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Daily Analysis 20 April 2022 (10-Minute Read)

Hello there,

A wonderful Wednesday to you as U.S. equities rise on better-than-expected U.S. economic data and growing confidence in the resilience of the U.S. economy.

In brief (TL:DR)

  • U.S. stocks saw their biggest single-day rise in over a month on Tuesday with the Dow Jones Industrial Average (+1.45%), the S&P 500 (+1.61%) and the Nasdaq Composite (+2.15%) all rising on economic data that suggests recession risks may be overstated.

  • Asian markets were higher on Wednesday with investors taking their cue from the robust performance on Wall Street and as the Bank of Japan appears committed to loose monetary policy.

  • Benchmark U.S. 10-year Treasury yields continued to rise to 2.94% taking up their traditional correlation with equities as risk appetite returned to the fray (yields rise when bond prices fall).

  • The dollar slipped and the yen stabilized after a prolonged fall.

  • Oil rebounded with May 2022 contracts for WTI Crude Oil (Nymex) (+0.93%) at US$103.51 after an industry report suggested a drop in U.S. stockpiles.

  • Gold was lower with June 2022 contracts for Gold (Comex) (-0.71%) at US$1,945.10 as risk appetite was back in play.

  • Bitcoin (+1.36%) continued to gain to US$41,326 in Asian trading alongside stocks and the recovery in U.S. tech shares.

In today's issue...

  1. Where have all the Stock Bulls gone?

  2. Yen's Epic 50-year Slide Against Dollar Opens Lucrative Carry Trade

  3. Billions on Bets that Ethereum will Make a Software Upgrade Breakthrough

Market Overview

The selloff in U.S. Treasuries took a breather as investors evaluated the economic outlook with better-than-expected U.S. housing starts and strong consumer spending being weighed against high inflation and a hawkish U.S. Federal Reserve.

Meanwhile, China's continued zero-Covid policies are raising concerns that the world's second largest economy may act as a drag on global demand, even as its economy slows rapidly and snarls supply chains.

It is as yet unclear whether a long-term shift to value stocks from growth stocks will prove durable and key to the next chapter will be monetary policy - investors have enjoyed low rates and loose financial conditions for so long, it may take time to recognize the shift in markets.

Asian markets were higher in Wednesday's morning trading session with Seoul's Kospi Index (+0.10%), Tokyo's Nikkei 225 (+0.64%), Sydney’s ASX 200 (+0.29%) and Hong Kong's Hang Seng Index (+0.82%) all higher.

1. Where have all the Stock Bulls gone?

  • U.S. equities rebound sharply on stronger-than-expected economic data, especially housing starts which are typically rate-sensitive.

  • Confidence of the strength of the economic recovery also increases the risk that the U.S. Federal Reserve may become more aggressive on interest rate hikes and policy tightening, capping the potential for a relentless rally in stocks.

Where have all the stock bulls gone,

long time passing.

Where have all the stock bulls gone,

long time ago.

– Sung to the tune of “Where Have All the Flowers Gone” by Pete Seeger

While the list of reasons to be bearish on the stock market is long, it hasn’t really changed all that much – from the Russian invasion of Ukraine, to soaring inflation, central bank policy tightening and the coronavirus (oh yes, that’s still around).

Yet investors have pretty much taken all of the bad news in their stride and assuming that markets are a good representative as to the outlook on the economy (debatable), the fact that stocks haven’t crashed already should be considered somewhat of a victory.

And it was with that sentiment in mind that on Tuesday, stocks posted their best day in over a month on a string of unexpectedly robust U.S. economic data that undermines arguments of an impending recession.

U.S. housing starts, often a good indicator of where sentiment is in the economy, came inf far better than forecast while hiring remains robust and applications for unemployment benefits are near historical lows.

Consumption data also reveals that Americans are out shopping and dining again.

Surging to their highest level since 2006, U.S. housing starts suggests strength in an area of the economy that is particularly sensitive to interest rate moves.

Over the past two weeks, falls in the quarterly profits at major Wall Street banks increased worries that confidence in the strength of American consumption was overstated, but recent data has boosted sentiment as credit card spending surged.

Travel and dining out has also surged in the first quarter and the recent removal of mask mandates on trains and planes should only fuel a greater desire to travel.

More importantly, the increase in spending hasn’t been met with higher credit card bill delinquency, and data suggests that American households are well capitalized to meet their obligations.

