Daily Analysis 14 July 2022 (10-Minute Read)

Hello there,

A terrific Thursday to you as high U.S. CPI hardens expectations for a short, sharp Fed rate-hike cycle.

In brief (TL:DR)

  • U.S. stocks continued to fall on Wednesday with the Dow Jones Industrial Average (-0.67%), S&P 500 (-0.45%) and the Nasdaq Composite (-0.15%) all down as investors assessed the prospect of a recession on hardened expectations for more aggressive U.S. Federal Reserve monetary tightening after white-hot U.S. inflation data.

  • Asian stocks struggled for traction, though Chinese technology stocks provided a modest lift.

  • Benchmark U.S. 10-year Treasury yields rose about two basis points to 2.95% (yields rise when bond prices fall).

  • The dollar pushed higher, hovering around its highest level in over two years.

  • Oil was higher with August 2022 contracts for WTI Crude Oil (Nymex) (+0.53%) at US$96.81 but continues to price in inflation risks.

  • Gold edged lower with August 2022 contracts for Gold (Comex) (-0.31%) at US$1,730.20.

  • Bitcoin (+3.64%) recovered to US$20,214, defying expectations of a sharp fall in response to inflation data and liquidating hundreds of millions of dollars' worth of short contracts.


In today's issue...

  1. U.S. Inflation Soars to 9.1% - Highest in Over 40 Years

  2. Chinese Homebuyers are Stiffing Banks on their Mortgages

  3. Has Bitcoin bottomed out?


Market Overview

Traders have shifted expectations towards an historic one percentage-point Fed interest-rate hike later this month as the U.S. inflation print surprised analysts at 9.1%, with median estimates expecting CPI to yield 8.8%.

The big question for markets is whether the latest U.S. inflation print marks the peak.

Commodity prices, pushed up this year in part by supply disruptions related to Russia’s war in Ukraine, have moderated somewhat of late.

But if higher costs prove to be persistent and come alongside a global economy buckling under rate hikes, that could be toxic for a range of assets already nursing heavy losses in 2022.

In Singapore, the city state’s currency strengthened on an unexpected tightening of monetary settings, part of a global wave of steps to curb the cost of living.

Asian markets were mixed on Thursday with Tokyo's Nikkei 225 (+0.60%), and Sydney’s ASX 200 (+0.44%) up, while Seoul's Kospi Index (-0.15%) and Hong Kong's Hang Seng Index (-0.52%) were down.



1. U.S. Inflation Soars to 9.1% - Highest in Over 40 Years

  • Median estimates of U.S. Consumer Price Index coming in at 8.8% fell short of yesterday’s white hot 9.1% print.

  • With price pressures now becoming the number one focus for policymakers, the risk that the central bank could tip the U.S. economy into recession is higher than ever, taking risk assets down with them.

Despite the best efforts by economists to forecast inflation and signs of inventory excesses, as well as a pullback in key commodity prices from recent all-time-highs, median estimates of U.S. Consumer Price Index coming in at 8.8% fell short of yesterday’s white hot 9.1% print.

Pressure will be on the U.S. Federal Reserve to act decisively on inflation, especially since employment remains robust and price pressures are the number one hot button issue for Americans.

Facing off against the fastest pace of inflation in over four decades, investors are now betting that policymakers will be forced to hike rates by a whole percentage point this month, and earlier bets of a more modest hike in September are now being replaced by wagers that a 75-basis-point rise is on the cards.

Even the more dovish Raphael Bostic, President of the Atlanta Federal Reserve, has conceded that stubbornly high inflation will require a broader range of measures to deal with.

Last month, Bostic had suggested that September might be a time for the Fed to take a pause in its tightening measures, but speaking to reporters yesterday in St. Petersburg, Florida, he made clear that,

“Everything is in play.”

And when asked if “everything” included hiking rates by a full percentage point, he replied, “it would mean everything.”

In the past several weeks, policymakers, much like the rest of the market, had been lulled into a false sense of security that inflation appeared to have peaked.

To be sure, retail inventories have been skyrocketing and commodity prices, which contribute significantly to food and fuel costs, have moderated on recession fears, leading many to believe that the worst of inflation was in the rearview mirror.

Yet retreating commodity prices and excess inventories have yet to translate to lower inflation and the Fed is under increased criticism for being behind the curve on inflation.

With price pressures now becoming the number one focus for policymakers, the risk that the central bank could tip the U.S. economy into recession is higher than ever, taking risk assets down with them.



2. Chinese Homebuyers are Stiffing Banks on their Mortgages

  • According to a Citigroup research report issued yesterday, buyers of 35 projects across 22 Chinese cities unilaterally stopped paying their mortgages as of July 12, citing project delays and an overall decline in real estate prices.

  • Some of China’s biggest property developers are struggling to pay the coupons on their bonds and many have gone into default.

In real estate-obsessed China, not paying down your mortgage is not only uncommon, but also a social taboo.

