A fabulous Friday to you as stocks slip on concerns over the omicron variant and China Evergrande Group's default.
In brief (TL:DR)
- U.S. stocks took a breather on Thursday with the Dow Jones Industrial Average (-0.00%), the S&P 500 (-0.72%) and the Nasdaq Composite (-1.71%) all down as traders weighed the efficacy of vaccines against the omicron variant.
- Asian stocks took their cue from U.S. markets and sank in Friday's morning session with concerns ranging from fresh pandemic restrictions to Evergrande Group's default.
- Benchmark U.S. 10-year Treasury yields rose to 1.498% (yields rise when bond prices fall).
- The dollar was unchanged.
- Oil was flat with January 2022 contracts for WTI Crude Oil (Nymex) (-0.11%) at US$70.86.
- Gold inched higher with February 2022 contracts for Gold (Comex) (+0.12%) at US$1,778.90.
- Bitcoin (-2.73%) resumed its slide to US$48,257 as broader macroeconomic concerns fueled risk-off sentiment that saw the benchmark cryptocurrency fail to sustain a push over US$50,000.
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In today's issue...
- Economists Bet Fed to End Asset Purchases by March
- Beijing Rebuffs Prospect of Bailing Out Evergrande Group
- Bitcoin Falls Through Key US$50,000 Level of Support
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Market Overview
Equity markets are drifting again as Chinese markets come into sharp focus with China Evergrande Group's official default on its dollar debt.
Asian stocks followed U.S. peers into the quagmire as traders weighed the economic threat of a potential renewal of pandemic restrictions because of the omicron variant against optimism about the efficacy of vaccines to counter the new threat.
Investors are weighing the prospect that the omicron variant will derail the fledgling economic recovery.
In Asia, the Friday morning session saw Tokyo's Nikkei 225 (-0.53%), Sydney’s ASX 200 (-0.38%), Seoul's Kospi Index (-0.74%) and Hong Kong's Hang Seng (-0.50%) all lower.
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1. Economists Bet Fed to End Asset Purchases by March
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Central banks appear to be of the view that inflation is like a dial on a thermostat that they can adjust, and this is misguided.
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And while monetary expansion has not been confined to the U.S., it has been the most aggressive in literally throwing money at the pandemic.
There are the knowable unknowns and the unknowable unknowns, but of these, one thing is certain, that the U.S. Federal Reserve will at some stage cease its monthly asset purchases is a given.
Simply “printing” more money into existence to purchase U.S. Treasuries and asset-backed securities would have to end at some point, when that is however was never a given.
And there have been no shortage of theories as to when the Fed will eventually end its monthly asset purchases, with bets increasing that it will be sooner rather than later.
The problem at the Fed right now is an issue of flexibility.
With U.S. headline inflation above 5% for 6 straight months now and prices rising at their fastest rate in over three decades, having the flexibility to raise interest rates would be a good thing.
But with asset purchases still in place, being able to do so is a bit more tricky, which is why U.S. Federal Reserve Chairman Jerome Powell has repeated that the central bank would not raise rates while asset purchases were still taking place.
With inflationary pressures increasingly anything but transient, there is more urgency for the Fed to roll back asset purchases so that even if it doesn’t raise rates, it has the flexibility to do so.
To be sure, the Fed could raise rates, but it would fly in the face of logic to do so, while still buying assets – a bit like cutting your nose to spite your face or shooting yourself in the foot.
Over half of the 48 economists polled by the Initiative on Global Markets at the University of Chicago Booth School Business said it was “somewhat” or “very” likely that the Fed would hasten the withdrawal of its stimulus by several months, bringing a complete stop to bond purchases by March next year.
Economists however were more circumspect on rate hikes, with just 10% expecting the Fed to raise rates in the first quarter of next year.
Because such an abrupt tightening of monetary policy would tank markets, most do not expect the Fed to act till June.
U.S. unemployment slid to 4.2% in November, suggesting that there is underlying strength in the labor market recovery, after months of halting progress due to worker shortages.
And the Fed has long made it one of its stated goals to reduce unemployment as well as see inflation over 2%.
Now that one of those two goals has been taken care of and the trend appears to be promising that unemployment will ebb, the Fed is likely to act more assertively.
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2. Beijing Rebuffs Prospect of Bailing Out Evergrande Group
Evergrande bondholders expecting a bailout from Beijing were left sorely disappointed when the People’s Bank of China declared that the embattled real estate developer would have to settle its own problems in the market.
