Novum Alpha - Daily Analysis 13 July 2022 (10-Minute Read)
A wonderful Wednesday to you as stocks wind lower on concerns that a high U.S. inflation print could see a more aggressive U.S. Federal Reserve interest rate hike later this month.
In brief (TL:DR)
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In today's issue...
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Market OverviewEconomists project U.S. inflation likely hit a pandemic peak in June that will keep the Federal Reserve geared for another big interest-rate hike.
The consumer-price index probably rose 8.8% from a year earlier, the largest jump since 1981, according to a Bloomberg survey ahead of the release Wednesday.
Rapidly tightening monetary policy in the U.S. and elsewhere to fight price pressures is fueling worries about growth and leaving markets nervous.
Asian markets were higher on Wednesday with Tokyo's Nikkei 225 (+0.54%), Seoul's Kospi Index (+0.47%), Hong Kong's Hang Seng Index (+0.01%) and Sydney’s ASX 200 (+0.23%) all up.
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1. Kansas City Fed President Warns Against Hiking Rates Too Quickly
With the macro picture as uncertain as ever, policymakers at the U.S. Federal Reserve are becoming increasingly divided over the magnitude and efficacy of rate hikes to rein in the fastest pace of inflation in over four decades.
Ahead of the U.S. inflation print for June, Federal Reserve Bank of Kansas City President Esther George warned that a rushed pace in policy tightening could do more harm than good.
In a speech to the Mid-America Labor and Management Conference in Missouri, George suggested “communicating the path for interest rates is likely far more consequential than the speed with which we get there” adding that raising rates “too fast” would heighten the risk of “oversteering.”
George stood out as the only dovish dissent in June’s 75-basis-point Fed rate hike and the Reserve Bank of Kansas City’s President was concerned that increasing rates rapidly risks tightening faster than the “economy and markets can adjust.”
While many policymakers have publicly expressed a further hike of 0.75% at the Federal Open Market Committee meeting later this month, George prefers a 50-point hike instead and investors appear to be betting on that.
Despite no shortage of rhetoric from policymakers of another hawkish outcome at the end of this month’s Fed rate-setting meeting, traders have priced in an estimated 3.4% for interest rates in the first half of next year, well beneath the central bank’s own plot.
The Federal Funds Rate currently sits between 1.5% to 1.75% with estimates of rates ending this year between 2.5% to 2.75%.
George argued that there was considerable uncertainty surrounding the correlation between the speed of the Fed’s actions, and their impact on the real economy suggesting it was imperative to “observe how the economy is adapting to changes in monetary policy.”
In contrast, U.S. Federal Reserve Chairman Jerome Powell once noted that there is no lag in the effect of monetary policy as economic stakeholders respond instantaneously to forward guidance, noting that businesses anticipating higher borrowing costs in the future, don’t necessarily wait till it happens before making provision.
But the Fed hasn’t been able to give clear forward guidance and much of that has to do with the fact that nobody knows what the outlook for the next several quarters is, let along the next several years.
With the Russian invasion of Ukraine dragging on, key agricultural and industrial commodities are being withheld from global markets and sending the price of basic necessities soaring globally.
Risk aversion is seeing the greenback soar to its highest level in years and companies are scaling back hiring, expansion and plans for public offerings, even as inflation remains stubbornly elevated.
Against this backdrop, it’s no wonder that the Fed can only make policy on the fly and that is contributing significantly to both market and business volatility.
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2. Investors Dump Chinese Policy Bank Bonds
For years, a favored trade of global investors was to gorge on bonds issued by Chinese state-owned lenders otherwise known as “policy banks” which funded Beijing’s ambitious public works projects, paying for everything from dams to motorways, airports to seaports, both at home and abroad.
But the Russian invasion of Ukraine and Beijing’s reticence to condemn the unprovoked military action is now forcing global investors to take a closer look at the Chinese banks that they’ve been funding, especially those with exposure to Russian borrowers.
With Washington and its allies imposing harsh sanctions on Russia, there are growing concerns that countries or institutions which continue to fund Moscow’s ability to wage war will eventually be caught in the crosshairs of western sanctions.
