impediment to its relentless rally as gains in the benchmark cryptocurrency saw it create a “golden cross” formation – a highly bullish pattern, almost immediately thereafter.
And there’s also reason to believe the “death cross” formation this time round may not necessarily be bearish, given that the 200-day moving average is still rising.
Bitcoin fell sharply yesterday on news that Beijing looks to be closing the last remaining loopholes left on cryptocurrency trading, summoning officials from its biggest banks to a meeting to reiterate a ban on providing cryptocurrency services.
The thing about China is that that which is banned, is often more desired than ever.
From VPN services that are used to vault the formidable Great Firewall of China and access content that Beijing would rather its citizens not consume, ever since the Chinese Communist Party first ruled the vast reaches of the Middle Kingdom, China has developed a strong culture of ostensible obedience, but covert comeuppance.
A popular Chinese saying goes “China is vast, and the Emperor is far away.”
And interestingly, investors haven’t sworn off the cryptocurrency industry altogether, with large flows heading into stablecoins like Tether and USDC, a sign that there is plenty of dry powder should there be a market catalyst for a sharp rally.
Investors are understandably skittish, what with the Fed promising earlier-than-expected hawkishness and a general risk-off sentiment.
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Jun 22, 2021