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Daily Analysis 8 February 2022 (10-Minute Read)

Hello there, A terrific Tuesday to you as stocks turn mixed with investors waiting on the sidelines ahead of key U.S. inflation data out later this week and a Treasury auction that could turn dicey in a jiffy. In brief (TL:DR)

  • U.S. stocks opened Monday a mixed bag with the Dow Jones Industrial Average (+0.00%), flat, while the S&P 500 (-0.37%) and the Nasdaq Composite (-0.58%) were both lower as tech shares started to decline on the prospect of higher inflation data reported this week inciting further policy tightening.

  • Asian shares were mixed as well on Tuesday's morning trading session as traders calibrated risks from a global wave of monetary policy tightening.

  • Benchmark U.S. 10-year Treasury yields soared to 1.937% (yields rise when bond prices fall), as yield curves are now reaching key technical inflection points that could see a broad selloff in U.S. Treasuries.

  • The dollar was stable as investors await Thursday's U.S. inflation data that is expected to show persistently elevated price pressures.

  • Oil was unchanged with March 2022 contracts for WTI Crude Oil (Nymex) (-0.01%) at US$91.31.

  • Gold continued to rise with April 2022 contracts for Gold (Comex) (+0.04%) at US$1,822.60.

  • Bitcoin (+3.13%) continued to remain firm at US$43,800 in Asian trading, even as the benchmark cryptocurrency soared above US$44,000 before pulling back slightly.

In today's issue...

  1. The Magic Number is 1.95%

  2. Chinese Companies Looking to List in the U.S. Again, Should You Bite?

  3. Bitcoin Bulls Take the Stairs

Market Overview

U.S. Consumer Price Index data is expected out this Thursday and most investors are pricing a continued increase in prices across the board.

But just as the jobs number may have surprised for January, it's entirely possible that the inflation picture may not be as dour as some strategists have painted, but the odds of a surprise in that department aren't high.

Across the rich world, central banks are having to contend with inflationary spikes, unsettled electorates and bond yields that are requiring intervention.

Yields on U.S. Treasuries are soaring, as are bonds from Australia, New Zealand and Japan, with the Bank of Japan's tolerance levels being tested and setting the stage for the central bank to intervene to reign in runaway bond yields.

Meanwhile Asian markets turned Tuesday a mixed bag with Tokyo's Nikkei 225 (+0.43%), Sydney’s ASX 200 (+1.16%) and Seoul's Kospi Index (+0.91%) all higher in the morning session while Hong Kong's Hang Seng Index (-1.41%) continued to struggle against a backdrop of economic challenges in China.

1. The Magic Number is 1.95%

  • Convexity hedging means that as U.S. Treasuries near 1.95% yield, a sharp selloff that could roil markets may ensue

  • Large institutional investors who hold on to large amounts of U.S. Treasuries and mortgage-backed securities may need to sell U.S. sovereign debt to balance their portfolios and the selloff could be sharp

As benchmark 10-year U.S. Treasury yields inch ever closer to 1.95% for the first time since 2019, a level which could change the current complexion of the selloff in U.S. sovereign debt. With the hawkish pivot by the U.S. Federal Reserve and central bank runoff on the cards (where the Fed starts to allow Treasuries on its balance sheet to expire without renewing those purchases), investors are starting to cut their positions on Treasuries. Already, the U.S. 10-year Treasury yield is at 1.938% and once it gets closer to 1.95%, some strategists are suggesting that that may induce mortgage-bond investors to protect their portfolios against the effects of rising yields by selling Treasuries or doing the equivalent in interest-rate swaps, a move known as convexity hedging. Negative-convexity hedging involves selling Treasuries to compensate for a scenario where rising yields lengthen the duration of mortgage debt as re-financings slow. Because the change in the price and interest rate (or yield) of a bond isn’t linear, if you chart it with prices on one axis and interest rates on the other, you end up with a line showing the curvature in the relationship – convexity. The greater the convexity, the quicker the rate of change of prices of bonds in relation to interest rates, which is where the 1.95% mark is so significant – it’s a technical level of peak convexity, where a small rate of change in yields can lead to a much bigger change in bond prices. Most fixed-income bonds have a positive convexity – prices move in the opposite direction to interest rates, but mortgage-backed securities have negative convexity, their prices tend not to fall as quickly, because borrowers are likely to extend the duration of their mortgages when rates rise. Because mortgage bonds are often held by large investors like pension funds which tend to prefer stable returns and constant duration to reduce risk in their portfolios, when interest rates rise and mortgage bond durations start to lengthen, these investors will scramble to balance their portfolios by selling Treasuries, which will send yields soaring in the market. Alternatively, interest rate swaps allow these investors to swam one stream of interest payments for another, which can also lead to an accelerating run on U.S. Treasuries. Which is why the 1.95% level is so significant and this week’s Treasury auctions could roil markets in everything from equities to cryptocurrencies.

