Daily Analysis 20 May 2022 (10-Minute Read)

Hello there,

A wonderful Friday to you as sentiment received a boost from a move by Chinese banks to lower a key interest rate for long-term loans by a record amount.

In brief (TL:DR)

  • U.S. stocks closed lower Thursday with the Dow Jones Industrial Average (-0.75%), S&P 500 (-0.58%) and the Nasdaq Composite (-0.26%) all down.

  • Asian stocks pushed higher Friday, shrugging off modest losses on Wall Street Thursday.

  • Benchmark U.S. 10-year Treasury yields rose three basis points to 2.86% (yields fall when bond prices rise).

  • The dollar trimmed its biggest one-day drop since 2020.

  • Oil fell with June 2022 contracts for WTI Crude Oil (Nymex) (-1.10%) at US$110.98.

  • Gold was lower with June 2022 contracts for Gold (Comex) (-0.22%) at US$1,843.80.

  • Bitcoin (+3.33%) rose to US$30,082 (at the time of writing) but otherwise maintaining ground as other asset classes slipped harder.


In today's issue...

  1. U.S. Jobless Claims Creep to Highest Since January

  2. Beijing Bites the Bullet and Stimulates Economy

  3. Tether’s Commercial Paper Claims Continue to Dog Stablecoin


Market Overview

Rebounds in risk sentiment have tended to fizzle this year. Investors continue to grapple with concerns about an economic downturn, in part as the Federal Reserve hikes interest rates to quell price pressures. Global shares are on course for an historic seventh week of declines.

Chinese banks cut the five-year loan prime rate, which will help to reduce mortgage costs and may boost loan demand amid a property slump and Covid lockdowns.

Traders in the US will be bracing for more volatility later Friday due to the monthly expiration of options tied to equities and exchange-traded funds.

Asian markets rose Friday with Tokyo's Nikkei 225 (+1.17%), Sydney’s ASX 200 (+1.00%), Seoul's Kospi Index (+1.62%) and Hong Kong's Hang Seng Index (+1.91%) all up in the morning trading session.



1. U.S. Jobless Claims Creep to Highest Since January

  • According to U.S. Labor Department data released yesterday, initial unemployment claims soared by 21,000 to 218,000, or about 9% above the median Bloomberg survey of economists’ estimate of 200,000.

  • While the overall level of unemployment claims remains relatively low, it is creeping higher and could complicate rate-setting in the latter half of the year.

In a surprising twist to the economy, the effect of waning pandemic-era support for Americans has seen an unexpected rise in applications for U.S. state unemployment insurance claims, led by Kentucky and California.

According to U.S. Labor Department data released yesterday, initial unemployment claims soared by 21,000 to 218,000, or about 9% above the median Bloomberg survey of economists’ estimate of 200,000.

Although the continuing claims figures suggest a rock-solid labor market, a durable increase in initial applications could signal the onset of weakening.

With the U.S. Federal Reserve tightening monetary policy more aggressively to hold back price pressures, higher interest rates are expected to dampen demand for both labor and business expansion and the increase in initial claims could be the first sign of that turn.

While the overall level of unemployment claims remains relatively low, it is creeping higher and could complicate rate-setting in the latter half of the year.

The rise in fresh unemployment claims isn’t likely to derail the Fed’s next two 50-basis-point policy hikes, as policymakers contend with the fastest pace of price increases in over four decades.

Investors looking for weaker job numbers to test the Fed’s resolve for tightening will need to wait for labor conditions to get far worse before the path of interest rate hikes gets derailed.

Last week, U.S. Federal Reserve Chairman Jerome Powell reiterated the central bank’s resolve to do whatever it takes to bring down price pressures, and signaled that more aggressive tightening was not off the table.



2. Beijing Bites the Bullet and Stimulates Economy

  • As zero-Covid hammers the Chinese economy, Beijing is increasingly realizing that it can’t just talk a good game, but has to put some real numbers behind the message, it’s pumping a whopping US$5.3 trillion back into the system.

  • In other words, if the Chinese economy can’t shake the funk from its zero-Covid dunk, Beijing still has plenty of room to spend more.

