Daily Analysis 5 May 2022 (10-Minute Read)

Hello there,

A terrific Thursday to you as stocks take a turn for the better on the prospect of more predictable monetary policy out of the U.S. Federal Reserve that has thus far avoided the most aggressive measures.

In brief (TL:DR)

  • U.S. stocks closed higher on Wednesday with the Dow Jones Industrial Average (+2.81%), S&P 500 (+2.99%) and the Nasdaq Composite (+3.19%) all up with the Fed sticking to its 0.50% rate hike and tabling out two more similar hikes.

  • Asian stocks climbed amid a bout of investor relief after the U.S. Federal Reserve raised interest rates as expected to tackle inflation while countering fears of super-sized hikes.

  • Benchmark U.S. 10-year Treasury yields fell four basis points to 2.93% Wednesday (yields fall when bond prices rise) as traders bet on a cap to yields with the Fed keeping policy on an even keel.

  • The dollar fell with the Fed raising rates by just 0.50%.

  • Oil edged up with June 2022 contracts for WTI Crude Oil (Nymex) (+0.14%) at US$107.96.

  • Gold rose with June 2022 contracts for Gold (Comex) (+1.74%) at US$1,901.30.

  • Bitcoin (+4.61%) rose to US$39,724 (at the time of writing) rebounding alongside other risk assets as risk appetite was whet at the prospect of a less aggressive Fed tightening.


In today's issue...

  1. Powell’s Path of Least Resistance for Interest Rates

  2. Beijing Pledges to Normalize Tech Regulation, Will Investors Bite?

  3. Bitcoin Blasts Back


Market Overview

Stocks climbed in Asia, bonds jumped and the dollar fell amid a bout of investor relief after the U.S. Federal Reserve raised interest rates as expected to tackle inflation while countering fears of super-sized hikes.

U.S. Federal Reserve Chairman Jerome Powell said a 75 basis points hike is “not something that the committee is actively considering,” spurring the market rally. The U.S. central bank raised rates a half point and signaled similar moves for the next couple of meetings.

The market reaction is likely to evolve as investors digest Powell’s commentary.

A global wave of monetary tightening alongside commodity-fueled price pressures could yet hurt economic growth.

Asian markets were mostly higher Thursday with Seoul's Kospi Index (-0.11%) down, while Hong Kong's Hang Seng Index (+0.52%) and Sydney’s ASX 200 (+0.64%) were higher, and Japan is still closed for the holiday.



1. Powell's Path of Least Resistance for Interest Rates

  • As widely expected, the Fed raised interest rates by 0.50% on Wednesday for the first time since 2000.

  • Significantly, Powell pushed back against more hawkish members of the central bank’s Federal Open Market Committee which sets interest rates, some of whom were asking for a hike of as high as 0.75%.

The equivalent of financial alchemy, the U.S. Federal Reserve is attempting to forge a path that combats inflation without necessarily tipping the U.S. economy into recession, but is the central bank’s porridge too hot, too cold, or just right?

Policymakers have had a poor track record when it’s come to attempting a “Goldilocks” approach to monetary policy, yet the current Fed is coming close to pulling it off as the central bank deploys its most powerful tightening measures in decades.

As widely expected, the Fed raised interest rates by 0.50% on Wednesday for the first time since 2000, in the aftermath of the dotcom bubble and U.S. Federal Reserve Chairman Jerome Powell has said similar moves have been tabled for June and July.

Equities and other risk assets rallying strongly in response and Bitcoin briefly touching US$40,000 before retracing to around US$39,600.

Significantly, Powell pushed back against more hawkish members of the central bank’s Federal Open Market Committee which sets interest rates, some of whom were asking for a hike of as high as 0.75%.

Facing the hottest inflation since the early 1980s, Powell and his colleagues are attempting a soft landing through a combination of higher borrowing costs and a shrinking balance sheet but concede that it might not be possible without hurting growth.

In the 1980s, then-Chairman Paul Volcker raised interest rates to as high as 20%, bringing down inflation, but the economy as well.

The Fed is wagering that inflation is driven primarily by supply-side issues, as Russia’s invasion of Ukraine and China’s zero-Covid lockdowns are continuing to roil global supply chains and its policy approach seems to reflect that view.

To be sure, increasing borrowing costs won’t make a Ukrainian field grow more wheat or facilitate more Russian oil entering the global market and to a large extent, policymakers recognize the limitation of monetary policy in the face of supply-side shocks.

Which is why investors ought to keep a closer eye on the U.S. labor market to plot the Fed’s path.

Powell himself acknowledged at a press conference following yesterday’s policy meeting when he emphasized that the central bank doesn’t have the tools to fight supply-side demand and was instead trying to use its tools to rebalance a labor market that had grown too hot.

Labor participation has been falling and that can put pressure on businesses to up wages to attract more workers especially as real wages, which cater for inflation, have decreased for 12 straight months.

In the interim, risk assets will get a brief reprieve if the Fed sticks to its additional two 50-basis-point rate hikes in June and July, as that will be within market expectations.



2. Beijing Pledges to Normalize Tech Regulation, Will Investors Bite?

  • In the face of a rapidly slowing economy, the Chinese central bank has pledged that it will implement “normalized” supervision on the financial activities of online platform companies.

  • The problem of course with all things China is what does “normalized” mean?

Since the IPO of Chinese e-commerce juggernaut Alibaba Group Holdings (+1.86%) in 2014, global investors could not get enough of Chinese tech companies.

