Daily Analysis 3 November 2022 (10-Minute Read)

A magnificent Thursday to you as investors position for higher peak in Fed funds rate next year.


In brief (TL:DR) 


  • U.S. stocks were lower on Wednesday with the Dow Jones Industrial Average (-1.55), the S&P 500 (-2.50%) and the Nasdaq Composite (-3.36%) all down after Jerome Powell said the Federal Reserve would raise interest rates more than previously anticipated, sapping risk appetite.

  • Asian stocks fell, though declines in most markets were less than in the US. 

  • Benchmark U.S. 10-year Treasury yields advanced six basis points to 4.10% (yields rise when bond prices fall). 

  • The dollar fluctuated against Group-of-10 counterparts as investors looked toward US jobs data, which may help to determine the pace of upcoming rate hikes. 

  • Oil dropped with December 2022 contracts for WTI Crude Oil (Nymex) (-1.31%) at US$88.82 after Powell’s comments on interest rates overshadowed tightening supply.

  • Gold fell with December 2022 contracts for Gold (Comex) (-1.09%) at US$1,632.00.

  • Bitcoin (-0.74) was at US$20,327.


In today's issue...


  1. .S. Federal Reserve Signals Death by a Thousand Pinpricks

  2. Chinese Real Estate Bonds are a Black Box 

  3. Crypto Miners Tighten Belts to Weather a Potentially Long Winter 


Market Overview


The Fed raised rates 75 basis points for the fourth time in a row, bringing the top of its target range to 4%, the highest level since 2008. 

 

Traders immediately raised the market-implied peak in interest rates for next year. 

 

Asian markets fell on Thursday with Sydney’s ASX 200 (-1.84%), Hong Kong's Hang Seng Index (-3.08%) and Seoul's Kospi Index (-0.33%) down, while Japan market is closed.



1. U.S. Federal Reserve Signals Death by a Thousand Pinpricks


  • The U.S. Federal Reserve approved another 0.75% interest rate hike for the fourth time in a row and signaled a potential change in how it will approach monetary policy to bring down inflation.

  • Against this backdrop, U.S. stocks reversed initial gains, with the S&P 500 suffering its worst rout on a Fed decision day since January 2021 as investors digested the message. 

 

An ancient (and possibly fictitious) form of Chinese torture would subject its victims to bloodletting by thousands of small cuts, over an extended period of time before suffering a long and agonizing death. 

 

And that appears to be precisely what the U.S. Federal Reserve appears to be ready to do to markets as it approved another 0.75% interest rate hike for the fourth time in a row and signaled a potential change in how it will approach monetary policy to bring down inflation. 

 

The move lifts the Fed’s benchmark to a 3.75%-4% range, from nearly zero in March.

 

U.S. Federal Reserve Chairman Jerome Powell said in the press conference after the rate-setting meeting, “incoming data since our last meeting suggests that the ultimate level of interest rates will be higher than previously expected.” 

 

Powell also warned the Fed had “some ways to go” in its quest to tame soaring prices and pointed to a string of economic reports suggesting it has yet to make a dent in inflation.

 

But what market participants took away was that Powell did not need to see several months of lower inflation reports before switching to smaller increases, clinging on to any hope of better conditions for risk assets. 

 

With U.S. labor markets strong and inflation showing no meaningful signs of easing, Powell and his colleagues were caught in a bind, unable to signal any meaningful pivot but increasingly wary about what over-tightening could do to the economy. 

 

What’s more relevant though is that investors steer their focus away from the size of the next rate hike to where interest rates will ultimately peak and how long they will have to stay at those levels, because that could have far longer-term implications on a variety of investments, assets and assumptions. 

 

Against this backdrop, U.S. stocks reversed initial gains, with the S&P 500 suffering its worst rout on a Fed decision day since January 2021 as investors digested the message. 

 

With unemployment at 3.5% matching five-decade lows, Powell called the labor market out of balance and expressed disappointment at the persistence of high inflation even though some goods prices have begun to decelerate.

 

Nevertheless, Powell did acknowledge that the path to a soft economic landing is getting narrower, because robust demand and stubbornly high inflation just haven’t budged much in response to higher rates.

 

And worryingly, the less volatile components of inflation, such as housing and durable goods costs are showing signs of price increases, instead of the usual suspects fuel and food, which could mean that policymakers may not be able to avoid a recession in their effort to fight inflation.



2. Chinese Real Estate Bonds are a Black Box


  • China’s offshore property notes have plummeted to record lows that reflect deep distress, as defaults mount to unprecedented levels.

