Daily Analysis 17 March 2022 (10-Minute Read)

Hello there,

A terrific Thursday to you as markets cheer a U.S. Federal Reserve policy tightening that is well within expectations and pledges to continue to attempt a "soft landing" for the U.S. economy.

In brief (TL:DR)

  • U.S. stocks were higher on Wednesday with the Dow Jones Industrial Average (+1.55%), the S&P 500 (+2.24%) and the Nasdaq Composite (+3.77%) all up in the aftermath of the U.S. Federal Reserve policy meeting.

  • Asian stocks jumped Thursday as Chinese technology shares soared again and traders digested the U.S. Federal Reserve’s view that the U.S. economy is strong enough to weather the campaign against high inflation now underway.

  • Benchmark U.S. 10-year Treasury yields fell four basis points to 2.15% (yields rise when bond prices fall) as demand for Treasuries and stocks rose in tandem.

  • The dollar climbed.

  • Oil snapped a three-day drop with April 2022 contracts for WTI Crude Oil (Nymex) (+1.08%) at US$96.07, but the prospect of Iranian supply coming back on tap putting a cap on short-term rallies.

  • Gold was higher with April 2022 contracts for Gold (Comex) (+1.38%) at US$1,935.60.

  • Bitcoin (+0.55%) rose to US$41,108 in the wake of the U.S. Federal Reserve policy meeting pledging to reign in inflation albeit tempered with the pledge to not derail the economic recovery.


In today's issue...

  1. U.S. Federal Reserve Hikes as Expected but What’s Next?

  2. Markets May be Ignoring the Risk of Covid-19 All Over Again

  3. The Smart Money Looking to Short Tether Don’t Get Crypto


Market Overview

The U.S. Federal Reserve raised rates by a quarter percentage point and signaled hikes at all six remaining meetings in 2022. Fed Chair Jerome Powell said the U.S. economy is “very strong” and can handle monetary tightening.

The key question for markets remains whether the U.S. central bank can tackle the fastest pace of inflation in four decades without triggering a sharp growth slowdown or even a recession.

The commodity shock from Russia’s war in Ukraine is continuing to aggravate price pressures and economic risks.

Asian markets jumped Thursday as Chinese technology shares soared again with Tokyo's Nikkei 225 (+3.06%), Sydney’s ASX 200 (+1.08%), Hong Kong's Hang Seng Index (+5.79%) and Seoul's Kospi Index (+1.81%) all up in the morning trading session.



1. U.S. Federal Reserve Hikes as Expected but What's Next?

  • As predicted and well-priced in by investors, the U.S. Federal Reserve announced yesterday that it would raise its key federal funds rate above zero, to 0.25%, paving the way for tightening monetary policy, or is it?

  • And some of the Fed’s projections appear more hopeful than prescient, with forecasts showing very little increase in unemployment despite rate hikes for the rest of the year – something that economists say happens very rarely in real life.

There’s never an easy time to be a central banker (perhaps when the dollar was tied to the gold standard it was ever so slightly more straightforward), but this coming period looks to be the most complicated yet.

As predicted and well-priced in by investors, the U.S. Federal Reserve announced yesterday that it would raise its key federal funds rate above zero, to 0.25%, paving the way for tightening monetary policy, or is it?

With headline inflation in the U.S. advancing at its fastest pace in four decades, pressure has been increasing on the Fed to do something about it, in a world that has suddenly become more uncertain than ever.

At a press conference following the rate hike, U.S. Federal Reserve Chairman Jerome Powell signaled that another six more rate hikes could be expected this year, with inflation too high and the labor market overheated, price stability would be a “pre-condition.”

“Pre-condition” to what though?

Previous rate hikes by the Fed have typically presaged a series of rate cuts further on and there are many economists who have suggested that the Fed is likely to raise rates to the point of 2.0% to 2.5% by the end of this year, only to begin cutting them again in 2024.

Powell has reassured the American public that the Fed’s policy tightening won’t tip the economy into recession, but he also had the same assurances that inflation was “transitory” even as prices were rising dramatically.

To be sure, the American economy is in a relatively strong position to absorb rate hikes, and the predictability of the Fed, sticking to its widely-anticipated 0.25% interest rate increase saw markets rally hard yesterday.

But whether the Fed can keep tightening as aggressively as some policymakers have the appetite for is less clear.

Because much of the price pressures that the U.S. economy is facing at the moment have little to do with current monetary policy – supply chain snarls and the Russian invasion of Ukraine – tightening won’t necessarily translate to lower prices overnight.

Walking a tightrope, policymakers face several challenges – tighten too quickly and risk sending the economy into recession but do nothing and price pressures could themselves put a damper on consumption, which makes up some 70% of the U.S. economy.

And some of the Fed’s projections appear more hopeful than prescient, with forecasts showing very little increase in unemployment despite rate hikes for the rest of the year – something that economists say happens very rarely in real life.



2. Markets May be Ignoring the Risk of Covid-19 All Over Again

  • The biggest danger now is not so much what investors are keeping their eyes on – the continuing war in Ukraine and U.S. Federal Reserve policy tightening, but the one that many are assuming is no longer an issue, the ongoing coronavirus pandemic.

  • What is perhaps more disconcerting is that markets have ruled out the prospect of the pandemic completely and have priced in recovery for those industry and sectors most exposed to the economy including energy and financials.

At the beginning of 2020, few, if any, global investors were concerned about early reports of a flu-like outbreak in the Chinese city of Wuhan.