Given their government-secured monopolies on everything from search to e-commerce and social media, super apps like Tencent’s WeChat and payment service providers like Alipay all but guaranteed investors a steady stream of reliable profits.

But since September 2020, when the vocal co-founder of Alibaba criticized Chinese banking regulators and officials, Beijing’s crackdown on China’s tech giants has been long and relentless and global investors have not stuck around to see the endgame.

From the lucrative afterschool education market to food delivery apps, China’s tech companies have been simultaneously hammered by authorities, as well as pre-emptive moves to cut fees to avoid further regulatory backlash.

Chinese companies listed on U.S. exchanges look dicey as Washington has insisted on greater transparency in both ownership and accounting on threat of de-listing and whole tech sectors inside China are worried about making too much money for fear of reprisals.

Nevertheless, and in the face of a rapidly slowing economy, the Chinese central bank has pledged that it will implement “normalized” supervision on the financial activities of online platform companies.

The problem of course with all things China is what does “normalized” mean?

On April 29, the People’s Bank of China met to discuss policies to implement financial support for the economy as well as boost the healthy development of tech platform companies and yesterday in a statement said that it would implement “normalized” supervision.

The PBoC’s comments mirror earlier statements by the Chinese Communist Party’s Politburo, the top decision-making body which also met on April 29, suggesting that authorities may ease up on a regulatory crackdown on China’s important tech sector.

While the statements sparked a rally in Chinese tech stocks, that rally was short-lived, and while yesterday’s statement also saw a rise in Chinese tech stocks again, it’s likely that this one won’t be durable as well.

The main problem of course is that Beijing’s interference in its tech companies has become so acute, global investors have been thoroughly spooked and it will take a lot more than rhetoric to entice them back into Chinese assets, it will take time.

Of all the commodities the global market is short on right now, trust remains at the top and with the dollar and U.S. yields rising, American assets are looking far more attractive than doubling down on dicey bets in an emerging market whose economy is increasingly looking like a basket case.

It wouldn’t be the first nor is it likely to be the last time that an emerging market full of potential flakes out and leaves investors nursing deep losses.

In fact, history is replete with examples of countries that held nothing but promise but delivered nothing but pain for foreign investors, including (in no order of “dis-merit”) Argentina, Zimbabwe, South Africa, Russia and Myanmar.

Why should China be treated any different?

For investors wondering if valuations look attractive enough to wade back into Chinese waters, consider that in the first three months of this year alone, some US$6 billion worth of foreign investment was hoovered out of Chinese assets.

Consider also that Chinese President Xi Jinping allegedly sits on no less than 76 different committees and sub-committees and it’s hard to see how the necessary independence to deal with policy issues on the ground can be had.

In 2015, global investors got burned when Beijing stoked the fires of a stock market bubble, egging retail investors on as they took out massive amounts of leverage to bet on Chinese equities.

After the 2015-2016 Chinese stock market crash, many global investors fled the Chinese scene, but time is a healer, and many forgot and went back in again.

As they say, “fool me once, shame on you, fool me twice, shame on me.”



3. Bitcoin Blasts Back

  • Bitcoin was already edging higher on expectations that the Fed would gradually water down the punch bowl.

  • Even then, Bitcoin has struggled to break out of its tight range over the past several months, nor has it pushed against key technical levels of resistance as it becomes a victim of its own success.

Guess who’s back,

Back again,

Bitcoin’s back,

Tell a friend

Guess who's back, guess who’s back Guess who's back, guess who's back

– Sung to the tune of “Without Me” by Eminem © 2002 off the album “The Eminem Show”

Bitcoin was already edging higher on expectations that the Fed would gradually water down the punch bowl, as opposed to flip over the entire table that it was sitting atop of and as soon as it became clear rate hikes would be within reason, Bitcoin was off to the races.

Staging its biggest rally in almost two months, Bitcoin rose as much as 6% to briefly touch US$40,000 before retracing.

The rebound in Bitcoin has been largely attributed to comments by U.S. Federal Reserve Chairman Jerome Powell who said that the central bank wasn’t looking to raise rates at 75-basis-points a pop at subsequent meetings.

A far more tempered approach to rate hikes assuaged the worst fears that interest rates would be raised aggressively to combat rising inflation and whet appetite for risk, with both equities and cryptocurrencies rallying in response.

Investors took comfort in Powell declaring at a press conference yesterday that a 75-basis-point increase was “not something that the committee is actively considering.”

To be sure, there isn’t as much leverage in the cryptocurrency markets today than there was last year.

Rate hikes don’t directly affect cryptocurrencies, but do affect appetite for speculative assets on the assumption that increased borrowing costs and yields will make investors less willing to speculate to generate returns.

Even then, Bitcoin has struggled to break out of its tight range over the past several months, nor has it pushed against key technical levels of resistance as it becomes a victim of its own success.

Growing institutional interest in Bitcoin, more participation has actually acted as a damper on Bitcoin’s price, reducing its volatility and swings that it was more prone to when it remained a far more niche asset class.

Today, the list of mainstream institutions either participating directly by trading cryptocurrencies or facilitating their take up is growing and that could tamp down Bitcoin’s most excessive price swings.

The world’s largest asset manager BlackRock (+5.41%) has backed stablecoin issuer Circle, while Fidelity recently revealed it would be making Bitcoin available to 401(k) accounts.

As more investors pile into Bitcoin, trading in the cryptocurrency matures and as a result, so does volatility.

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