Hello there,

A fantastic Friday to you as markets find their footing with a strong rebound on Thursday in light of conflicting economic data that has some investors speculating could temper the U.S. Federal Reserve's most excessive hawkish tendencies.

In brief (TL:DR)

• U.S. stocks rode better on Thursday with the Dow Jones Industrial Average (+1.85%), S&P 500 (+2.47%) and the Nasdaq Composite (+3.06%) all higher.

• Asian stocks were boosted by China tech Friday.

• Benchmark U.S. 10-year Treasury yields declined one basis point to 2.82% as investors calibrated risks from the prospect of aggressive U.S. Federal Reserve monetary-policy tightening to tackle high inflation (yields fall when bond prices rise).

• The dollar was set for its best week since 2021 amid investor caution and as the U.S. Federal Reserve readies sharp interest-rate hikes to slow inflation.

• Oil was lower with June 2022 contracts for WTI Crude Oil (Nymex) (-0.13%) at US$105.22.

• Gold inched higher with June 2022 contracts for Gold (Comex) (+0.60%) at US$1,902.70.

• Bitcoin (+0.59%) recovered to US$39,679 (at the time of writing) against a sea of risk appetite and with tech stocks rebounding.

Hello there,

A fantastic Friday to you as markets find their footing with a strong rebound on Thursday in light of conflicting economic data that has some investors speculating could temper the U.S. Federal Reserve's most excessive hawkish tendencies.

In brief (TL:DR)

• U.S. stocks rode better on Thursday with the Dow Jones Industrial Average (+1.85%), S&P 500 (+2.47%) and the Nasdaq Composite (+3.06%) all higher.

• Asian stocks were boosted by China tech Friday.

• Benchmark U.S. 10-year Treasury yields declined one basis point to 2.82% as investors calibrated risks from the prospect of aggressive U.S. Federal Reserve monetary-policy tightening to tackle high inflation (yields fall when bond prices rise).

• The dollar was set for its best week since 2021 amid investor caution and as the U.S. Federal Reserve readies sharp interest-rate hikes to slow inflation.

• Oil was lower with June 2022 contracts for WTI Crude Oil (Nymex) (-0.13%) at US$105.22.

• Gold inched higher with June 2022 contracts for Gold (Comex) (+0.60%) at US$1,902.70.

• Bitcoin (+0.59%) recovered to US$39,679 (at the time of writing) against a sea of risk appetite and with tech stocks rebounding.

In today's issue...

1. U.S. Economy Shrinks for First Time Since Pandemic

2. China Risks are Rising from a Receding Yuan

3. Wall Street Pushes Deeper into Crypto

Market Overview

Corporate earnings are just the latest variable to whipsaw markets. There are concerns that tightening U.S. monetary policy, the war in Ukraine and China’s Covid outbreak all herald more challenges for investors.

The latest U.S. data showed that the world’s largest economy unexpectedly shrank for the first time since 2020 and that reflected an import surge tied to solid consumer demand, suggesting growth will return imminently.

Asian markets rose Friday with Seoul's Kospi Index (+0.85%), Tokyo's Nikkei 225 (+1.75%), Hong Kong's Hang Seng Index (+1.07%) and Sydney’s ASX 200 (+0.73%) all up in the morning trading session.

1. U.S. Economy Shrinks for First Time Since Pandemic

• The U.S. economy has shrunken unexpectedly for the first quarter of 2022 and the first time since the outbreak of the pandemic.

• Nevertheless, the economic contraction took many by surprise and could provide sufficient food for thought as U.S. Federal Reserve policymakers gather to set rates next month.

Like a sweater fresh out of the dryer, the U.S. economy has shrunken unexpectedly for the first quarter of 2022 and the first time since the outbreak of the pandemic, reflecting a slew of bearish factors including growing trade imbalances and weaker inventory growth.

GDP actually fell by 1.4% on an annualized basis for the first three months of 2022 according to the U.S. Department of Commerce, which reported the data on Thursday, and was a significant slump from the 6.9% growth clocked in the fourth quarter of 2021.

The shrinking economy comes at a time when there is no shortage of headwinds to growth, from soaring inflation to geopolitical risks, China’s Covid-zero policies and tightening monetary policy are all conspiring to create a mélange of market mayhem.

GDP was also dragged lower by a yawning trade deficit, which hit a record high in March as import volumes and prices surged and exports fell 5.9% even as imports rose to 17.7%.

Consumption, which makes up some 70% of the U.S. economy grew 2.7% in the first quarter, up from 2.5% from the previous quarter but shy of most economist estimates, and more importantly business investment soared to 9.2% from just 2.9%.

Nevertheless, the economic contraction took many by surprise and could provide sufficient food for thought as U.S. Federal Reserve policymakers gather to set rates next month.

The shrinking economy comes at the worst possible time for policymakers whose “Goldilocks” window for rates is rapidly narrowing – not so high as to push the economy into recession, but not so low as to continue stoking the fires of inflation – and with that the risk of policy errors rises.

There are already signs that some traders are betting on policymakers getting it wrong, as the yield curve (the slope between long-dated yields and short-dated ones) briefly inverted earlier this month and is widely used as an indicator of recession expectations.

Most market participants have already priced in a 50-basis-point rate hike in May and given that investors are more or less prepared for that, it would be prudent for the Fed to take that course.

Raising by only 0.25% could be an indication that the Fed doesn’t believe the economy is sufficiently strong to take higher rates and ratcheting up to 0.75% at the next meeting could be the straw that breaks the camel’s back – the stakes could not be higher.

That stocks advanced in response to GDP data suggests at least more investors are betting on the Fed getting it right this round.

2. China Risks are Rising from a Receding Yuan

• Against the backdrop of a strengthening dollar, China’s tightly managed yuan is starting to show signs of weakness that could precipitate a run on its currency.

