Daily Analysis 18 January 2022 (10-Minute Read)
A terrific Tuesday to you as markets wavered on a mix of signals and China slashing its key interest rate.
In brief (TL:DR)
U.S. stocks were a mixed bag at the close on Friday with the Dow Jones Industrial Average (-0.56%), tumbling on concerns over weaker-than-expected retail sales while the S&P 500 (+0.08%) and the Nasdaq Composite (+0.59%) and were closed Monday for the Martin Luther King Jr Day holiday.
Asian stocks mostly climbed Tuesday as China slashed rates.
Benchmark U.S. 10-year Treasury yields increased three basis points to 1.82% (yields rise when bond prices fall) from last week.
The dollar slipped in Asian trading.
Oil climbed with February 2022 contracts for WTI Crude Oil (Nymex) (+1.05%) at US$84.70 as geopolitical tensions stirred in the Middle East.
Gold rose with February 2022 contracts for Gold (Comex) (+0.27%) at US$1,821.40.
Bitcoin (-1.52%) fell to US$42,287 with the benchmark cryptocurrency continuing to trend sideways in the absence of strong macro factors to take it in either direction.
In today's issue...
China Slashes Interest Rates as Growth Wanes
What will it take to rattle the U.S. Federal Reserve?
Fidelity Advises Central Banks to bet on Bitcoin
Global stocks have dipped this year, hurt by a retreat in U.S. shares. A key question now is whether company profits will revive sentiment, despite higher costs and challenges from the omicron virus strain.
JPMorgan Chase & Co. strategists contend that global corporate earnings will deliver significant returns this year, again defying doomsayers and skeptics, but early reporting numbers are not encouraging.
In Asia, markets were mostly higher Tuesday with Tokyo's Nikkei 225 (+0.83%), Sydney’s ASX 200 (+0.08%) and Hong Kong's Hang Seng (+0.38%) up, while Seoul's Kospi Index (-0.15%) was lower in the morning trading session.
1. China Slashes Interest Rates as Growth Wanes
On its current trajectory, the Chinese economy will begin to shrink sometime within the next two years through measures of its own making.
And as Europe and U.S. look set to tighten monetary policy, if risk-off sentiment should take hold, Chinese assets may continue to gradually trend downwards until there is greater certainty.
The bargain that the Chinese Communist Party has made with the Chinese people has for the longest while been that so long as the economic goods keep getting delivered, the populace would look the other way on personal freedoms. Ahead of an integral leadership conclave that will see Chinese President Xi Jinping being anointed for an unprecedented third term and ushering in his role as leader for life of the world’s second largest economy, China’s economy has slowed dramatically. On its current trajectory, the Chinese economy will begin to shrink sometime within the next two years through measures of its own making. From an ill-advised crackdown on the real estate sector that is estimated to affect up to 20% of GDP, to its zero-tolerance Covid-19 policies, China’s central bank has had little choice other than to cut interest rates, in stark contrast to other major economies. Cutting its key interest rate for the first time since the pandemic started, the People’s Bank of China lowered one-year loan rates to banks by 0.10%, the first reduction since April 2020. To be sure, unlike Europe and the U.S., inflation has been relatively muted in China, with price stability helped in no small part to the fact that the country is still the world’s factory and it was far less affected by supply chain disruptions. This provides the necessary backdrop for Beijing to slash rates to cope with the slump in the property sector and repeated outbreaks of the Omicron variant that are putting a strain on economic conditions. Official data yesterday revealed that China’s GDP grew a tepid 4% last quarter from a year earlier, the weakest since 2020, when the brunt of the pandemic’s effects was felt and in stark contrast to the rebounding economies of the U.S. and Europe which are recovering rapidly. Property sales and housing investment in China are in near freefall and consumer spending has plummeted because of tight pandemic movement restrictions/ Nonetheless, China’s economy still grew at 8.1% last year, above the target “over 6%” albeit much of that growth was from a far lower base in 2020, when the full brunt of Covid-19 was experienced. Chinese stocks recovered following the rate cuts, with the benchmark CSI 300 Index up as much as 1% after falling in the previous two sessions. Whether the rebound will be durable is less clear – Chinese companies listed in Hong Kong, a barometer of global investor appetite for exposure to the Middle Kingdom, remains tepid. Some institutional investors have already called a bottom on the rout in Chinese assets, with Goldman Sachs snapping up the bonds of Chinese real estate developers at pennies on the dollar, in anticipation that Beijing won’t allow its property sector to bottom out. Global investors are also nibbling on shares of embattled Chinese tech firms as well, as their valuations reach attractive levels. The biggest fear for investors remains the arbitrary shifts in policy from Beijing – with the lack of certainty, communication and predictability major turnoffs for global asset allocators unsure of which portions of the Chinese economy could suffer the wrath of lawmakers. And as Europe and U.S. look set to tighten monetary policy, if risk-off sentiment should take hold, Chinese assets may continue to gradually trend downwards until there is greater certainty.
2. What will it take to rattle the U.S. Federal Reserve?
The prospect of tightening liquidity has seen assets from cryptocurrencies to supercharged tech stocks tumble.
But it’s expectation that matters in a market that has seen records set despite an economically debilitating pandemic.
