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Daily Analysis 13 June 2022 (10-Minute Read)

Hello there,

A terrific Tuesday to you as stocks waver over inflation fears on the last day of May, a month that has ended well (all things being considered) but provided no shortage of volatility for investors.

In brief (TL:DR)

  • U.S. stocks closed on Friday deeply in the red with the Dow Jones Industrial Average (-2.73%), S&P 500 (-2.91%) and the Nasdaq Composite (-3.52%) and this week could test nerves as the U.S. Federal Reserve meets Wednesday to set rates.

  • Asian stocks were hammered on Monday's open, continuing the decline as investors mulled the prospect of a stronger dollar as the Fed gets more aggressive on inflation.

  • Benchmark U.S. 10-year Treasury yields soared to 3.163% (yields rise when bond prices fall) as inflation data had traders betting on steep rate hikes by the U.S. Federal Reserve, putting upwards pressure on yields.

  • The dollar continued to strengthen in Asian trading amid a toxic mix of rising costs and slower growth.

  • Oil slipped with July 2022 contracts for WTI Crude Oil (Nymex) (-1.39%) at US$118.99 as fresh Covid-19 restrictions in China raised questions about demand.

  • Gold fell with August 2022 contracts for Gold (Comex) (-0.50%) at US$1,866.10 on the back of a strengthening dollar and as traders moved into cash positions.

  • Bitcoin (-6.30%) was hammered to US$25,753 dropping below US$25,000 at one stage and with possibility further to fall as investors shun risk assets.

In today's issue...

  1. Why the Fed is unlikely to raise rates by 75-basis-points in June

  2. China Can't Help Itself Against its Endless Covid Crackdown Cycle

  3. Do Asian Markets have outsized influence on Bitcoin's Gains?

Market Overview

There has never been a tougher time to be a long-term investor than now.

With valuations from the most staid of companies hammered alongside those which sold the most fluff, investors have been left scratching their heads as to which will be the next shoe to fall and what it means to remain invested, especially given that cash in the form of the dollar is also actively losing 8.3% per annum at this stage.

With inflation likely to continue to persist, odds are high that the U.S. Federal Reserve will get even more aggressive on tightening its monetary policy because it has few other good options.

Asian markets hammered at the open on Monday with Tokyo's Nikkei 225 (-2.79%), Seoul's Kospi Index (-3.34%), Hong Kong's Hang Seng Index (-2.81%), and Sydney’s ASX 200 (-1.25%) all sharply lower in the morning trading session.

1. Why the Fed is unlikely to raise rates by 75-basis-points in June

  • Fed policy has been one for predictability and a slightly higher than forecast CPI data on Friday shouldn't be enough to shake its resolve, stiffer rate hikes in July is a possibility, but not June.

  • Even if the Fed is panicking, it can't be seen to be panicking and that should help to calm nerves by slowly positioning for more aggressive tightening instead of yanking the cord which will crash markets and do little to help overall sentiment.

Judging by the reaction of the markets to last Friday’s U.S. Consumer Price Index data, investors would be forgiven for thinking that the U.S. Federal Reserve could hike rates by as much as 75-basis-points this Wednesday, but there’s little in the data to suggest that.

Using the Chicago Mercantile Exchange’s Fed Watch Tool, the probability of a 75-basis-point hike is 23% - it’s not even a coin toss, so not likely, but to begin with, shouldn’t even be at this level unless the market thinks that CPI data has panicked the Fed at some level.

To be sure, the Fed’s preferred measure of inflation is the Personal Consumption Expenditures measure, but nonetheless, policymakers are not immune to CPI data.

Now assuming that the Fed hikes 50-basis-points this week (likely), the probability that the central bank hikes 75-basis-points at the next meeting in July becomes 55%, up from 20% just before the CPI data was released.

So, what will the Fed do?

Not so long ago in a galaxy not so far away, U.S. Federal Reserve Chairman Jerome Powell said (in May) that a 75-basis-point hike was not being “actively” considered, but the market believes that this may have changed.

It’s possible, but not likely that June will be when the Fed gets more aggressive,

Remember that not so long ago, Atlanta Federal Reserve President Raphael Bostic suggested a “pause” for rate hikes could be appropriate in September.

Unfortunately, as dovish as most policymakers are wont to be, they may have little choice in the matter.

The “transitory” inflation card has been played and the Fed can’t blame Putin indefinitely.

May payroll numbers were at around 390,0000 with a whopping 11 million job vacancies so policymakers can crush markets without greater unemployment, and they will, because it is the lesser of two evils.

But even though the Fed delivers helicopter money, it isn’t a helicopter in its ability to change course suddenly, think of it more like a supertanker under way that takes large stretches of time to make small course corrections.

Even when there were plenty of signs that the U.S. economy was headed towards inflation, the Fed persisted in its messaging that price pressures were “transitory.”

There is a large component of monetary policy that is theater, and, in that sense, the show must go on.

U.S. Federal Reserve Chairman Jerome Powell’s style has been to provide predictability to the U.S. economy and on that front, his Fed has been relatively consistent.

A sudden change in course would suggest that the Fed has lost the plot, and is well behind the curve, even if it is, it will not admit to being so.

Which is why a 75-basis-point hike in June is not likely, July is harder to say, so investors should look for clues at Wednesday’s meeting.