• Onshore yuan has lost around 4% in just over a week while its offshore cousin is headed for its worst month relative to the dollar in history.

As has so often happened, economic crises tend to come from corners of the emerging markets full of promise and potential but just as laden with pitfalls in the pursuit of pecuniary payouts.

From overselling the promise of riches in the swamplands of Louisiana through the shares in the Mississippi Company in the 18th century to the mineral riches of Myanmar in our more recent epoch, it’s often difficult to know what risks lay around the corner when investors are blinded by the prospect of riches beyond the dreams of avarice.

But this time, the risks mounting for the global economy aren’t coming from just any emerging market, they’re coming from the world’s second largest economy, that makes everything from our Christmas trees to the presents that sit under them.

Against the backdrop of a strengthening dollar, China’s tightly managed yuan is starting to show signs of weakness that could precipitate a run on its currency.

In 2015, the yuan devaluation roiled markets and sparked an estimated US$1 trillion in capital flight, and there are alarming signals that the yuan is once again weakening at a similar pace.

Onshore yuan has lost around 4% in just over a week while its offshore cousin is headed for its worst month relative to the dollar in history.

With China’s economy rapidly slowing, a circumstance of Beijing’s own creation, from crackdowns in lucrative sectors such as tech and real estate, to its ill-conceived full lockdowns of entire cities to stem the tide of coronavirus infections, there are plenty of reasons for the yuan to weaken against the dollar as the monetary policy in the two countries diverge.

Beijing has been reluctant to completely loosen its monetary policy, taking piecemeal action and using a nutcracker where nothing less than a sledgehammer would do, while the U.S. is having to tighten conditions to deal with white hot inflation and prices rising at their fastest pace in four decades.

On its part, there are signs that China may just be allowing its currency to break with a rallying dollar, but there is a risk that such moves will accelerate and exacerbate a growing loss of confidence in the world’s second largest economy.

In the first three months of this year alone, global investors have withdrawn some US$6 billion from Chinese assets and pressure is building on Chinese President Xi Jinping to act as he seeks an unprecedented third term in office later this year.

Chinese policymakers and the People’s Bank of China have repeatedly pledged to boost sentiment in financial markets, but their actions so far have been long on rhetoric and short on action.

Global investors spooked by China’s 2015 record aren’t sticking around to find out, especially as Beijing draws closer to Moscow, which has become an international pariah thanks to its unprovoked invasion of Ukraine.

China’s stocks are in virtual freefall, taking a breather every now and then before continuing to

plummet, and its sovereign debt no longer offers a carry over comparable U.S. Treasuries, dramatically diminishing the appeal of yuan-denominated assets.

Covid lockdowns and a slowing property market are darkening the outlook of an economy that has only known growth since Chinese leader Deng Xiaoping first instituted reforms to open the world’s most populous nation to capitalist systems.

3. Wall Street Pushes Deeper into Crypto

• The latest financial juggernaut to throw its hat in the ring has been Jefferies Financial Group, which is expanding banking services for cryptocurrency clients.

• These moves by Wall Street’s financial heavyweights underscore just how far some of the world’s most staid financial institutions have come in accepting and even going so far as to embrace cryptocurrencies.

If you can’t beat them, join them.

At least that’s what appears to be happening for a slew of some of the biggest names on Wall Street who had previously derided cryptocurrencies as anything from a mere “puff” to an outright “fraud.”

The latest financial juggernaut to throw its hat in the ring has been Jefferies Financial Group, which is expanding banking services for cryptocurrency clients and perhaps inspired by the performance of Silvergate Capital, the long-trusted bank of many cryptocurrency firms.

In a quarter which saw profits at major Wall Street banks plunge, on a sharp decline in fees from dealmaking and capital-raising, Silvergate Capital’s bank was the standout performer by servicing the rapidly growing cryptocurrency industry.

Jefferies is hardly alone in ratcheting up cryptocurrency activity, with the world’s largest asset manager BlackRock (+1.24%) now backing a stablecoin issuer and Goldman Sachs which had previously opened and closed its cryptocurrency trading desk, now doubling down on trading digital assets.

These moves by Wall Street’s financial heavyweights underscore just how far some of the world’s most staid financial institutions have come in accepting and even going so far as to embrace cryptocurrencies.

For years, some of Wall Street’s most high profile executive have derided cryptocurrencies, with JPMorgan Chase CEO Jamie Dimon once calling it a “fraud” until the lure of lucre meant that firms who turned a nose at the nascent asset class were missing out on the flood of investor money chasing it.

But even as Wall Street’s finest chase after the digital dollar, regulatory uncertainty and internal compliance cloud expansion plans, with many firms having to either create distinct legal entities to hive off should things go pear-shaped or limit their participation.

While institutional trading volume is increasing – US$1.14 trillion worth of cryptocurrencies were traded on Coinbase Global (+0.11%) in 2021 – it still remains a drop in the ocean compared with traditional assets – US$4-$12 trillion of derivatives are traded in a single day.

And while some large banks are trading cryptocurrency derivatives, none of them is trading cryptocurrency itself.

Wall Street is also finding itself having to play catch up with the rapidly evolving cryptocurrency landscape, the lingo and in many cases has been slow to keep up with changes and advancements in the sector.

Nevertheless, Wall Street appears to be (for now) committed to its cryptocurrency endeavor, regardless of the compliance costs or the trading and technology work required, because as clients continue to demand exposure to the asset class, banks will, in the words of Dimon, who was speaking to the Wall Street Journal in 2021,

“I’m not a Bitcoin supporter. I don’t care about Bitcoin. I have no interest in it. On the other hand, clients are interested, and I don’t tell clients what to do.”