Novum Alpha - Daily Analysis 22 August 2022 (10-Minute Read)
A magnificent Monday to you as markets get mauled by growing concerns over the U.S. Federal Reserve's decidedly hawkish rhetoric that threatens to take down the nascent rebound.
In brief (TL:DR)
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A jump in global shares from June’s bear-market lows has begun to cool, weighed down by repeated Fed warnings that interest rates are going higher.
Troubling global economic developments, including power shortages in a Chinese industrial heartland, are also hanging over investors.
In China, banks lowered the one-year and five-year loan prime rates on Monday in the slipstream of a decision by the nation’s central bank last week to cut a key policy rate.
Asian markets were mostly lower on Monday with Tokyo's Nikkei 225 (-0.47%), Seoul's Kospi Index (-1.21%), Sydney’s ASX 200 (-0.95%) and Hong Kong's Hang Seng Index (-0.59%) were all down.
1. The Bears are Back
“The Sand People are easily startled, but they’ll soon be back, and in greater numbers.”
– Obi Wan Kenobi, Star Wars Episode IV: A New Hope
It’s not just Sand People who get startled easily, so do bears, especially in a market as volatile as the present.
But just like the Sand People, bears will regroup, reorganize, and come back in greater numbers as evidenced from the hammering taken by stocks and bonds these past several weeks.
The latest MLIV Pulse survey, ahead of the central banker conclave at Jackson Hole, Wyoming next week, saw 68% of respondents anticipating the most destabilizing era of price pressures in decades eroding margins and sending stocks lower.
The MLIV Pulse survey of over 900 contributors, including professional analysts and day traders, reckon that inflation has likely topped out, but that the U.S. Federal Reserve would take as long as 2 years to bring inflation to the target 2%.
In the meantime, survey respondents are betting that American consumers will cut spending because of persistently higher prices and unemployment is likely to rise to well over 4%.
Which is why the unexpected US$7 trillion equity rebound, which has trimmed 2022 losses of the S&P 500 from 23% to just 11% looks shaky.
What markets are only just starting to price in is that although inflation isn’t likely to rise as fast, prices remain stubbornly high and that puts pressure on policymakers to continue to act, which is bad for both stocks and bonds.
To be sure, benchmark 10-year U.S. Treasury yields have settled comfortably below 3%, having peaked near 3.5% this year, and both retail and institutional investors have bought the dip in stocks.
But the rebound looks increasingly less durable, as current Fed funds futures show traders betting the central bank will raise benchmark rates to 3.7% before cutting borrowing costs sometime next year.
And while there is no shortage of risks that threatens to take down the nascent recovery in equity markets, a quickened pace of policy tightening, its resultant economic fallout, could spark a recession in substance, even if one is avoided in form.
2. Beijing Gets Serious on Bolstering its Battered Real Estate Sector
For a while, investors were left guessing if Beijing would budge on its policy to deleverage its heavily geared real estate sector and whether the central bank would be roped in to ease monetary conditions as the property crisis deepened.
And for the longest time, Chinese government officials were long on rhetoric, but light on action to shore up China’s massive real estate sector, with some easing but nothing significant enough to demonstrate that policymakers understood the full extent of the problem.
But as the property crisis worsens in China, with hundreds of thousands of homebuyers on a mortgage strike, and more households saving up and avoiding taking on debt, Beijing’s hand has been forced and Chinese banks lowered their benchmark lending rates while authorities stepped up support for the property market with additional loans.
The rate cuts follow news late Friday of additional financing to prop up the real estate sector which said China would offer special loans through policy banks to ensure property projects are delivered to buyers, adding to signs of official support for an industry grappling with a debt crisis, slumping home sales and worsening sentiment.
The one-year loan prime rate was cut to 3.65% from 3.7%, the first reduction since January, but less than the 10 basis-point drop that economists had expected.
The five-year rate, a reference for mortgages, was reduced by 15-basis-points to 4.3% after being cut by the same amount in May.
It isn’t clear how effective the rate cuts will be, especially given that the outlook on the Chinese economy is bleak and the sentiment is poor.
The People’s Bank of China, the central bank, and two other ministries have made special loans available through policy banks to ensure stalled property projects are delivered to buyers, but completing properties doesn’t necessarily translate into improving the economic stock of the country.
Beijing is hoping that lower borrowing costs will help spur demand for loans, though it’s unlikely to reverse the sharp slump in consumer and business confidence triggered by turmoil in the property market and the stop-start reopening of the economy under the zero-Covid strategy.
3. Stablecoin Issuers hold US$80 billion of Short-Dated U.S. Treasuries
Designed to act as a bridge between the cryptocurrency and fiat currency markets, stablecoins have long made it faster and easier for traders to buy and sell digital tokens, providing a brief respite from the volatility inherent in cryptocurrencies.
According to price-tracking site Coingecko, Tether’s USDT, Circle’s USDC and Binance’s BUSD alone have a combined market cap of roughly US$140 billion, making their movements in traditional financial markets increasingly important and significant.
While stablecoins are supposed to be backed at all times by reserves of actual dollars, or highly liquid mainstream financial assets, in practice, they have not been free from controversy, especially Tether, which has long been coy about what backs its USDT.
However the collapse of the TerraUSD algorithmic stablecoin, have put regulators on alert and spurred many of them to question the quality of the assets that stablecoin operators say they hold in reserve.
According to research from JPMorgan, as of May, Tether, the biggest stablecoin operator, and its peers, accounted for 2% of the market for U.S. Treasury bills – short-term debt instruments that are commonly used as a cash equivalent on corporate balance sheets.
Stablecoin issuers such as Tether and Circle now hold US$80 billion worth of short-term U.S. government debt, highlighting the expanding role of digital asset players in traditional financial markets.
And while 2% of the liquid U.S. Treasury markets may not sound like a lot, if stablecoin issuers were to dump their holdings of U.S. government debt, for instance, in the case of a slew of redemptions, their selling may have serious repercussions, especially given that liquidity is no longer a given.
U.S. Treasury markets have long been assumed to be the deepest and most liquid in the world, but the reality however is that periods of market crisis have seen liquidity evaporate and forced central banks to shore up Treasury values by becoming a buyer of last resort.
Even though a handful of the largest stablecoin issuers hold just 2% of short-term U.S. Treasuries, if a fresh market crisis were to emerge that would require issuers to sell off their holdings, it could have a material impact on Treasury prices, especially as markets become less liquid during difficult times.
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Aug 22, 2022
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