In a pre-recorded video message to a top-level seminar about Hong Kong’s future as an international financial center, the PBoC’s Governor Yi Gang declared,
“The rights and interests of creditors and shareholders will be fully respected in accordance to their legal seniority.”
The comments provide the latest signal that Beijing won’t be the lender of last resort to Evergrande as it buckles under US$305 billion in liabilities.
So far, the real estate developer has yet to pay overdue interest on two bonds this week but said today that it would “actively engage” with offshore creditors on a debt restructuring.
Offshore dollar-denominated bondholders make up only a fraction of Evergrande’s overall liabilities, with the bulk owed to onshore lenders, almost all of which are entirely state-owned.
While Beijing has made clear that it will not tolerate massive debt build-ups that threaten financial stability, nor will it bailout companies that do so, it has also helped to limit the fallout from Evergrande’s restructuring.
This week, the PBoC reduced the reserve requirement ratio by a further 0.5%, injecting an estimated US$188 billion of liquidity into lending markets, while simultaneously pushing banks behind the scenes to approve mortgage applications more quickly.
While Beijing can’t be ostensibly seen to support Evergrande, it’s actions away from the spotlight suggest just that.
The bulk of Evergrande’s problems come from Beijing’s move to curb excesses in China’s white hot real estate market, but those measures on top of a crackdown in technology, afterschool education and coal-fired power stations, have hastened a broad slowdown in the economy.
Although China was one of the first countries to emerge from the pandemic, Beijing’s attempt to restructure the economy all at once, has seen the country’s economic recovery now lag other major economies, especially the United States.
On Monday, a Chinese Communist Party Politburo meeting signaled looser curbs on real estate, in an attempt to wind back some of the measures that have been responsible for Evergrande’s current predicament.
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3. Bitcoin Falls Through Key US$50,000 Level of Support
First it was US$10,000, then US$20,000, now US$50,000 appears to be a key psychological level of resistance and support for bitcoin traders, whether you’re a bull or a bear.
For now, the bears appear to have the upper hand with bitcoin failing to keep its head over US$50,000, declining for the first time five trading sessions amidst a general risk-off sentiment in markets that has seen cryptocurrency prices slip.
Chart watchers will note that it appears as if bitcoin is now caught in technical purgatory, between moving averages with no discernible pattern over what happens next.
Although bitcoin is forming what’s known by technical traders as a “head-and-shoulders” pattern, a classic bearish formation, the last time this happened in 2017, bitcoin also soared to a fresh new high of close to US$20,000.
Bitcoin plunged swiftly last Saturday, falling by over 20% in the span of a few hours, in a “flash crash” that has become increasingly common for the cryptocurrency, where derivatives can cause a cascading series of forced liquidations.
It’s estimated that around 4,000 bitcoins were sold over a short period of time on Saturday, amounting to just US$280 million at the time, but that resulted in over US$600 million in liquidations.
Given that bitcoin’s total market cap is in the region of US$1 trillion, a sale of that magnitude ought not to have riled markets so much, but weekend markets for cryptocurrencies are notoriously thinner, with much of the trading left to bots while their human comptrollers head off to enjoy a brief respite.
And that contributed to the cascading liquidations and margin calls which saw the sharp selloff.
Heading into the week though, bitcoin rapidly entered oversold territory and recovered sharply to over US$50,000, hitting as high as US$51,000 before pulling back again.
With bitcoin increasingly attracting interest from more mainstream financial players and institutions, the arrival of an albeit futures-backed U.S. bitcoin ETF, a key macro event on the horizon could help shape up how bitcoin finishes 2021, in what has been an otherwise stellar year for the cryptocurrency.
The U.S. Federal Reserve is due to meet in less than a week, where expectations are high that policymakers will accelerate the tapering of asset purchases, bringing forward their end to as early as March next year.
That move would pave the way for a potential interest rate increase by June next year, which many analysts see as being a bearish outcome for risk assets in general, which would encompass bitcoin.
Bitcoin bulls however remain unperturbed, with many, including Mike McGlone at Bloomberg Intelligence noting that the cryptocurrency is a risk asset that is slowly evolving into a digital reserve asset, which should have positive implications for its price.
McGlone estimates that bitcoin could reach as high as US$100,000 next year, but that short term volatility can be expected to stay.
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