Two of three Chinese policy banks, China Development Bank (CDB) and the Export-Import Bank of China (Exim Bank), are known to have extended credit lines worth billions of dollars to Russian borrowers using those monies to fund everything from infrastructure to energy.
In February, international investors liquidated US$27 billion in yuan-denominated Chinese policy bank bonds, roughly a sixth of accumulated holdings of such debt.
According to data from China Central Depository & Clearing, the pace of the selloff has increased greatly since May, when western allies imposed a fresh round of sanctions on Moscow.
A 2017 U.S. law that gives the U.S. government the right to penalize foreign entities that trade with sanctioned firms, countries, and people has provided plenty of food for thought for global investors who want to keep doing business with America and forcing a rethink of even some of the most lucrative investments that have tangential links to Russia.
Although not the target of sanctions themselves, these “secondary sanctions” could jeopardize already embattled Chinese banks and potentially stymie their ability to raise fresh capital in global bond markets.
Between 2000 and 2017, CDB and Exim Bank extended loans north of US$73 billion to Russian state-owned businesses and financial institutions, according to AidData’s statistics which follows China’s international lending activities.
And recently, further loans extended to a Russian borrower by CDB and Exim Bank amounting to US$2.54 billion are said to have been issued.
But it’s entirely possible that the “Russian connection” could be nothing more than a convenient excuse for global investors to drop Chinese policy bank bonds.
There has been growing concern that China’s heavily leveraged banks are in bad shape with some estimates putting Chinese banks at 350% indebtedness, compared with U.S. banks at 100%.
Reports of regional and state-owned banks freezing deposits in parts of China, leading to mass protests outside bank branches, have surfaced in recent weeks and managers may simply be looking to de-risk their portfolios in a time of heightened economic uncertainty.
Soaring U.S. Treasury yields are also a possible reason why investors are looking to exit China – the benchmark 10-year U.S. Treasury yields close to 3% at the moment, while CDB bonds yield 2.83% and Chinese sovereign debt, 3.08%.
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3. Texan Bitcoin Miners Shutdown Rigs as Price Plummets and Power Grid Maxed Out
With a searing heat wave on the horizon and in the middle of a Crypto Winter, industrial-scale Bitcoin miners in Texas have been forced to shut down their rigs temporarily to prevent overtaxing the state’s power grid.
Listed cryptocurrency miners Riot Blockchain, Argo Blockchain and Core Scientific, who run millions of energy-intensive computers to secure transactions on the Bitcoin blockchain, were attracted to the Lone Star State due its cheap energy and flexible regulations.
In the wake of a harsh crackdown on cryptocurrency miners in China, many industrial-scale miners moved offshore to places like Texas, leading to the state becoming one of the world’s largest contributors of hashrate, a measure of the computational power being contributed to secure the blockchain.
But plummeting prices of cryptocurrencies, in particular Bitcoin, and a heat wave that will likely see energy prices skyrocket in Texas may put further pressure on profits at already struggling cryptocurrency miners.
With Bitcoin and Ether have both fallen by over 70% from their all-time-highs, many cryptocurrency miners who borrowed money to buy equipment are now facing major cost pressures and some have been forced to offload their substantial holdings of crypto, exacerbating the downswing.
But unutilized machines continue to depreciate and the loans taken in better times will need to be paid off.
President of Texas Blockchain Association Lee Bratcher share with Bloomberg that there are “over 1,000 megawatts worth of Bitcoin mining load” that has been halted due to ERCOT’s (Electric Reliability Council of Texas) conservation appeal.
Many miners have found themselves grappling to repay their debts and raise further capital with Bitcoin’s price remaining depressed and shares of publicly-listed crypto miners have already fallen an estimated 75% this year alone, far more than the cryptocurrencies they mine.
Texas is expected to face more energy shortages with miners increasing demand to an estimated six gigawatts by mid-2023 increasing the cost of Bitcoin mining, and drawing into sharp focus whether Texas was necessarily the right place to situate crypto mines.
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Jul 13, 2022