For investors looking to buy the dip, if (and this is still an “if”) the U.S. can avoid a recession, there are plenty of opportunities in areas of structural growth for investors looking to make longer-term bets to find value in stocks, including areas like telecommunications, particularly 5G providers, automation and artificial intelligence, robotics, smart mobility, and electric vehicles.

2. Yen's Epic 50-year Slide Against Dollar Opens Lucrative Carry Trade

  • Japanese yen slides to 50-year low against the dollar, opening up carry trade to borrow in yen and lend in dollars as monetary policies of these two countries diverges.

  • Japanese yen has room to continue falling further as Tokyo has shown no inclination to shore up its currency while continuing to keep monetary policy loose to stimulate the economy.

Nursing its longest losing streak in over 50 years, the Japanese yen’s relentless slide against the dollar comes as Tokyo has been long on rhetoric to defend the yen, but short on concrete intervention to prop up the currency and opening a potentially lucrative yen-dollar carry trade.

With the U.S. Federal Reserve turning more hawkish by the day, to deal with inflation chasing four-decade-highs, there are some policymakers even touting rate rises of as high as 0.75% at the central bank’s next policy meeting in May.

Meanwhile, the Bank of Japan has maintained policy rates at close to zero, as it commits to continue stimulating Japan’s fragile economic recovery.

The last time Japan has intervened to soak up yen and sell dollars was in June 1998, at the height of the Asian Financial Crisis, an unfamiliar role for the country at the time, with its huge current account surplus.

A weak yen is positive for the Japanese economy, but a rapid drop can disrupt corporate planning and affect imports of commodities and raw materials for its manufacturers, especially with the price of oil rising because of the Russian invasion of Ukraine.

In the meantime, traders are placing bearish bets on the yen to fall further and arbitrageurs are running a profitable carry trade to borrow in yen and to lend in dollars – a lucrative trade for as long as the divergence in monetary policies continues.

Most economists believe that that Bank of Japan is still a long way off from raising interest rates – inflation in Japan is still relatively benign, and years of economic stagnation and underperformance would benefit with a boost from cheaper exports.

3. Billions on Bets that Ethereum will Make a Software Upgrade Breakthrough

  • Billions of dollars' worth of Ether are being used to bet that Ethereum will finally complete its ambitious shift to a proof-of-stake means of securing its blockchain.

  • Traders are increasingly taking bullish bets on Ether's price as a successful software upgrade would also convert the cryptocurrency to a deflationary emissions schedule which means that over time, the amount of Ether will be expected to decrease.

If successful, Ethereum, the world’s second most valuable blockchain by market cap, would have pulled off the seemingly impossible for only the second time in its short history – the first was surviving the ideological struggle from the DAO hack in 2016.

Ethereum is set to make history by being the first blockchain in the world to move from the energy-intensive proof-of-work method of securing transactions, to the far more energy-neutral proof-of-stake mechanism and serious money is betting that the transition will work.

Over US$10 billion worth of Ether, or approximately 3.22 Ether tokens, have already been staked on decentralized finance or DeFi protocol Lido Finance, in anticipation of a successful completion of the long-awaited shift to proof-of-stake for the Ethereum blockchain.

The software upgrade, dubbed the “Merge” has been years in the making and now has a timeline, with some of its top developers suggesting that the latter half of this year will be when the change is instituted.

So far, the “hard fork,” a software upgrade that will need to be adopted by cryptocurrency miners has been through several important stress tests and passed them with flying colors, raising expectations that the ambitious shift will be successful.

Ethereum’s upgrade won’t just shift the blockchain to a proof-of-stake methodology, it will also change its native cryptocurrency Ether into a deflationary token, which has many traders betting that the price of Ether will be expected to rise, especially as it will generate value through its use as a means to stake to secure the Ethereum blockchain.

Staking enables holders of Ether to earn passive income by way of more Ether, by using their staked tokens to help validate transactions and secure the Ethereum blockchain.

But staked Ether isn’t without its risks.

If the Ethereum upgrade doesn’t go according to schedule, a common occurrence in software, staked Ethereum holders could rush to swap their staked tokens for regular Ether on the open market, potentially causing the value of the staked token, which is pegged to Ether, to lose its peg and therefore its value.

While this wouldn’t affect the price of Ether so much, it would affect the value of staked Ether tokens, which are a derivative of the Ether staked, regardless of platform.

Traders looking to cash in on the returns from staking Ether are best advised to monitor closely the liquidity of the staked Ether tokens that they hold, because should that liquidity dry up, it may be difficult to swap a staked Ether for a regular one without forcing an unpegging of the value.

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