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Novum Alpha - Weekend Edition 18-19 September 2021 (10-Minute Read)

Investors are facing an ever-growing list of headaches from weakening earnings forecasts, a slow but perceptible shift in central bank policy and the prospect of an overseas credit implosion. And that's not to mention the delta variant that could defeat the current clutch of vaccines and derail the nascent economic recovery. 

A wonderful weekend to you and some respite for investors as equities marked their second weekly drop on concerns over the economic recovery. 

In brief (TL:DR)

  • U.S. stocks closed lower on Friday, with the Dow Jones Industrial Average (-0.48%), S&P 500 (-0.91%) and tech-centric Nasdaq Composite (-0.91%) all lower as investors digested the mixed bag of economic data.  
  • Asian stocks were mostly higher on Friday, as Beijing's move to shore up liquidity in its banking sector provided an unexpected bump for Asian equities. 
  • Benchmark U.S. 10-year Treasury yields rose to 1.371% (yields rise when bond prices fall) on a weakening economic outlook. 
  • The dollar continued to rise amidst uncertainty. 
  • Oil slipped with October 2021 contracts for WTI Crude Oil (Nymex) (-0.88%) at US$71.97 amidst an uncertain demand outlook. 
  • Gold was flat with December 2021 contracts for Gold (Comex) (-0.30%) at US$1,751.40.
  • Bitcoin (+1.95%) was higher into the weekend at US$48,400 Saturday, 1500 GMT) with inflows slowing against outflows (inflows suggest that traders are looking to sell Bitcoin in expectation of lower prices). 


In today's issue...

  1. In China, Some Will Stay Rich First
  2. Could the ECB Raise Rates Ahead of the Fed? 
  3. Go Ahead, Make My (Crypto) Market 



Market Overview

Investors are facing an ever-growing list of headaches from weakening earnings forecasts, a slow but perceptible shift in central bank policy and the prospect of an overseas credit implosion. 
And that's not to mention the delta variant that could defeat the current clutch of vaccines and derail the nascent economic recovery. 
The weekend should bring brief respite and things should look brighter on Monday though as the People's Bank of China has moved to shore up its credit markets, indirectly supporting beleaguered real estate giant China Evergrande Group (-3.42%) that is buckling under a US$300 billion of debt. 
So far the PBoC has pumped in US$14 billion, but it may have to do more and fast. 
In Asia, markets ended Friday up, buoyed by the prospect of Beijing bailing out its real estate giant with Tokyo's Nikkei 225 (+0.58%), Hong Kong's Hang Seng (+1.03%) and Seoul's Kospi Index (+0.33%) higher while Sydney’s ASX 200 (-0.76%) was lower at the close. 

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1. In China, Some Will Stay Rich First

  • Chinese central bank seeks to shore up short term liquidity in credit markets by flooding the financial system with liquidity 
  • Beijing may need to consider bigger moves though as time starts to run out on embattled real estate giant China Evergrande Group, including the nationalization of the entity  
After surveying the vast work that was needed to bring the Chinese economy into the modern era, then-Chinese leader Deng Xiaoping famously declared that the world’s most populous country (at the time) should let “some get rich first.”
And while Chinese President Xi Jinping may be looking to “shared prosperity,” it’s evident by recent moves to shore up the banking system that in China “some stay rich forever” regardless of what happens.
As the debt crisis intensifies at China’s largest real estate developer China Evergrande Group (-3.42%), the People’s Bank of China flooded the banking system with an additional US$14 billion on a net basis through 7-day and 14-day repo agreements, the most since February.
The move to shore up short-term liquidity, the most in a single day, comes as the trouble facing China Evergrande Group spills over into the real estate and credit markets.
Making matters worse, a seasonal spike in demand for cash has left banks hesitant to make loans at the end of the quarter ahead of regulatory checks.
A one-week holiday at the start of October, China’s “Golden Week” is also a time when most Chinese start to draw on more cash from banks.
While Chinese authorities continue to take action against its tech giants, afterschool education companies, ride-hailing leader Didi Chuxing (+1.59%) and video games, other “favored” sectors have been propped up with taxpayer funds, like real estate.
Despite concerns that soaring real estate prices have led to disquiet over rising inequality, steps to cool property prices have taken their toll, even as China’s economy is already showing signs of slowing.
Last Wednesday, China reported a sharper-than-expected slowdown in retail sales in August, along with weaker growth in industrial production and fixed asset investment.
The People’s Bank of China, the Chinese central bank, is walking a tightrope to ensure sufficient liquidity, without fueling unwanted asset bubbles.
As it stands, China Evergrande Group is likely to find a white knight in Beijing, because the collapse of the real estate developer would have broader repercussions on the property market, with potentially debilitating effects on the economy and the evaporation of billions of dollars of Chinese wealth, which is heavily tied to property.
Fitch Ratings has warned that numerous industries could be exposed to credit risks if China Evergrande Group was allowed to default on its debt, with many smaller domestic banks and vulnerable developers likely to collapse in the fallout.
But with over US$300 billion in liabilities, Beijing will need to act fast to shore up the beleaguered real estate giant, as China Evergrande Group’s liquidity stress is stoking worries over the broader Chinese property industry. 