2. China Can't Help Itself Against its Endless Covid Crackdown Cycle

  • Beijing is hamstrung in its ability to relent on zero-Covid crackdowns because the Chinese population isn't prepared to face off against a more virulent strain that its local vaccines aren't effective against.

  • Flagging economic conditions in China may help to put a lid on otherwise runaway commodity prices.

Just when you thought it was safe to go out again in Beijing, authorities have started re-imposing harsh Covid-19 restrictions, just weeks after major easing in key Chinese cities and raising concern that the country may relapse into its draconian zero-Covid policies.

The past weekend saw fresh lockdowns in Shanghai and Beijing, with mass testing as authorities responded to new infection clusters.

Plans to reopen for most schools in Beijing were delayed and most districts in Shanghai suspended dine-in services at restaurants.

Daily infections in China fell below 100 last month, for the first time since early March after strict curbs were instituted, but over the weekend, the number of new infections crept up and 143 cases were reported nationwide on Sunday alone.

Chin is facing off with an entirely different kind of pandemic than it started off with, one that is far more virulent and which its population is ill-prepared for.

Many Chinese remain unvaccinated, especially the elderly who are most susceptible to serious infections from Covid-19 and those who are vaccinated have doubtful protection against the current Omicron strain, especially given that China’s vaccine is not based on mRNA technology.

A combination of hubris and nationalism have meant that the most proven and effective vaccines remain out of the reach of the Chinese forcing Beijing to resort to lockdowns to at least keep up the impression that China is winning the battle against the pandemic.

And that means China remains stuck in a self-destructive cycle of disruptive lockdowns that will result in lingering economic pain which is being reflected in a price cap on many key industrial commodities, especially oil.

That China’s inflation has moderated below national targets, should be telling.

Lockdowns have seen unemployment soar and roiled global supply chains impacting the operations of global giants from Sony to Tesla.

Which is why investors need to be wary that the recent rebound in China’s tech stocks is nothing more than a relief rally or a dead cat bounce, more likely to help with unemployment and securing stability ahead of a key leadership conclave later this year.

China’s President Xi Jinping looks set to install himself for an unprecedented third term in office and then possibly leader for life – stability and control are top of his agenda, and not the fortunes of capitalists watching their stock price.

3. Do Asian Markets have outsized influence on Bitcoin's Gains?

  • Data suggests that there are large intraday swings for Bitcoin, falling at the close of New York trading hours and rising at the open, with a simple possible strategy to buy in U.S. and sell in Asia.

  • Strategy to buy in U.S. close and sell at Asia open may still work given the divergence in monetary policy from the U.S. and Asia, in particular Japan and China.

Part of the allure for Bitcoin traders has been that being decentralized, it’s a market that never sleeps.

But given the steep declines in the benchmark cryptocurrency of late, it’s easy to imagine that most investors would want Bitcoin to sleep at some point in time, especially given the sharp declines regardless of time zone.

Observant traders however have noticed that Bitcoin does tend to do better while Wall Street sleeps, notching gains in Asian markets and having some cook up a hypothetical strategy of buying in U.S. hours and selling in Asian hours to a rising market.

According to Bespoke Investment Group, a plucky trader could buy Bitcoin at the New York market close at around 4 p.m. Eastern Time and selling at the next day’s open, 9.30 a.m. ET, which would yield gains of roughly 260% per annum, going back to the start of 2020.

Doing it the other way, buying at the U.S. open and selling it at the close sees just a 3.6% gain, according to Bespoke Investment Group and plying the trade over the weekends, when volumes are even thinner delivers even better returns.

One theory is that as traders have to close out on stocks, the availability of the 24-hour casino that is Bitcoin draws more degen traders into the fray, whereas another theory posits that crypto traders are forced to process loads of information overnight, which results in large price swings.

Another possible reason for the time zone variance could also be monetary policy – while the U.S. and Europe are seeing central banks tighten, inflation in Japan and China is moderate and both are nursing more accommodative policy stances.

Whereas risk-off may be the order of business in the U.S. and Europe, risk-on might still be at play in Asia and that could be leading to the Asian premium.

Investors will recall that in 2015, China had been a focal point for Bitcoin trading and was also the birthplace of industrial-scale mining operations and where most of the trading volume originated.

Chinese cultural attitudes towards riskier investments differs dramatically from American and European sensibilities, especially given the newfound fortune of most Chinese as opposed to the multi-generational wealth more prevalent in U.S. and European societies.

The other key could also be leverage – with offshore (non-U.S. and non-E.U.) trading venues offering copious amounts that goose up bets and lead to large price swings in either direction.

But how does that work in a bear market?

Probably not very well, especially when sentiment is bearish, and the market gets extremely volatile.

As Bitcoin has grown in institutional interest and acceptance, with asset management giants like Fidelity even offering it for 401(k) accounts, the general risk-off sentiment has seen large scale selloffs in U.S. trading hours, as institutional investors de-risk.

But that hasn’t translated into a large take up in Asian trading hours, as Asian investors struggle with their own basket of problems, not least of which is the prospect that China could either grow a lot more slowly, or even shrink, in the wake of its disastrous Covid-19 lockdowns that appear to have no end in sight.

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