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Daily Analysis 16 June 2022 (10-Minute Read)

Hello there,

A terrific Thursday to you as markets rebound on the Fed's promise of no super-sized rate hikes while concerns over a possible recession seeped back into Asian markets, with ensuing weakness.

In brief (TL:DR)

  • U.S. stocks gained on Wednesday on the possibility that the U.S. Federal Reserve promised no super-sized rate hikes with the Dow Jones Industrial Average (+1.00%), S&P 500 (+1.46%) and the Nasdaq Composite (+2.50%) all higher, and risk appetite returning but the durability of the rally suspect on recession concerns.

  • Asian stocks fluctuated Thursday as investors continue to question whether central banks can raise interest rates to rein in inflation without sparking a recession.

  • Benchmark U.S. 10-year Treasury yields rose to 3.451% (yields rise when bond prices fall) as the post-Fed rally lost steam.

  • The dollar gained.

  • Oil slipped with July 2022 contracts for WTI Crude Oil (Nymex) (-0.44%) at US$114.80 as recession fears mount.

  • Gold gained with August 2022 contracts for Gold (Comex) (+0.64%) at US$1,831.30.

  • Bitcoin (+5.02%) rose to US$21,245, by the end of Asian trading hours, as some semblance of stability returned following the potential collapse of cryptocurrency hedge fund Three Arrows Capital.

In today's issue...

  1. Upsize my Rate Hikes

  2. 80% Rally in Chinese Brokerage Should be Warning not Windfall

  3. Cryptocurrency Post-Fed Relief Rally

Market Overview

The post-Fed rally failed to gain traction as U.S. stock futures slumped, suggesting a rally on Wall Street after the U.S. central bank approved its biggest rate hike since 1994 was not durable.

A stronger dollar saw markets in Asia waver as recession fears dented optimism in the region's manufacturers.

Asian markets were mixed with Tokyo's Nikkei 225 (+0.40%) and Seoul's Kospi Index (+0.16%) marginally higher while Hong Kong's Hang Seng Index (-2.17%) and Sydney’s ASX 200 (-0.15%) were down at the close.

1. Upsize my Rate Hikes

  • Yesterday, a senior Fed official called for rate hikes to a level which stunt economic growth by the end of the year, unperturbed by what that would do to the labor market.

  • Investors therefore should keep a keen eye on Friday’s U.S. labor report, which has routinely outperformed economist estimates and could embolden hawks on the Fed.

Given the persistently high rate of inflation in the U.S., the U.S. Federal Reserve weighed in with its highest rate hike since 1994, a whopping 0.75% increase in borrowing costs, and above its guidance provided earlier of a 50-basis-point raise.

Last week’s Consumer Price Index data defeated economist expectations of a yearly inflation rate of 8.3%, coming in at a hot 8.6% and rolling back suggestions that the pace of price increases was slowing.

To be sure, there has been little to suggest that prices are moderating, especially for food and fuel.

If nothing else, Russia’s continued and dogged determination to wrestle a victory in Ukraine will delay crucial supplies of fertilizers, agricultural commodities and energy from re-entering the global market at a time when decades of loose policy have left far too much liquidity in the financial system.

On Wednesday, the Fed lifted the target range for the Federal Funds Rate to 1.5% to 1.75%, up from 1% to 1.25% previously and with more analysts suggesting the year could end with rates being closer to 3.4% and as high as 3.8% by the end of 2023 from 1.9% to 2.8% the Fed had penciled into their March projections.

Nevertheless, markets rallied on remarks from U.S. Federal Reserve Chairman Jerome Powell’s post meeting comments, where he noted supersized rate hikes were unlikely in the future,

“Clearly, today’s 75 basis-point increase is an unusually large one and I do not expect moves of this size to be common.”

But investors may simply be looking for any reprieve in a year that has delivered only bloodshed and a flexibly hawkish Fed is a low bar to land at for risk assets.

Whether or not the rally will prove durable is less certain, especially since inflation expectations remain elevated and are likely to stay that way for some time, while policymakers appear determined to bring price pressures closer to target 2%.

Confounding matters for market bulls, the Fed reiterated that it would shrink its massive balance sheet by US$47.5 billion a month, a move that started at the beginning of this month and which will gain pace to US$95 billion a month by September.

