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Novum Alpha - Daily Analysis 30 September 2021 (10-Minute Read)

Investors are finishing the third quarter concerned about global growth amid inflationary pressures, a looming energy crisis, supply chain bottlenecks and regulatory risks emanating from China.

 
A wonderful Thursday to you as today marked the end of Q3.
 

In brief (TL:DR)

 
  • U.S. stocks ticked higher on Wednesday with the Dow Jones Industrial Average (+0.26%) and the S&P 500 (+0.16%) up while the tech-centric Nasdaq Composite (-0.24%) was lower on concerns that a potential energy crisis could skyrocket inflation. 
  • Asian stocks were mixed Thursday as investors assessed the impact of skyrocketing energy costs on inflation and the pandemic recovery.
  • Benchmark U.S. 10-year Treasury yields fell one basis point to 1.51% (yields fall when bond prices rise).
  • The dollar traded near the highest since November as investors opted for safe havens. 
  • Oil was little changed after declining with November 2021 contracts for WTI Crude Oil (Nymex) (-0.13%) at US$74.73.
  • Gold was steady after declining with December 2021 contracts for Gold (Comex) (+0.58%) at US$1,732.90.
  • Bitcoin (+3.19%) jumped to US$43,501 with data showing that whales have been moving record amounts of Bitcoin in the past two weeks.
 

In today's issue...

 
  1. Evergrande Sells Away to Pave a Way
  2. Stagflation’s Ugly Head Looms
  3. U.S. CFTC Fires First Salvo at Cryptocurrency Firms
 

Market Overview

 
The deadline for the U.S. government to keep running and avoid a default is looming amid wrangling in Washington. Treasury yields remained around the highest since June.
 
Investors are finishing the third quarter concerned about global growth amid inflationary pressures, a looming energy crisis, supply chain bottlenecks and regulatory risks emanating from China.
 
Meanwhile, China’s factory activity contracted in September for the first time since the pandemic began last year, a sign of the damage a widespread electricity crunch is having on an already slowing economy.
 
In Asia, markets were mixed with Tokyo's Nikkei 225 (-0.36%) and Hong Kong's Hang Seng (-0.96%) down while Seoul's Kospi Index (+0.54%) and Sydney’s ASX 200 (+1.43%) were up in the morning session.
 

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1. Evergrande Sells Away to Pave a Way

 
  • Evergrande Group raised US$1.5 billion by selling a 20% stake in Shengjing Bank to a state-owned investment group, providing a potential roadmap out of its US$305 billion liabilities.
  • There are good indications that Beijing isn’t about to let Evergrande Group implode.
 
In what is likely to have been a move “motivated” by Beijing and similar to other Chinese restructurings, embattled Evergrande Group (-5.54%) is starting to pare down assets in an attempt to stave off a collapse of the second largest real estate developer in China.
 
The first of what is likely to be several major sales, Evergrande Group raised US$1.5 billion by selling a 20% stake in Shengjing Bank (-1.83%) to a state-owned investment group, providing a potential roadmap out of its US$305 billion liabilities.
 
Although US$1.5 billion is a drop in the ocean compared to Evergrande Group’s overall liabilities, it’s important to note that just US$20 billion of the real estate developer’s borrowings are offshore dollar-denominated obligations.
 
And this provides many avenues for creative dealmaking for the Evergrande Group within the Middle Kingdom, including the sale of assets at “fair market prices” as a face-saving way to shore up the firm’s finances, without calling it a government bailout.
 
Because almost all of China’s lenders, which also happen to form the bulk of Evergrande Group’s creditors, are state-owned, the prospect of entering into multiyear, multistage deals such as the Shengjing Bank one are good.
 
If nothing else, the speed at which the Shengjing Bank deal was consummated should provide some comfort for investors who remain concerned that the failure of Evergrande Group could seriously dent China’s economy, where as much as 29% of GDP comes from its property sector alone.
 
And there are good indications that Beijing isn’t about to let Evergrande Group implode.
 
In the southern industrial city of Guangzhou for instance, where property prices have only ever gone in one direction, a local government department has said that revenues at an Evergrande Group subsidiary ought to be put into a government account, to protect homebuyers’ interest.
 
Another government housing bureau in Zhuhai, another major city just a stone’s throw from Guangzhou echoed such sentiments for property sales proceeds to be secured in government accounts.
 
And that charts a potential path out of a collapse of Evergrande Group – the ideal outcome would be a restructuring of the real estate giant’s debilitating debts, with creditors being forced to take write downs where necessary and transferring valuable assets out of the group to state-owned entities.
 