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2. Could the ECB Raise Rates Ahead of the Fed?

  • European Central Bank internal models suggest inflation targets will be met ahead of schedule 
  • Some investors are already pricing in an accelerated rate hike by the ECB, although there are more who believe that the ECB won't raise rates as quickly 
You raise rates if you want to, the Lady’s not for raising.
So far, European Central Bank President Christine Lagarde hasn’t played on the famous words of former U.K. Prime Minister Margaret Thatcher with respect to interest rates, though she has repurposed those words to speak about tapering asset purchases.
And while the ECB may be buying fewer sovereign bonds, raising rates is an altogether different proposition.
According to unpublished internal models, the ECB expects to hit its thus far elusive inflation target of 2% by 2025, raising the prospect of an earlier-than-expected interest rate increase in the eurozone.
Some investors are already pricing in rate rises by the end of 2023, a view that appears to be confirmed by the ECB’s longer term inflation outlook.
Nonetheless, an internal model does not a policy decision make, but will no doubt intensify debate over how quickly major central banks will reverse their massive stimulus programs this year, that were meant to counter the economic effects of the pandemic.
For years, the ECB has struggled to hit inflation targets – a crucial factor in setting interest rates and adjusting asset purchases.
Other analysts believe that the U.S. Federal Reserve will hike rates before the ECB though, with the Fed widely expected to increase rates as early as next year if the U.S. economy continues to rebound from the pandemic.
The eurozone has seen inflation soar to a decade-high 3% in August, but the ECB has stressed that the spike was due to transient factors, including supply chain disruptions and pent-up demand.
But the odds of an accelerated rate hike by the ECB are still somewhat remote.
To raise rates, the ECB must forecast inflation will reach 2% within 18 months and stay there for another 18 months.
Simultaneously, core inflation, which excludes more volatile energy and food prices, must rise enough to be consistent with the ECB’s 2% target.
With the delta variant slowing down the recovery in both the U.S. and China, major markets for Europe, the odds of these metrics being met to trigger rate hikes isn’t high.
If nothing else, the nascent rally in European equities is perhaps just beginning.
The eurozone has rebounded strongly from the pandemic, thanks in large part because of mass vaccination campaigns and strict measures to exclude the unvaccinated from many aspects of European living, from eating out at cafes and restaurants, to drinking at bars and attending concerts.
These measures have had a dramatic effect in encouraging a higher vaccination rate, despite widespread misinformation.
And with European companies still trailing their American counterparts in terms of valuation, and the likelihood that the ECB is likely keep rates lower for longer, the medium term outlook for eurozone equities looks rosy. 

3. Go Ahead, Make My (Crypto) Market

  • Big Wall Street market making and high frequency trading firms are pouring more money and talent into trading cryptocurrencies 
  • Institutional demand is spurring on competition in the cryptocurrency markets with substantial returns from gross inefficiencies possible 
Tucked away in a nondescript office building in downtown Singapore, a group of twentysomethings knocks back cans of Red Bull as they pour over thousands of lines of code to figure out how to optimize their order management system.
No, this isn’t Singapore’s next big startup nor are the coders looking to make money from stocks or other traditional financial assets, instead, a young and talented team of software developers is looking to discern the ever increasing number of ways to make money from the inefficiencies inherent in cryptocurrency trading.
As any seasoned crypto trader will tell you, the price for any specific crypto asset depends on where you’re looking to buy or sell that asset, and how much of it.
Given the decentralized nature of cryptocurrencies, exchanges both big and small, with both real and fake volumes, post prices for thousands of crypto assets, providing myriad opportunities to skim and profit from arbitrage and price dislocation.
Which is what has drawn some of the biggest names on Wall Street in the market making business to duke it out in cryptocurrencies, in an attempt to cash in on the lucrative flows coming from institutional investors.
Some of the biggest names in the U.S. equity markets, including Jump Trading, GTS and Jane Street, are all stepping up their investment in cryptocurrency trading after years of secrecy surrounding their initial forays into the nascent asset class.
High frequency trading has transformed the landscape of the U.S. equity markets, with highly optimized, low-latency execution of trades that help market makers like Jump Trading, GTS and Jane Street make just pennies on each transaction, but billions in revenues a year.
Many of these market markers now want to bring their expertise honed in equities into cryptocurrencies, as institutional investors are increasingly drawn by the high returns the digital asset space has on offer.
Analysts at JPMorgan Chase (-0.24%) estimate that by late last year, high frequency traders were responsible for almost 80% of the Bitcoin prices sent to exchanges, with many of these computer-driven trades targeting the “basis trade” – the discrepancy between the spot price and derivatives price of a cryptocurrency.
For instance, earlier this month, the spread between Ether and an Ether future expiring in March next year was as wide as 7.1%, allowing a trader to lock in that spread by simply buying the underlying token and selling the futures contract.
But Wall Street firms may have their work cut out for them as the cryptocurrency markets are by design decentralized, and specialist cryptocurrency trading firms are already prowling the markets with potentially the exchanges themselves, many of which remain unregulated, blocking their path to easy profits. 

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Sep 18, 2021

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