2. Chinese Companies Looking to List in the U.S. Again, Should You Bite?

  • Smaller Chinese IPOs in very traditional brick-and-mortar type businesses are looking to list again in the U.S. under the watchful eye of regulators on both sides of the world

  • Chinese listings are unlikely to do well in the immediate term because of investor wariness over Beijing's often rapid and apparently arbitrary policy moves

Like the squirrel coming out of its burrow at the first spring thaw, Chinese companies are gingerly wading back into the U.S. capital markets to find their fortunes, wary at all times that they could be an easy lunch for a fox. Nevertheless, as the dust settles from the disastrous IPO of Chinese ride-hailing giant Didi Global, a handful Chinese firms seeking out the depth and liquidity of U.S. capital markets will be the first to go public in the U.S. since last July. Six Chinese and Hong Kong-based groups filed new or updated documents with the U.S. Securities and Exchange Commission for an IPO on Nasdaq in January. What helps is that these Chinese companies, like the squirrel, are small, but investors will nonetheless be watching them closely for signs that there is still a future for the once thriving market for Chinese listings in the U.S. Not being mega IPOs might actually work in these Chinese firms’ favor, because they are less likely to raise Beijing’s ire at a time when the Chinese Communist Party is pursuing “common prosperity.” Running the gauntlet of regulators (on both sides of the Pacific) may only be part of the challenge for these Chinese firms seeking out the incomparably deep pools of investor capital in the U.S. because their success is not guaranteed should they make it out the gates. Investor sentiment towards Chinese IPOs has soured dramatically since the ruinous and forced delistings of high-profile Chinese names. Continued regulatory uncertainty by Beijing’s various moves in sectors as disparate as real estate to afterschool education also has global investors questioning whether now is the opportune time to take a bet on China, given continuing uncertainties. A Trump-era law that would force Chinese companies to delist if they refuse to give audit regulators access to their audited accounts still hangs over Chinese companies, meaning that even if these Chinese companies get listed, there’s no guarantee that they will stay listed. All of which provide an unfavorable backdrop for bets on fresh Chinese IPOs even if those companies are in old economy businesses that are unlikely to draw unnecessary attention from Beijing.

3. Bitcoin Bulls Take the Stairs

  • Bitcoin makes quiet gains for 5 consecutive days without much fanfare and even as other risk assets have been hit with elevated volatility

  • Bitcoin continues to surprise with its rise in the face of multiple sources of uncertainty, from central bank policy tightening to geopolitical risks in Ukraine

In sharp contrast to the typically rapid and large-scale moves in cryptocurrencies, Bitcoin’s latest ascent has been marked by something typically not associated with the nascent asset class – a slow move higher. Rising for a fifth consecutive day, Bitcoin is now on its longest (albeit it measured) winning streak since last September, just ahead of the cryptocurrency hitting an all-time-high as investors begin to fall in love again with risk assets (just not Meta stock). Bitcoin now trades around US$44,000 at the time of writing, leading other cryptocurrencies higher as well. While global markets have been whipsawed in recent weeks as investors swing from risk-on to risk-off against a backdrop of conflicting indicators, from central bank hawkishness to signs that the U.S. economy is on a tear, Bitcoin has generally trodden quietly upwards. And while some have termed Bitcoin’s precipitous fall from near US$69,000 last November to around US$44,000 now as a “Crypto Winter,” it’s probably too early to call. Unlike in 2018, when there were no institutional investors even considering cryptocurrencies, let alone adding them to their balance sheet, the roster of high-profile names bullish on Bitcoin has only continued to grow. This past week, audit giant KPMG revealed that its Canadian office had added Bitcoin and Ether to its corporate treasury as part of a commitment to emerging technologies and asset classes, becoming just the latest of a string of high-profile companies to back cryptocurrencies. Based on its current trajectory, Bitcoin could test the US$45,000 level of resistance, with Monday’s performance pushing the cryptocurrency above its 50-day moving average for the first time in over two months. But the strengthening correlation between Bitcoin and tech stocks, in particular the Nasdaq 100 index, means that what’s bad for those assets could potentially be bad for Bitcoin as well. Investors remain on tenterhooks with lingering uncertainty on multiple fronts, including the speed and aggressiveness of the U.S. Federal Reserve’s policy tightening, inflation and job data and the Russian standoff in Ukraine.

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