And even when reports started leaking out of China that a virulent and potentially lethal flu-like virus was rapidly spreading through Wuhan and to other cities, many investors assumed that it was an “Asia” problem, akin to SARS, which was confined mainly to the region.

Asian equities corrected slightly, but few could have been prepared for the course correction that was about to roil global markets once the full extent of the coronavirus pandemic became more apparent.

As central banks flooded the financial markets with liquidity, equities and other risk assets rallied.

The biggest danger now is not so much what investors are keeping their eyes on – the continuing war in Ukraine and U.S. Federal Reserve policy tightening, but the one that many are assuming is no longer an issue, the ongoing coronavirus pandemic.

That’s right, ongoing.

Markets appear to be pricing the conclusion of the pandemic into the dustheap of history at a time when infections are rising in Europe and evidence is suggesting that the U.S. is set for a fresh wave of cases just as immunity is declining.

Vaccination efficacy has been demonstrated to wane six months after receiving a second dose and while booster shots in Europe are around 50%, the U.S. is well below that figure at a time when mask mandates are being lifted.

A more virulent variant of omicron, dubbed BA.2 has shown a doubling according to Nowcast data from the U.S. Centers for Disease Control and Prevention.

Data from the United Kingdom Health Security Agency also reveals that the country’s rise in infections also happened concurrently with the BA.2 strain gaining prominence and accounting for over half of overall infections.

The good news is that BA.2 appears to be no more severe than the omicron variant, meaning that for most healthy, vaccinated people, symptoms are generally mild and researchers in the U.K. have found that the variant does not seem to carry a higher risk of hospitalization than the omicron strain.

But what has immunologists concerned is that a perfect storm is brewing – the lifting of pandemic-era restrictions, lowered levels of immunity and the rise of more problematic variants could see a resurgence of more deadly strains of the coronavirus.

During the 1918 flu pandemic, which did not have the benefit of effective vaccines, populations in a hurry to return to life as normal saw a shocking resurgence and a second pandemic wave – healthcare officials are worried the same thing could play out again.

Vaccines remain the safest path out of another pandemic resurgence, with a fresh wave of infections hopefully providing sufficient incentive for more people to receive booster shots.

And U.S. Federal Reserve tightening as well as balance sheet runoff should provide the headroom to roll back those measures should markets face a fresh shock so there are some built-in buffers should the global economy face a resurgent pandemic.

What is perhaps more disconcerting is that markets have ruled out the prospect of the pandemic completely and have priced in recovery for those industry and sectors most exposed to the economy including energy and financials.



3. The Smart Money Looking to Short Tether Don't Get Crypto

  • Since its early beginnings, Tether has gone from stablecoin to the lynchpin of the entire cryptocurrency industry, with Tether trading pairs on a more cryptocurrencies than any other stablecoin, it has become indispensable.

  • In theory, shorting Tether’s peg seems like a relatively risk-free trade, but in practice can be far more complicated to execute – borrowing rates on Tether are expensive, and put options can be hard to find.

When Bloomberg first broke news of Fir Tree Capital Management taking substantial short bets on U.S.-dollar “based” stablecoin Tether, cryptocurrency markets responded with predictable indifference.

Tether has long been a background risk of plying cryptocurrency markets, acting as the first dollar-backed (it was initially) stablecoin that provided a means for traders looking to take a breather from the volatility of other cryptocurrencies.

But since its early beginnings, Tether has gone from stablecoin to the lynchpin of the entire cryptocurrency industry, with Tether trading pairs on a more cryptocurrencies than any other stablecoin, it has become indispensable.

As a stablecoin, Tether has been constantly dogged by controversy, first over whether its reserves were actually backed by real dollars (it’s not) and whether there was misappropriation of Tether’s reserves to bailout its closely-related (they have the same owners) exchange Bitfinex.

Last year, Tether entered into a settlement with the New York Attorney General’s Office to make quarterly reports on its reserves without necessarily admitting any wrongdoing.

According to Tether’s website, a breakdown of Tether’s reserves shows that 84.25% is backed by “cash and cash equivalents and other short-term deposits and commercial paper” but around 53% is commercial paper (a type of short-term loan).

Although Tether has previously claimed that it doesn’t hold any commercial paper in the troubled Chinese property developer Evergrande Group, there’s no real way to verify those claims or what sort of commercial paper that Tether holds.

But does it really matter anyway?

Not to most cryptocurrency traders.

While traditional hedge funds like Fir Tree Capital Management see an obvious win in betting against Tether, because if Tether breaks its peg and falls, their bearish put options will be in the money, Tether has rarely slipped its peg in the past despite being dogged by controversies.

A US$41 million fine by the U.S. Commodity Futures Trading Commission last year saw no drop in demand for the stablecoin, nor did the NYAG lawsuit.

If nothing else, increasing interest in cryptocurrencies, especially in the wake of Western sanctions against Russia will drive demand for Tether, rather than see it lose its peg.

Tether plays a significant role as an on-ramp to cryptocurrency markets, especially because cryptocurrency traders often don’t have access to the traditional banking facilities.

In 2017, the popularity of Tether soared amongst Chinese when Beijing banned the purchase of cryptocurrencies using cash and it remains a popular means to spirit capital out of places like China and Russia.

Periods which have seen an increase in cryptocurrencies have also seen Tether not only maintain its peg, but trade at a premium to the dollar it’s supposed to be backed by.

Even today, rangebound cryptocurrency markets haven’t precluded a premium for Tether.

In theory, shorting Tether’s peg seems like a relatively risk-free trade, but in practice can be far more complicated to execute – borrowing rates on Tether are expensive, and put options can be hard to find.

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