Novum Alpha - Daily Analysis 1 August 2022 (10-Minute Read)
A magnificent Monday to you as a slide in China factory activity underscores global challenges, while U.S. equities closed higher on Friday.
In brief (TL:DR)
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Check out Novum Alpha Weekly Interview #1: What is the future of Crypto Lending?
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Market OverviewThe risk of a recession has cooled expectations for how sharply the U.S. Federal Reserve has to hike rates to tame inflation, spurring a July rebound in stocks and bonds.
But market jumps on the back of easing financial conditions can imperil the goal of curbing demand to contain the cost of living, adding pressure on central banks to tighten.
Recent developments underline the economic challenges facing China, including shrinking property sales and a contraction in factory activity that highlighted the cost of Beijing’s preference for mobility curbs to tackle Covid-19.
Asian markets were higher on Monday with Sydney’s ASX 200 (+0.69%), Seoul's Kospi Index (+0.03%), Tokyo's Nikkei 225 (+0.69%) and Hong Kong's Hang Seng Index (+0.11%) all up in the morning trading session.
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1. U.S. Wage Hikes Keeps Pressure on Fed to Remain Hawkish
While markets may have cheered a brief summer respite thanks to the U.S. Federal Reserve taking a well-deserved break in August and leaving a priced-in 75-basis-point hike in July before swapping their corporate suits for the bathing variety, wage pressures threaten to cut short the risk-on party.
Two closely watched inflation reports show little relief from record-setting price pressures in the U.S. and underscore the urgency with which the Fed will need to act, even possibly having to ratchet up measures in September if things do not quiet down.
The latest Employment Cost Index (ECI) report, which tracks wages and benefits paid out by U.S. employers showed that total pay for non-government workers during the second quarter increased by 1.3%, slightly lower than the 1.4% jump in the first quarter of the year.
Whether or not that slowing is durable or represents a momentary pause in wage hikes is less clear.
For the year ended June, pay-related expenses for American employers rose 5.1%, well above the 4.5% annual increase recorded last year.
Given the threat of a wage-price spiral escalating already debilitating inflationary pressures, a growing number of analysts believe that the Fed will stick to a 75-basis-point hike when it returns from its recess in September, as opposed to the far more sanguine 50-basis-point increase markets appear to be pricing in at the moment.
ECI data was released by the U.S. Bureau of Labor Statistics last Friday, alongside the Fed’s preferred measure of inflation, the Personal Consumption Expenditures (PCE) index.
PCE rose 1% in June, after a 0.6% rise in May and lifted the annual rate to 6.8%, higher than the 6.3% measured earlier.
Although the Fed professes to use the PCE to judge inflation, the last two meetings of policymakers demonstrated that decisions may have been heavily swayed by the more high-profile Consumer Price Index or CPI data, that printed a 9.1% rate of inflation to June.
CPI data includes volatile items such as food and energy, whereas PCE strips these items out, but nonetheless saw a 0.6% increase in June, or double the 0.3% monthly increase in May.
The Fed targets PCE at 2% per annum, well below the 6.8% that inflation currently sits at.
In the past, policymakers said that they were willing to tolerate periods of higher inflation to make up for periods of slower price pressures if the long-term trend was towards the target 2%.
But public discontent at the soaring cost of living have put pressure on policymakers to act in much shorter timeframes, including amping up the pace of rate hikes and dramatically dialing back quantitative easing.
That fresh approach to policymaking was revealed by U.S. Federal Reserve Chairman Jerome Powell at a press conference concluding last month’s Federal Open Market Committee meeting where he noted that the central bank would shift to a “meeting-by-meeting” approach in deciding on rate hikes, instead of providing specific forward guidance.
And that means greater volatility for markets because every new piece of economic data, especially from now up till the next Fed meeting, will be open to interpretation and subject to the response and reaction from policymakers.
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2. Could Chinese Savers Save China's Bond Markets?
It’s a cliché that the Chinese are conscientious savers.
Generations of political upheaval, famine and economic ruin has ingrained into the Chinese psyche the need to save for a rainy day, a quality often compared to their U.S. counterparts whose profligacy was borne out of their privileged position in the world and knowing nothing but a life of plenty.
But that Chinese propensity to save may be just what could save China’s embattled economy from lurching into a fresh crisis, as mainland Chinese investors take advantage of the Southbound Bond Connect scheme, which launched late last year.
Under the Southbound Bond Connect scheme, Chinese investors can gain access to bonds traded in Hong Kong via China’s domestic financial institutions where sales of international yuan-denominated bonds have surged as yield-starved investors seek better returns.
Yet the revival of Hong Kong’s long stagnant Southbound Bond Connect scheme stands in sharp contrast to the bearish sentiment and lack of appetite within China’s domestic market for onshore yuan-denominated debt, which foreign investors have been dumping at a record pace thanks to high-yielding dollar-denominated debt.
Since the U.S. Federal Reserve started its policy of tightening, dollar debt demand has been soaring, helping to put a lid on U.S. Treasury yields while spreads between haven securities like U.S. government debt and those issued by American companies have been opening up.
But for the legions of mainland Chinese investors, dollar-denominated debt is basically out of reach because of strict capital controls and Hong Kong is perceived as a suitable halfway house.
It also helps that yuan-denominated debt in Hong Kong offers a yield premium versus onshore yuan debt, where easing measures are in place to combat an economic slowdown that has depressed onshore yields.
Because mainland Chinese investors just don’t have that many options, the premiums offered on yuan-denominated debt in Hong Kong provides a welcome respite, especially against a rapidly weakening yuan versus the dollar.
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3. Is the Crypto Bear market Over?
The digital asset industry has experienced a period of sharp declines that culminated in the collapse of Terra and its sister token Luna — once one of the industry’s largest stablecoins — and prompted the failure of several prominent crypto hedge funds and lenders such as Three Arrows Capital and Celsius Network.
Bitcoin fell as much as 70% from its all-time high in November, while the size of the digital asset market dipped below US$1 trillion, down from a November high of over US$3 trillion.
However, with the market cap of digital assets rising US$280 billion in July after a painful sell-off and credit crisis that had scared many players out of the market, cryptocurrency traders are showing signs of renewed confidence.
According to data from cryptocurrency asset management group CoinShares, investment products tracking cryptocurrencies have pulled in just under US$400 million since the start of July, racking up the longest run of sustained weekly net inflows since March of this year.
In recent weeks, the market capitalization of the 500 biggest tokens recovered to above US$1 trillion, up 30% in July which proves that the market is starting to show tentative signs of recovery.
Ether, the second-largest cryptocurrency by market cap, rallied 40% last week, triggered by the network’s developers announcing a tentative date for a massive software update.
Investors and developers are calling its upgrade “the Merge,” and it will change how transactions on Ethereum are ordered, making it more efficient and sustainable for widespread use.
According to CoinShares, inflows and improving token prices have boosted total assets under management in cryptocurrency investment products back to early June levels of US$30 billion.
However, investors should remain cautious as the market could easily come crashing down again given the current macro environment and overall weak sentiment.
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Aug 01, 2022