Daily Analysis 18 August 2022 (10-Minute Read)

Hello there,

A terrific Thursday to you as stocks struggle after an examination of the last U.S. Federal Reserve's meeting minutes gave cause for alarm with investors realizing just how serious policymakers are about the fight against inflation.

In brief (TL:DR)

  • U.S. stocks were lower on Wednesday with the Dow Jones Industrial Average (-0.50%), the S&P 500 (-0.72%) and the Nasdaq Composite (-1.25%) all down in the aftermath of the Fed's meeting minutes showing a resolute push to raise rates.

  • Asian stocks fell after U.S. Federal Reserve minutes showed officials face a delicate balancing act to quell inflation while averting recession and as investors weighed a dim Chinese economic outlook.

  • Benchmark U.S. 10-year Treasury yields fell about three basis points to 2.87% (yields fall when bond prices rise).

  • The dollar was steady.

  • Oil hovered around $88 a barrel with September 2022 contracts for WTI Crude Oil (Nymex) (+0.07%) at US$88.17 on concerns over demand.

  • Gold edged lower with December 2022 contracts for Gold (Comex) (-0.03%) at US$1,776.10.

  • Bitcoin (-4.16%) fell to US$23,379 as traders pared back risk positions on both rates and recession risks.


In today's issue...

  1. Could the End of Rate Hikes be in Sight?

  2. China’s Economic Troubles are Just Beginning

  3. Macro Not Merge will Determine End of Crypto Winter


Market Overview

Swaps tied to the U.S. Federal Reserve policy meeting indicated lower odds of a 75 basis points hike next month as opposed to a half-point move, despite meeting minutes that paint a far less dovish central bank than advertised.

Expectations of slower policy tightening and a pivot to cuts later next year have already contributed to a 12% jump in global stocks from June lows.

The question is whether that’s too optimistic. A darker scenario is of persistent price pressures forcing restrictive borrowing costs even as the economy shrinks.

Asian markets were lower on Thursday with Tokyo's Nikkei 225 (-0.96%), Hong Kong's Hang Seng Index (-1.11%), Sydney’s ASX 200 (-0.21%) and Seoul's Kospi Index (-0.33%) all down.



1. Could the End of Rate Hikes be in Sight?

  • Investors hoping for a reprieve were left disappointed when minutes from the Fed’s most recent meeting revealed that policymakers saw little sign of inflation improving, even though headline inflation was lower in July than it was in June.

  • Fed minutes signaled policymakers were intent on pressing ahead with tightening monetary policy but aware of the risks of overdoing it, until inflation hit targets even to the point where they act as a drag on economic growth.

With the U.S. Federal Reserve raising benchmark interest rates by 75 basis points for a second straight month, marking the fastest pace of tightening since the early 1980s in a battle against inflation, investors are increasingly concerned that this will become a pattern until price pressures subside.

The Fed’s benchmark policy rate has increased from near zero to a target range of 2.25% to 2.5% percent in just four months, roiling all manner of risk assets, from cryptocurrencies to equities and raising recession risks to take down commodities as well.

Investors hoping for a reprieve were left disappointed when minutes from the Fed’s most recent meeting revealed that policymakers saw little sign of inflation improving, even though headline inflation was lower in July than it was in June.

Latest U.S. inflation data saw no increase in consumer price growth between June and July and a slower annual rate of 8.5% following a surprisingly strong jobs report the previous week, which showed that the U.S. economy added 528,000 positions in July, over double economist estimates of 258,000.

Fed minutes signaled policymakers were intent on pressing ahead with tightening monetary policy but aware of the risks of overdoing it, until inflation hit targets even to the point where they act as a drag on economic growth.

Some Fed policymakers indicated that it would probably be appropriate to maintain higher interest rates to ensure that inflation was firmly on a path back to the Fed’s target of 2% once rates had been raised to the point where they were cooling down the economy sufficiently.

Minutes of the Fed’s most recent meeting paint a dramatically less sanguine path for interest rates, especially against the backdrop of Fed Chairman Jerome Powell’s comments at the post-meeting press conference that suggested it might be “appropriate to slow the pace of increases.”