For weeks, investors had grown weary of the endless rhetoric out of Beijing on how the Chinese

government would do whatever it takes to support the economy, but without any clear or concrete plans on what would be done.

As zero-Covid hammers the Chinese economy, Beijing is increasingly realizing that it can’t just talk a good game, but has to put some real numbers behind the message, it’s pumping a whopping US$5.3 trillion back into the system.

The figure is based on Bloomberg’s calculation of monetary and fiscal measures so far and roughly equates to around a third of China’s US$17 trillion economy, but pales in comparison to the stimulus in 2020 when the pandemic first hit.

In other words, if the Chinese economy can’t shake the funk from its zero-Covid dunk, Beijing still has plenty of room to spend more.

That assurance that Beijing is willing to dig deep has seen Chinese shares rally this past week, even as the rest of the world has struggled, but whether or not that resilience is durable remains to be seen.

There continues to be a flood of headwinds facing the Chinese economy, not least of which is its insistence on zero-Covid policies.

Periodically locking down entire cities is not good for confidence or business.

Even as cities like Shanghai look to return back to normal, another case or cluster could roll back any move to lift restrictions and plunge the financial center back into another lockdown.

Arbitrary policy moves as well as the reluctance of Chinese borrowers to make good on their dollar-denominated offshore bonds also means that much of the global fund flows into China may have left for the foreseeable future.

Making matters worse, the refusal of Chinese President Xi Jinping to condemn the Russian invasion and Beijing’s apparent cozying up with Moscow, risks creating an axis on the so-called “World Island” that could subject global investors in China to higher political exposure than many would feel comfortable with.

Spending more on infrastructure and loosening monetary policy also won’t do anything for Chinese consumer sentiment.

China has so far refused to accept foreign mRNA vaccines, which have proved to be the most effective, and so it’s hard to see an end in sight for zero-Covid lockdowns, making it unclear that Beijing can spend its way out of its economic malaise.



3. Tether's Commercial Paper Claims Continue to Dog Stablecoin

  • Tether, the company that issues the supposedly backed dollar-based stablecoin USDT, claims that it had reduced the amount of commercial paper in the reserve backing its USD$74 billion token.

  • Although the cryptocurrency markets aren’t likely to take down the financial markets with it, if a run on Tether was to be initiated, the forced selling of Tether’s commercial paper could cause a collapse and contagion into already embattled financial markets.

If you thought the TerraUSD collapse was bad, just imagine that a stablecoin as systemically important to the financial and cryptocurrency ecosystem such as Tether were to collapse.

Tether, the company that issues the supposedly backed dollar-based stablecoin USDT, claims that it had reduced the amount of commercial paper in the reserve backing its USD$74 billion token.

In a week that has seen over US$7 billion worth of USDT redemptions to USD, Tether has recently revealed that as of March 31 this year, it held US$82.4 billion in assets versus US$82.2 billion in liabilities, according to “assurances” from its Cayman Islands-based accountant MHA Cayman.

The main issue of course is that the value of commercial paper isn’t static and also depends heavily on its quality, duration and current credit market conditions.

With interest rates rising, yields have been soaring (the difference between the face value of the bond with its coupon rate and how much an investor is willing to pay for it).

Alarmingly, the spread between high yield bonds (the riskiest) and investment-grade, has been steadily growing, reversing a multiyear convergence due to loose credit conditions.

Unlike TerraUSD, Tether relies on a reserve of actual dollars and dollar-equivalent assets to maintain its 1-to-1 peg with the actual greenback.

The actual quality of Tether’s reserves has long been the subject of much debate and their liquidity even more suspect, with investors deciding not to take any chances last week in the wake of the TerraUSD collapse.

Nevertheless, Tether, in a statement yesterday, noted a 17% decrease in commercial paper holdings to US$20.1 billion compared with the previous quarter, and added that it had completed a further 20% reduction on that amount since April 1.

Although the cryptocurrency markets aren’t likely to take down the financial markets with it, if a run on Tether was to be initiated, the forced selling of Tether’s commercial paper could cause a collapse and contagion into already embattled financial markets.

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