Make no mistake about it, the key U.S. Federal Reserve rate remains at near zero. At the end of the last Federal Open Market Committee meeting, the world’s foremost central bank determined to keep rates at close to zero, whilst communicating that it would be normalizing monetary policy in short order to tackle inflation. The prospect of tightening liquidity has seen assets from cryptocurrencies to supercharged tech stocks tumble. In numerical terms, over 220 listed U.S. companies with market capitalizations over US$10 billion are down at least 20% from their highs and many remain in bear-market territory, including Walt Disney, Netflix, Salesforce and Twitter. The tech-heavy Nasdaq Composite, which for the most part of last year was a one-way sure bet, has since seen around 39% of stocks halved from their highs, with the index itself off 7% from its peak. Bitcoin currently trades around US$42,000, well shy of its all-time-high of close to US$69,000 last November. All that without even a single interest rate hike to speak of. But it’s expectation that matters in a market that has seen records set despite an economically debilitating pandemic. The selloff and risk-off sentiment highlights how shaky markets have been in 2022, with U.S. stocks posting a second-straight weekly decline, dragging the S&P 500 down by 2.2% while the Nasdaq Composite has been hammered down by 4.8% at the start of the year. Meanwhile Treasury yields have soared on expectation that the Fed is positioning to raise interest rates this year, while Cathie Wood’s flagship ARK Innovation ETF, the darling of the pandemic, is down around 50% from its 52-week high. In the past, market turmoil would be enough for the Fed to waver on hiking interest rates, but with inflation pushing forty-year highs, it’s less clear if the central bank will blink. The economic picture painted by corporations as earnings start coming in from the final quarter of 2021 appears far less rosy. With the Omicron variant rippling through the United States, airlines which had hoped for a swift recovery are having to cancel flights and seeing demand dip. Results from big banks also showed that the pandemic profits they churned out are starting to ebb, even as the “value rotation” has provided a tailwind for their stocks. Critically, spending and manufacturing activity slowed to end 2021, while consumer sentiment, with consumption making up 70% of the U.S. economy, worsened. Whether these observations combined will be enough to rattle the Fed into either postponing a rate rise that is widely expected in March or up rates by just 0.25% remains to be seen. In 2015, the Fed wavered on rate hikes as China’s economy started to slow down dramatically following a steep stock market crash that saw almost a third of market capitalization wiped out in a matter of days. As China’s economy slows and its central bank slashes interest rates to revive its economic prospects, the Fed may yet adjust its assessment of the economic situation. The risks of policy missteps are higher now than at any time in the recent past. A closer study of inflation data from the U.S. Bureau of Labor Statistics suggests that many of the key components of price pressures can be attributed to supply chain issues, in particular the demand for used vehicles, while more durable data points such as food price increases are starting to plateau, especially meat. As the U.S. economy begins showing hints of weakness at the periphery, hiking rates too quickly could easily set things off in the wrong direction. There are some clues that the Fed may not be set to yank the cord just yet. At his Senate confirmation hearing, U.S. Federal Reserve Chairman Jerome Powell noted that growth is still an important policy consideration, even as the central bank keeps a keen eye on inflationary pressures.
3. Fidelity Advises Central Banks to bet on Bitcoin
Wall Street giant Fidelity is suggesting that other countries should follow the lead of El Salvador and buy bitcoin while the price is low.
Nevertheless, many politicians in emerging markets watched El Salvador’s bitcoin experiment intently for signs of success and said they would consider a similar move if it paid off.
Not since Bretton Woods has a fiat currency been backed by anything other than the promises of a central bank. In the aftermath of the ruinous Second World War, besides political reform, the winners sought to remake the world order to prevent the economic and monetary brinksmanship that laid the ground for global conflict, creating institutions including the Bretton Woods system. Bretton Woods, established monetary management rules for commercial and financial relations among the U.S., Canada, Western Europe, Australia and Japan. One of the chief features of Bretton Woods was for each country to adopt a monetary policy that maintained its external exchange rates with 1% by tying its national currency to gold and the ability of the International Monetary Fund to bridge temporary imbalances of payments. The thinking behind Bretton Woods was to address the lack of cooperation among nations and to prevent a competitive devaluation between currencies. But on August 15, 1971, the U.S. unilaterally terminated the dollar’s convertibility to gold, effectively ending the Bretton Woods system and ushering our current epoch of fiat currency. Soon after the end of Bretton Woods, many previously fixed currencies became free-floating and the world has since accepted floating exchange rates as the norm. The period immediately following Bretton Woods saw a rapid increase in the monetary base in the United States and a period of sharp inflation, not dissimilar to the current time. Against this backdrop, Wall Street giant Fidelity is suggesting that other countries should follow the lead of El Salvador and buy bitcoin while the price is low. In a note, Fidelity analysts Chris Kuiper and Jack Neureuter wrote, “There is very high stakes game theory at play here, whereby if bitcoin adoption increases, the countries that secure some bitcoin today will be better off competitively than their peers.” “[We] wouldn't be surprised to see other sovereign nation states acquire bitcoin in 2022 and perhaps even see a central bank make an acquisition.” The IMF was quick to discourage El Salvador’s move last year to adopt bitcoin as legal tender alongside the dollar and in a statement at the time noted, “Given bitcoin's high price volatility, its use as a legal tender entails significant risks to consumer protection, financial integrity, and financial stability. Its use also gives rise to fiscal contingent liabilities.” Nevertheless, many politicians in emerging markets watched El Salvador’s bitcoin experiment intently for signs of success and said they would consider a similar move if it paid off. This week, the Rio de Janeiro’s mayor reportedly said he plans to allocate 1% of the city’s treasury reserves to cryptocurrencies, while Miami’s mayor Francis Suarez said last year that he wants to put some of the city’s treasury in bitcoin. Whether these moves will lead to a broader push to move back in the direction of a Bretton Woods type system with bitcoin as the backing for national currencies still remains to be seen, but stranger things have happened.
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