The market rally that gathered steam in recent weeks as investors interpreted Powell’s comments as dovish, has since been hit with the harsh reality of the inner workings of policymakers and markets have retraced from their previous sharp rally.



2. China's Economic Troubles are Just Beginning

  • A worsening property slump and Covid lockdowns in July continued to curb business and consumer activity, dampening sentiment and deepening China’s slowdown.

  • China is still grappling with the fallout of its moribund real estate sector, which is estimated to account for around 70% of the economy by extension and 29% of GDP.

More gloomy economic data has come out of the world’s second largest economy with weaker-than-expected domestic demand and worsening Covid conditions as well as a power crunch, undermining China’s full-year growth outlook.

Goldman Sachs (-0.35%) lowered its projection for gross domestic product growth to 3% from 3.3% earlier, while Nomura (-0.83%) slashed its forecast to 2.8% from 3.3%, with both targets well below Beijing’s slated aim of achieving 5.5% growth this year looking increasingly aspirational.

A worsening property slump and Covid lockdowns in July continued to curb business and consumer activity, dampening sentiment and deepening China’s slowdown.

The People’s Bank of China, the central bank, which had so far held off on looser monetary policy, unexpectedly cut interest rates this week to help bolster growth, while local governments are set to sell more bonds to ramp up spending, all signs that the economic conditions in the Middle Kingdom are far more dire than officially reported.

Top Chinese economic officials have been downplaying the 5.5% GDP growth target recently, and have privately acknowledged that it’s unlikely to meet it this year, in order not to draw unnecessary attention to what is likely to be another public failure of Chinese President Xi Jinping’s administration.

Economists from Goldman Sachs wrote in a report to clients on Wednesday that July data “confirmed the lack of domestic demand,” with Covid-19 cases rising, power supply stressed due to the hot summer, and major new stimulus unlikely.

China is still grappling with the fallout of its moribund real estate sector, which is estimated to account for around 70% of the economy by extension and 29% of GDP.

Demand for real estate has been slow and homebuyers have held back on repaying mortgages for uncompleted projects, deepening the crisis.



3. Macro Not Merge will Determine End of Crypto Winter

  • Although cryptocurrencies have benefited in recent weeks, the bulk of gains have been erased this week on release of the Fed’s meeting minutes, suggesting that investors shouldn’t take their risk before it’s been released by the Fed.

  • The two largest cryptocurrencies, Bitcoin and Ether both slumped for the fourth consecutive day and a durable recovery will require more certainty, especially with respect to interest rates and economic conditions.

Macro not Merge will ultimately determine when this current “Crypto Winter” will end, with each rebound retracing to earlier levels as investors sit on the sidelines given increasingly uncertain economic conditions.

Although cryptocurrencies have benefited in recent weeks on expectations of a more dovish U.S. Federal Reserve, based on the fact that inflation in the U.S. has slowed and the long-awaited software upgrade of Ethereum, known as the “Merge,” the bulk of gains have been erased this week on release of the Fed’s meeting minutes, suggesting that investors shouldn’t take their risk before it’s been released by the Fed.

And while the Merge has largely been seen as a bullish factor for Ethereum and crypto in general, detractors looking to fork the Ethereum blockchain to remain on Proof-of-Work has created uncertainty and allowed for new trading strategies that will exploit possible chaos as a result of the upgrade.

The two largest cryptocurrencies, Bitcoin and Ether both slumped for the fourth consecutive day and a durable recovery will require more certainty, especially with respect to interest rates and economic conditions.

Institutional players are deploying a variety of sophisticated delta-neutral trading strategies around the Merge, which would pay out regardless of what happens with Ethereum’s upgrade, using a variety of options, swaps and futures to hedge positions.

Nevertheless, the crypto market malaise has seen corporate investors take advantage of lower prices to double down on investments in the industry, with the top 40 publicly traded U.S. companies investing a combined US$6 billion into blockchain startups from September last year to June this year.

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