Daily Analysis 16 February 2022 (10-Minute Read)

Hello there,

A wonderful Wednesday to you as stocks rebound sharply on increasing expectations that a potential Russian invasion of Ukraine may have been averted (or never actually contemplated).

In brief (TL:DR)

  • U.S. stocks climbed on Tuesday with the Dow Jones Industrial Average (+1.22%), S&P 500 (+1.58%) and the Nasdaq Composite (+2.53%) all up on the prospect of easing Ukraine tension.

  • Asian equities rose Wednesday as traders evaluated the prospect of diminishing geopolitical tension over Ukraine, after Russia said it was withdrawing some forces.

  • Benchmark U.S. 10-year Treasury yields fell one basis point to 2.03% (yields fall when bond prices rise).

  • The dollar remained lower.

  • Oil edged lower with March 2022 contracts for WTI Crude Oil (Nymex) (-0.09%) at US$91.99 as traders reassessed worries about potential disruptions to commodity supplies ranging from energy to metals and grain.

  • Gold held on its recent gains with April 2022 contracts for Gold (Comex) (-0.14%) at US$1,853.60.

  • Bitcoin (+1.02%) rose to US$44,014 on a raft of risk appetite as geopolitical tensions in Ukraine ease.


In today's issue...

  1. Betting Against the House – Gambling on Interest Rates

  2. Professional Investors Are Sheltering in Cash, Should You?

  3. Could the New York Stock Exchange become the next NFT trading venue?


Market Overview

Russia announced a partial pullback of thousands of troops massed near the Ukrainian border and appeared to favor a diplomatic solution to the crisis there.

U.S. President Joe Biden said the U.S. has yet to verify Moscow’s claims and an invasion remains possible, which the Kremlin has repeatedly denied.

The Ukraine crisis has buffeted markets already contending with concerns that aggressive interest-rate hikes are needed in the U.S. to quell inflation.

The U.S. producer price index jumped in January by more than forecast as companies contend with supply-chain and labor constraints.

Asian markets were higher on Wednesday with Sydney’s ASX 200 (+0.75%), Tokyo's Nikkei 225 (+2.05%), Seoul's Kospi Index (+1.65%) and HongbKong's Hang Seng Index (+1.23%) all up in the morning trading session.



1. Betting Against the House - Gambling on Interest Rates

  • With traders betting on the fastest pace of interest rate hikes amongst major central banks since 2010, policymakers are starting to waver in their resolve.

  • But with U.S. inflation at its highest level in four decades, traders are now pricing in as many as six Fed hikes.

The house always wins – it’s always been a matter of mathematics.

Individual gamblers and high rollers may beat casinos on some days, but probability and skewed odds has meant that over the long run, the house always wins.

And with traders betting on the fastest pace of interest rate hikes amongst major central banks since 2010, policymakers are starting to waver in their resolve.

To be sure, being a central banker at this moment in history is far from easy – policymakers want to slow inflation without crash landing their economies, whilst a backdrop of data has made charting the path forward less certain.

As recently as last October, U.S. Federal Reserve Chairman Jerome Powell continued to describe inflation as “transitory”, and markets were pricing in at best two rate hikes this year.

But with U.S. inflation at its highest level in four decades, traders are now pricing in as many as six Fed hikes.

Across G-10 economies, swaps futures show traders expect the average central bank rate to be 1% higher in a year, a lot steeper than the January 2010 tightening cycle.

But slowing growth, the threat of war, surging oil prices and a pandemic that is very much still with us (despite all attempts to pretend otherwise) have created a macro landscape that is far more nuanced than a tool as blunt as interest rates is attuned to addressing.

Typically, raising interest rates would raise borrowing costs and cool some of the inflationary pressures in the economy, but monetary policy doesn’t act with a lag.

Traders and investors aren’t going to send yields soaring when rates are hiked, they’ll do so the minute there are signs of borrowing costs increasing, and that’s already happened.

U.S. benchmark 10-year Treasury yields are inches within 2%, their highest since 2019 and the yield curve (the difference between long-term and short-term Treasury yields) is the flattest it’s been in years – suggesting that investors are unsure of the economic path ahead (long-dated debt yields less than short-dated debt).

European Central Bank President Christine Lagarde has warned recently that a rushed tightening would hurt the Eurozone’s rebound from the pandemic.

And even as the Bank of England lifted rates twice in recent months, Governor Andrew Bailey has also cautioned that the outlook is clouded with uncertainty.

While the U.S. Federal Reserve turned hawkish last November, the recent posturing has been far more nuanced, with Fed Chair Powell describing the need to stay nimble in policymaking.

China’s central bank stepped up support for its slowing economy on Tuesday, pumping in cash via policy loans for a second straight month, even as Russia and Brazil are aggressively raising rates to cater for inflation.