In the meantime, the citizenry could be protected by securing the payments on their homes and ensured that they are completed, which will help to avoid the mess of a disorderly default on Evergrande Group’s liabilities that could destabilize the global financial system.
 

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2. Stagflation's Ugly Head Looms

 
  • A post-pandemic landscape would result in slow growth against a backdrop of high inflation.
  • While fiscal and monetary stimulus may have helped to soften the blow, even as developed economies emerge from the pandemic lockdowns, the expected pent-up surge in consumption has failed to materialize.
 
There was always the risk that a post-pandemic landscape would result in slow growth against a backdrop of high inflation.
 
To say that the pandemic came at the worst possible time in the global economy’s development cycle is putting it mildly.
 
Already present structural changes were afoot, with increasing automation and digitalization rendering a swathe of jobs and entire sectors redundant.
 
The pandemic has only accelerated the pace of change and accentuated the mismatch between skills and jobs.
 
While fiscal and monetary stimulus may have helped to soften the blow, even as developed economies emerge from the pandemic lockdowns, the expected pent-up surge in consumption has failed to materialize.
 
Instead, while consumption did increase initially, souring consumer sentiment has seen early gains since plateau.
 
Complicating matters, an ill-timed Chinese crackdown on everything from its tech companies to its property sector could see the world’s second largest economy grow far more slowly than the world had grown accustomed to.
 
And in the backdrop, the inflationary demons that central bankers have long dismissed as transitory, are now threatening to stick around that much longer, exacerbated by supply chain disruptions and soaring energy prices.
 
At a time when the U.S. Federal Reserve has delayed tapering its asset purchases, rising bond yields are putting downwards pressure on equities.
 
And testifying before Congress on Tuesday, U.S. Federal Reserve Chairman Jerome Powell conceded that headline U.S. inflation had been kept over 5% for three consecutive months, which was “larger and longer lasting than anticipated.”
 
With stimulus checks all but spent and the looming U.S. debt ceiling on the horizon threatening to see the world’s biggest economy default on its obligations, the macroeconomic risks are soaring at a time when growth is slowing and inflation is rising.
 
And while governments and central banks will do all that they can to avoid stagflation, they are fast running out of tricks in their toolbox.
 
More stimulus won’t automatically make the problem go away, nor will a return to a more normal monetary policy at a time when growth is slowing.
 
The painful structural problems that have been present in the global economy even before the pandemic have yet to be sorted, wishing them away won’t help.  
 

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3. U.S. CFTC Fires First Salvo at Cryptocurrency Firms

 
  • U.S. cryptocurrency exchange Kraken, paid US$1.25 million in fines to settle allegations that it had enabled U.S. residents to trade in illegal margin products linked to Bitcoin and other cryptocurrencies.
  • If regulators genuinely seek to protect the public interest, they should instead work together with those who choose to be regulated, as that will naturally bring more customers within the regulatory orbit.
 
While the U.S. Securities and Exchange Commission may be jostling for primacy in the Wild West of cryptocurrency regulation, it’s been its rival agency, the U.S. Commodity and Futures Trading Commission that has fired the first salvo against exchanges.
 
According to a CFTC statement on Tuesday, U.S. cryptocurrency exchange Kraken, paid US$1.25 million in fines to settle allegations that it had enabled U.S. residents to trade in illegal margin products linked to Bitcoin and other cryptocurrencies.
 
Earlier this month, U.S.-listed cryptocurrency exchange Coinbase Global (-1.98%) walked back plans to launch its cryptocurrency lending product called “Lend” after the SEC threatened to sue should it go ahead.
 
The CFTC also alleged that Kraken had failed to register itself with the agency as a futures commission merchant.
 
“Margined, leveraged or financed digital asset trading offered to retail U.S. customers must occur on properly registered and regulated exchanges in accordance with all applicable laws and regulations.”
 
The statement highlights the uneven playing field that cryptocurrency exchanges operate in, with those that pursue regulatory compliance being hamstrung by trigger-happy regulators, while offshore cryptocurrency exchanges that still find means to cater to U.S. residents allowed to offer a smorgasbord of investment and trading options.
 
Products such as cryptocurrency lending and derivatives have long been offered by offshore cryptocurrency exchanges domiciled in places like the Bahamas and Seychelles.
 
And it’s not entirely clear how regulators will police the decentralized finance space, where traders (retail or otherwise) are able to gain access to derivatives via smart contracts, with no barriers to entry or trading.
 
If regulators genuinely seek to protect the public interest, far from bringing the hammer down on cryptocurrency firms, they should instead work together with those who choose to be regulated, as that will naturally bring more customers within the regulatory orbit.
 

 

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Sep 30, 2021

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