  • Some investors are throwing in the towel and conceding that meaningful analysis is no longer possible amid the extreme crisis in Chinese property dollar bonds. 

 

Investors today rely on data more than ever before, but now imagine an asset class that you can no longer value, let alone analyze, which is precisely what is happening for China’s offshore dollar-denominated real estate debt. 

 

China’s offshore property notes have plummeted to record lows that reflect deep distress, as defaults mount to unprecedented levels, with no signs of meaningful intervention by Beijing to lift the embattled real estate sector and no end in sight for economically debilitating zero-Covid policies. 

 

Some investors are throwing in the towel and conceding that meaningful analysis is no longer possible amid the extreme crisis in Chinese property dollar bonds. 

 

The market value of investment-grade Chinese real estate dollar bonds has dropped about 23% in the past month alone and this may be only the beginning. 

 

The Chinese property crisis has its roots in a crackdown that started in 2020 on excessive leverage by developers as well as speculation among homebuyers, and has been worsened by Covid restrictions that have exacerbated a slump in housing sales. 

 

Better-quality builders are seeing their notes now trade at about 73% of par value on average, compared with 88% a month ago and about par as of the end of 2021 (high quality notes should trade in excess of 100% of their value).  

 

Initial optimism that Beijing would ease its zero-Covid restrictions have since given way to resignation that Chinese President Xi Jinping remains determined to push on with his signature policy, regardless of the economic damage. 

 

And with Chinese Premier Li Keqiang now in retirement, Xi has surrounded himself with loyalists and allies, who are unlikely to push back in any meaningful way if the third-term President insists on the current path. 

 

Earlier measures by the People’s Bank of China, the central bank, were muted to try and shore up the real estate sector, and moves to ease credit conditions so that builders complete their unfinished projects have been piecemeal.

 

There is also increasing opacity over bond repayments and possible preferential treatment of onshore lenders as Chinese builders appear inclined to allow offshore bonds to go into default, even as onshore lenders are repaid first.



3. Crypto Miners Tighten Belts to Weather a Potentially Long Winter


  • While salaries, rent and electricity have to be paid for in fiat currency, cryptocurrency miners are now struggling to make those payments given falling prices of digital assets. 

  • In some cases, the biggest miners operating in Texas actually sold energy back to the grid as it became more profitable to do so rather than mine crypto. 

 

In the world of digital assets, one of the most capital intensive has to be cryptocurrency mining. 

 

Not for the faint-of-heart, cryptocurrency mining is in many ways no different than any other high capital outlay business, from hardware costs to land rent, and cooling to electricity. 

 

Making matters even more challenging for cryptocurrency miners, the fruit of their labor can be volatile. 

 

While salaries, rent and electricity have to be paid for in fiat currency, cryptocurrency miners are now struggling to make those payments given falling prices of digital assets. 

 

The Crypto Winter is having wide-ranging implications for the overall crypto ecosystem, hitting miners, who play a crucial role in securing Proof-of-Work blockchains such as Bitcoin’s particularly hard.

 

As the high cost of energy and the flatlining price of digital tokens pushes more miners close to a financial cliff edge, there is a growing pressure of bankruptcy, especially at some of the more highly levered listed-miners. 

 

Last week, Nasdaq-listed Core Scientific, the world’s largest Bitcoin miner, warned it could file for bankruptcy protection as its cash resources would be depleted by the end of the year. 

 

According to the filing, “the payments are in respect to several of its equipment and other financings and that creditors may decide to sue the company for non-payment or take action with respect to collateral.”

 

On Monday, London-listed Argo Blockchain echoed that gloomy outlook, saying it may be forced to cease operations after a critical fundraising fell through.

 

Those warnings came only weeks after Computer North, which operates data centre services for miners, filed for bankruptcy in light of challenging market conditions and potentially owing up to US$500 million to creditors. 

 

Industry analysts and executives have questioned the sustainability of mining especially after prices of leading tokens have been rangebound since June and made worse by Ethereum, the world’s second most valuable blockchain, moved to a Proof-of-Stake method to secure transactions that would negate the need for miners.  

 

The high cost of energy has also caught many miners out and trimmed ambitions, with Argo, Core Scientific and Riot Blockchain scaling back their Texas operations in July, as demand for energy threatened to overwhelm the power grid.

 

In some cases, the biggest miners operating in Texas actually sold energy back to the grid as it became more profitable to do so rather than mine crypto.

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