The global policy landscape is far from uniform and the odds of misstep is higher than ever.

Ironically, because Treasury yield curves have flattened toward pre-pandemic lows, it signals that investors expect rate hikes will be aggressive enough to risk souring the medium-term growth outlook, something that the Fed will no doubt be taking note of.

Last week, investors started pricing a higher probability that while the Fed may raise rates this year and next, it will be forced to start cutting them again in 2024.

The Fed may be the house, but it may not always win.



2. Professional Investors Are Sheltering in Cash, Should You?

  • A Bank of America survey of fund managers with a combined US$1 trillion in assets found that average cash holdings among professional investors soared to 5.3% this month, up from just 5% in January and the highest level of cash stockpiling since May 2020, in the early days of the pandemic.

  • Rising cash allocations however should not be misinterpreted for an endorsement of stuffing your money into your mattress.

In the world of investments, cash, is rarely (if ever) king.

Because of the ill-effects of inflation, cash actually loses value over time and most professional investors would want to at the very minimum keep their money in safe, liquid investments, like money market funds or Treasuries, to at least try and keep up with inflation.

But the volatility in markets has meant that there has been very few safe harbors of late, with U.S. Treasury yields spiking (yields rise when bond prices fall), penalizing bondholders, and equities hammered by everything from tightening monetary policy to a potential Russian invasion of Ukraine.

Nonetheless, as idle as cash is, a Bank of America survey of fund managers with a combined US$1 trillion in assets found that average cash holdings among professional investors soared to 5.3% this month, up from just 5% in January and the highest level of cash stockpiling since May 2020, in the early days of the pandemic.

That shift into cash comes against a backdrop of equities hammered by the prospect of central bank policy tightening – the MSCI World index that tracks global stocks is down almost 6% since the beginning of this year, while Bloomberg’s government and corporate bond tracker has slipped 3.5% over the same period.

Given the lack of “safe” havens, more professional investors are choosing to stay in cash instead.

Investors currently receive next to nothing from the cash stashed in U.S. money market funds, whereas these products provided yield of over 2% as recently as 2019.

Rising cash allocations however should not be misinterpreted for an endorsement of stuffing your money into your mattress.

Instead, higher cash hordes are emblematic of investors uncertain over the prognosis of the path forward.

Given that equity and bond prices could both move lower and in unison should another interest rate led selloff occur, the “smart” money is understandably keeping plenty of dry powder available, ready for deployment, once things become clearer.

When exactly that is however, is less certain.

The U.S. Federal Reserve has seemed of late to be inclined towards a policy of strategic ambiguity under the guise of “nimbleness.”

And everything from potential Eastern European conflict to traders pricing in slower growth have meant that whereas the Fed of the past could dot plot with some degree of certainty, things are far from set in stone in the current epoch.

Against this backdrop, holding on to more cash may not just be prudent, it may be prescient.



3. Could the New York Stock Exchange become the next NFT trading venue?

  • According to a regulatory filing with the U.S. Patent and Trademark Office, the NYSE, the world’s deepest and most liquid financial market, said that it plans to be a financial exchange for cryptocurrencies and NFTs that would compete with the likes of OpenSea and Rarible.

  • Nevertheless, the NYSE had minted its first NFTs last year, in a move that digitally memorialized some of the exchange’s biggest IPOs, including Spotify, Snowflake and Roblox.

As recently as 2018, there was no shortage of cryptocurrency exchanges.

At the height of the initial coin offering or ICO craze, there were at times more cryptocurrency exchanges than there were coins to list on them.

Because there are no barriers to entry, decentralized exchanges which rely on smart contracts to facilitate transactions have technically no means to block anyone from listing a cryptocurrency token.

But as more institutional investors look at cryptocurrencies and the non-fungible token space continues to grow, the New York Stock Exchange is stepping in to bring some adult supervision to the space.

According to a regulatory filing with the U.S. Patent and Trademark Office, the NYSE, the world’s deepest and most liquid financial market, said that it plans to be a financial exchange for cryptocurrencies and NFTs that would compete with the likes of OpenSea and Rarible.

The filing dated February 10, indicates plans for the NYSE to issue its own token and a marketplace to trade NFTs.

But advocates who have long been waiting for more institutional participation in the cryptocurrency sector may want to manage their expectations of the NYSE’s impending move, with the exchange saying in a statement that it had no immediate plans to launch its own token or NFT trading.

Instead, the NYSE may simply be staking its own turf, in the event that cryptocurrencies and NFTs go mainstream and pre-emptively protecting its intellectual property rights.

Nevertheless, the NYSE had minted its first NFTs last year, in a move that digitally memorialized some of the exchange’s biggest IPOs, including Spotify (+3.61%), Snowflake (+3.05%) and Roblox (+7.29%).

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