Yet across the Middle Kingdom, homebuyers are refusing to pay mortgages as embattled property developers drag their heels on construction projects, exacerbating China’s real estate crisis and increasing risks to the banking system.

According to a Citigroup research report issued yesterday, buyers of 35 projects across 22 Chinese cities unilaterally stopped paying their mortgages as of July 12, citing project delays and an overall decline in real estate prices.

For many Chinese, private ownership of property is a relatively new construct and became a reality only in the early 1980s when then-Chinese leader Deng Xiaoping instituted sweeping reforms that permitted private ownership of assets.

Since then, the seemingly constant rise in real estate prices has helped lift an entire generation out of poverty and even to this day, many Chinese see property as a means to improve their financial situation.

But a broad crackdown by Beijing to deleverage its heavily-geared real estate sector, has since sent the Chinese property market into a slump, with zero-Covid lockdowns sparking a decline in property prices for the first time in decades.

Some of China’s biggest property developers are struggling to pay the coupons on their bonds and many have gone into default.

Junk bonds of Chinese real estate developers are trading at their highest yields since the 2008 financial crisis and some are trading at distressed levels.

Citigroup’s research reveals that average selling prices of properties in the 35 projects were already selling on average 15% lower than purchase costs in the past three years, meaning that many homebuyers are underwater on their mortgages.

The contagion from China’s real estate market is also spreading to banks and other shadow lenders.

Non-performing loans triggered by the recent wave of homebuyers withholding payments on their mortgages could hit as high as US$83 billion, or around 1.4% of the national outstanding mortgage balance.

Nevertheless, Citigroup analyst believe that the recent wave of mortgage defaults are still manageable, even if China Construction Bank, Postal Savings Bank of China and Industrial and Commercial Bank of China, which have more exposure to mortgages, suffer setbacks amid dampened investor sentiment.

What ought to be worrying investors though is if some Chinese homebuyers withhold their mortgage payments with almost no consequence, it could embolden others to follow suit, potentially sparking a mortgage crisis.

The rate of default on Chinese mortgages is one of the lowest in the world as there is a cultural stigma attached to not paying off one’s debts in China, but as more real estate developers fail to complete their projects, more Chinese may be emboldened to go against cultural mores and that could spell bigger trouble for the Chinese economy at large.



3. Has Bitcoin bottomed out?

  • Data from blockchain analytics firm Glassnode suggests that it is far from clear if a bottom has been hit.

  • Many of those short-term Bitcoin wallet addresses are now deeply underwater and if economic stresses in the real world intensify, these holdings could very quickly trigger a cascade of selling.

Down over 70% from its all-time-high in November last year, some investors may be tempted to dip their toe into cryptocurrency waters and buy their first Bitcoin, or maybe more.

But data from blockchain analytics firm Glassnode suggests that it is far from clear if a bottom has been hit.

Calling a bottom on an asset as volatile as Bitcoin is challenging even on a good day, let alone against a backdrop of soaring U.S. inflation and a U.S. Federal Reserve that is now being forced to take more aggressive measures to tighten policy than ever.

Despite expectations that Bitcoin would tank in the wake of the U.S. Consumer Price Index inflation print of 9.1%, the world’s largest cryptocurrency by market cap staged a stunning recovery, pushing Bitcoin over US$20,000, having tested US$19,000 as a level of support earlier.

A sobering reminder of just how unpredictable and perhaps manipulated cryptocurrency markets continue to be, an avalanche of short positions on Bitcoin were liquidated, with short covering pushing Bitcoin well over US$20,000, a level it had struggled to break for the past several days.

Of greater interest however is whether there are signs of capitulation by long-term holders of Bitcoin and to that end Glassnode data suggests that while probabilities have necessarily increased, no break in the dam has yet to be detected.

According to Glassnode analysts,

“Bottom formation is often accompanied by long-term holders shouldering an increasingly large proportion of the unrealized loss. In other words, for a bear market to reach an ultimate floor, the share of coins held at a loss should transfer primarily to those who are the least sensitive to price, and with the highest conviction.”

Glassnode data also appears to suggest that there has been a fresh influx of smaller transactions from smaller entities, signaling a potential recovery in demand and speculation for Bitcoin and evidencing some degree of dip-buying.

Bitcoin miners, a significant source of selling pressure, especially when the price of Bitcoin slips below mining costs, have also slowed their sales, cutting operation costs and in some cases, swapping to mine other cryptocurrencies instead, where the competition is not as intense.

Nonetheless, trying to discern a bottom for Bitcoin using blockchain data is akin to reading tea leaves for relationship advice – the data will reveal whatever you’re looking for and is highly susceptible to confirmation bias.

In previous bear markets, supply held by short-term holders made up just 4%, according to Glassnode, but that figure has quadrupled to 16%, thanks in large part to speculation peaking around 2021.

Many of those short-term Bitcoin wallet addresses are now deeply underwater and if economic stresses in the real world intensify, these holdings could very quickly trigger a cascade of selling.

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