Markets haven’t yet fully priced in the effect of this reversal of years of quantitative easing, how it will affect yields, and the impact on risk assets.

The risk of recession has been raised even further, despite Powell dismissing the suggestion that the central bank was trying to induce one, noting that he saw “no sign” of a broader slowdown while assuring Americans that higher rates could be borne.

Despite the central bank rhetoric, there are plenty of reasons for concern.

Credit card debt has increased in March and April at a pace faster than before the pandemic and much of that spending has gone into purchasing necessities.

More Americans are living paycheck to paycheck and ample savings are now starting to be whittled down.

2. 80% Rally in Chinese Brokerage Should be Warning not Windfall

  • When the price of crude blasts past US$120, it’s a big deal, and not just for consumers, but for every area of the economy.

  • It’s entirely possible that as oil prices continue to rise, it could be a harbinger of the economic pain that is to come.

Those wondering if speculative excesses have all but evaporated from the market should take a look at shares of Everbright Securities, a Chinese brokerage firm that has seen its price rocket by over 80% in June alone.

In an exchange filing on Wednesday, Everbright Securities warned that traders should be “rational and prudent” as the valuation of its stock has risen above the industry average and comes despite waning retail interest in stocks in China.

While global investors have been dipping their toes into Chinese assets yet again, lured by the promise of looser monetary policy and attractive valuations, it’s mainly been the investment tourists who have been shopping, while locals stay home.

An easing of crackdowns on China’s major industries such as technology and real estate, as well as signs that the bottom for Chinese assets may be in, has lured global investors back into China’s stock market, even as retail flows prove lackluster.

Chinese brokerage firms are getting a boost from an uptick in market sentiment, as Chinese stocks buck the trend against the selloff in global peers and some investors have been doubling down on the picks-and-shovels trade by betting on brokers.

Volume for onshore financial firms reached its highest level in almost two years, and typically rally when the stock market is running strong as trading activity picks up.

But the rally is looking excessive, at overbought levels and not reflective of the fact that retail investors, who make up the bulk of Chinese flows, still remain visibly absent.

3. Cryptocurrency Post-Fed Relief Rally

  • It is now coming to light that Tether may actually have some real dollars, outside of the commercial paper, Treasuries, precious metals and cryptocurrencies that it uses to back USDT, in a small Bahamas bank called Capital Union.

  • In an interview with the Financial Times earlier this month, Tether’s Chief Technology Officer Paolo Ardoino said that its most liquid reserves, cash deposits, were held at two banks in the Bahamas and it’s been said that Capital Union is one of those banks.

Although the U.S. Federal Reserve raised rates by 0.75%, the pledge not to supersize increase in borrowing costs was sufficient to fuel a relief rally that has lifted even the fortunes of beaten down cryptocurrencies.

Bitcoin gained for the first time in 10 days, but whether the rally is durable is less anyone’s guess.

Rumors about the insolvency of a major cryptocurrency hedge fund, Three Arrows Capital, has spooked markets still managing the potential implosion of crypto lender Celsius Network, which halted all transactions just days earlier.

Given the interconnectedness of both Three Arrows Capital, Celsius Network and the ongoing fallout of the collapse of TerraUSD and its sister token Luna, it may still be premature to call a bottom.

In the coming days and weeks, the unwinding of leverage and the resolution of liquidations will need to be managed.

Blockchain analytics firm Glassnode has noted that even long-term holders of cryptocurrencies, who avoided selling, are also coming under pressure, and listed companies such as MicroStrategy may be subject to margin calls on their Bitcoin, if price falls further.

For now, it appears that the cascading liquidations have taken a breather, but as more information becomes available in the coming days and weeks, there may be fresh rounds of selloffs.

Bitcoin miners, a key source of selling pressure if they should capitulate, are being squeezed on both sides with soaring energy costs and capex commitments forced up against declining Bitcoin prices.

At some stage, Bitcoin miners will be forced to sell to manage their operational costs, and that could see Bitcoin descend further.

On average, Bitcoin is below its cost basis, and data from Glassnode suggests that even long-term holders are being purged from the holding base, with many taking money off the table.

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