Novum Alpha - Daily Analysis 2 November 2021 (10-Minute Read)
The earnings season has underpinned the equity market, countering worries about inflation and the prospect of tighter monetary policy.
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A terrific Tuesday to you as markets tear up records and continue to pile on the gains.
In brief (TL:DR)
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In today's issue...
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Market OverviewThe earnings season has underpinned the equity market, countering worries about inflation and the prospect of tighter monetary policy.
But pandemic-era supply-chain challenges coupled with higher energy costs could become a bigger test if they feed into wider, more enduring price pressures.
Lesser central banks have already caved to inflationary pressures, but it remains to be seen if the U.S. Federal Reserve will lose its resolve.
In Asia, markets were mixed Tuesday with Tokyo's Nikkei 225 (-0.34%) and Sydney’s ASX 200 (-0.72%) down, while Seoul's Kospi Index (+1.53%) and Hong Kong's Hang Seng (+1.42%) were up in the morning trading session.
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1. HNA's US$170 billion Restructuring Provides Roadmap for Evergrande
When Chinese conglomerate HNA Group (-2.90%) first started showing signs of difficulty, after going on a high-profile global heavily levered global acquisition binge, it stood as one of the biggest potential defaults in Chinese history.
But looking back now, HNA Group was perhaps just the tip of the iceberg compared with China Evergrande Group, whose total liabilities are almost double those of HNA Group’s.
Nonetheless, a Chinese court has approved the US$170 billion restructuring of HNA Group in a move that could pave the way for a resolution of the China Evergrande Group crisis.
The deal, which will see HNA Group’s creditors get around ten cents in the dollar, received overwhelming support by creditors and will see HNA Group’s aviation, airport, financial and commercial divisions split into separate business entities with fresh state and private shareholders.
In what appears to be a quasi-nationalization of the HNA Group’s assets, which sees both private investors and state entities bailing out the embattled conglomerate, expectations are growing that a similar resolution could be tabled for China Evergrande Group as well.
Unlike HNA Group, China Evergrande Group’s struggles are already spilling over into China’s wider economy and a messy collapse could result in system-wide failures.
With a full 70% of the Chinese economy and 29% of GDP directly or indirectly linked to the property sector, pressure is mounting for Beijing to act before it becomes too late.
Evergrande has already missed several interest payments on its offshore bonds in late September but managed to transfer funds just before the end of the 30-day grace period which would otherwise have put it in default.
Some are suggesting that if HNA Group can be split into more manageable bite-sized chunks, there is a chance that China Evergrande Group could very well end up the same way.
In many ways, China Evergrande Group’s ascent mirrors that of HNA Group’s, where a powerful and politically-connected Chinese conglomerate went on a debt-fueled global acquisition binge, in many cases paying rich premiums for trophy assets.
But HNA Group’s house of cards started to waver when Chinese financial regulators stepped up scrutiny over its leveraged acquisitions and opaque ownership, much the same way that China Evergrande Group faced issues as soon as Beijing tightened policy in China’s white-hot real estate sector.
Yet given that HNA Group is not as systemically important to the Chinese economy as compared to China Evergrande Group, there’s more than an outside chance that HNA Group’s restructuring will provide a necessary blueprint for the latter.
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2. Bond Traders Betting Big on Global Monetary Policy Shift
“I fought the law and, I won.”
– Lyrics adapted by Sonny Curtis of the Crickets “I Fought the Law” © 1960
The last time that a trader went up against a central bank, it was the central bank who caved.
Billionaire macro trader George Soros, who’s been blamed by conspiracy theorists for everything from chemtrails to Covid-19, bet in 1992 that the Bank of England, the United Kingdom’s central bank, would no longer be able to maintain the European Exchange Rate Mechanism which pegged the British pound with the German deutschemark.
The Bank of England blinked first.
In the lead up to so-called “Black Wednesday” the pound had more or less shadowed the deutschemark for the better part of a decade, but given the dramatic differences between the German and British economies at the time, was untenable.
The U.K. was suffering from inflation many times that of Germany, but was keeping interest rates low while trying to peg the pound to the deutschemark, a situation that ultimately proved untenable.
And now with inflation across the globe spiking, supply chain snarls, commodity prices spiking and wages increasing in the U.S., bond traders are once again betting that central bankers globally will be forced to up rates.
Some central bankers have already caved.
The Reserve Bank of Australia has already allowed its benchmark 3-year bond yield to soar to 0.85%, well above its 0.1% target, instead of trying to keep prices down by ramping up purchases, but it’s hardly alone.
In Canada, the central bank abruptly scrapped its own quantitative easing program las week, which saw bond prices all but collapse and now investors are taking the fight to the European Central Bank, which has remained steadfast so far in the face of inflationary pressures.
The Bank of England, perhaps stung by its track record of being beat by traders, cheered the market to a sharp retreat in short-term gilt prices, which has since spread to other bond markets, when it signaled a potential rate rise in September, which has so far failed to materialize.
U.S. two-year yields have soared to 0.55%, their highest level since before the pandemic and more than double the 0.21% from a month ago, just ahead of the U.S. Federal Reserve’s meeting on Wednesday, with many expecting the central bank to pare its pandemic-era bond purchases.
Some bond traders were burned by central bank guidance that inflationary pressures were “transitory” and are understandably unwinding their loss-making positions, which as seen bond prices plummet, but there is at least some reason to believe that the Fed will hold steady.
Unemployment in the U.S. remains stubbornly above pre-pandemic levels, even as there is a shortage of workers and wages are creeping upwards and the Fed has intimated on multiple occasions that labor is a key metric when considering its policy direction.
Nonetheless, central bankers have been known to say one thing, but caved when the market delivered another.
For now at least, the deck appears to be stacked against the central bankers who can only hope they have an ace or two up their sleeve to play.
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3. Could Stablecoins Result in Financial Instability?
The thing about cracks in dams is that they’re never a problem until they become one and now that the stablecoin universe has grown so large, thanks in large part to a relentless rally in cryptocurrencies, regulators are concerned they could be the point of weakness in the global financial system.
Taking their first step towards regulating stablecoins, U.S. federal agencies are urging lawmakers to allow them to police stablecoin issuers as if they are banks, with robust capital requirements and constant supervision.
Even if lawmakers are reticent to hand over the reigns of stablecoin supervision to U.S. federal agencies, they are likely to activate secondary powers to investigate whether stablecoins could pose a systemic threat to financial stability, a review that could trigger a raft of new regulations.
Stablecoins have exploded alongside interest in cryptocurrencies.
A halfway house between cryptocurrencies like ether and bitcoin, stablecoins started off as a means by which traders could place assets momentarily to avoid the volatility inherent in cryptocurrencies, with the first stablecoin Tether, ostensibly backed by its equivalent in dollars.
Since 2012, stablecoins have since grown to a US$130 billion market, underpinning a cryptocurrency market that is now worth in the trillions of dollars.
Stablecoins are labeled “stable” because they are supposed to have their value tied to that of another asset, such as the dollar and issuers allege that they maintain such a peg by keeping an amount in reserve that’s equivalent to the tokens in circulation, often guaranteeing convertibility.
But such pledges of full convertibility may ring hollow, especially during times of crisis.
Tether for instance, the largest issuer of dollar-based stablecoins, has just 3% of its US$70 billion in dollar deposits, with the rest in “cash-like” instruments such as commercial paper and other money market instruments.
A loss in confidence in a stablecoin could cause a run on an issuer, such as Tether, which may force the company to unload assets in a fire sale and risk not being able to meet redemptions, which may ripple through the financial system.
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Nov 02, 2021