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Weekend Edition 11-12 June 2022 (10-Minute Read)

Hello there,

A wonderful weekend to you as U.S. stocks suffer their worst week since January on the back of hot inflation data that has investors concerned the U.S. Federal Reserve will raise rates aggressively to temper price pressure.

In brief (TL:DR)

  • U.S. stocks closed on Friday deeply in the red with the Dow Jones Industrial Average (-2.73%), S&P 500 (-2.91%) and the Nasdaq Composite (-3.52%) all sharply lower as CPI data saw inflation rise at the fastest pace in four decades.

  • Asian stocks closed lower on Friday as investors fretted over fresh lockdowns and testing in China.

  • Benchmark U.S. 10-year Treasury yields soared to 3.163% (yields rise when bond prices fall) as inflation data had traders betting on steep rate hikes by the U.S. Federal Reserve, putting upwards pressure on yields.

  • The dollar gained against all major currencies.

  • Oil slipped with July 2022 contracts for WTI Crude Oil (Nymex) (-0.69%) at US$120.67 as waning demand from China and recession fears put a damper on demand expectations.

  • Gold rose with August 2022 contracts for Gold (Comex) (+1.23%) at US$1,875.50 enjoying a brief moment as a potential hedge against inflationary pressures as traders shifted into the precious metal as well as cash.

  • Bitcoin (-3.02%) fell to US$28,476 at the midpoint of the weekend with signs that it could fall further before possibly recovering to where it started on Sunday, European time.

In today's issue...

  1. Have you heard? Inflation's the Word

  2. Beijing Doesn't Care about Investors, it cares about Communists

  3. Ethereum is Getting Hammered on Multiple Fronts

Market Overview

It will be hard to sell investors the story that inflation has peaked, not especially when May's U.S. CPI data defeated most economist expectations, coming in at 8.6% and forcing the U.S. Federal Reserve to act more decisively to rein in price pressures.

Investors no longer appear to be willing to take the gamble that the Fed can thread the U.S. economy through the needle, avoiding a recession, while bringing down inflation and odds are increasing that a hard landing, as opposed to a soft one, will inevitably ensue.

Asian markets were all down at the close on Friday with Tokyo's Nikkei 225 (-1.49%), Seoul's Kospi Index (-1.13%), Hong Kong's Hang Seng Index (-0.29%), and Sydney’s ASX 200 (-1.25%) in the red.

1. Have you heard? Inflation's the Word

  • U.S. Consumer Price Index shows prices surged by 8.6% yearly, up 1% from April and the fastest pace in four decades.

  • Pressure is on for the U.S. Federal Reserve to act more aggressively to rein in inflation, which could see rate hikes of as high as 75-basis-points this month.

By now investors would have heard that the U.S. Consumer Price Index rose 8.6% in May annually, a 1% advance from April, with basic necessities forming the bulk of price increases, including shelter (rent), food and gas.

Defying economist expectations that inflation had moderated forecasts of an 8.3% rise in prices, the far higher inflation print caught the market off guard sending both bonds and stocks plummeting.

Investors are now speculating whether the U.S. Federal Reserve will be forced to hike rates by 75-basis-points in June, as opposed to the earlier communicated 50-basis-point rise.

While many had been hoping for inflation to have slowed, especially given signs of rising inventories at some of America’s biggest retailers, the biggest contributors had more to do with geopolitics than anything else.

Russia remains at war with Ukraine, holding back supply of grains, fertilizers and energy from global markets and contributing to stubbornly persistent price pressures.

More economists are predicting a recession as being likely next year, especially as the cost-of-living weighs heavily on Americans and pressures the Fed to act decisively to cool the economy.

By way of comparison, the last time inflation was this high, the Federal Funds Rate was at 6%, as opposed to where it is now, between 0.75% to 1%.

In other words, the Fed has a long way to go, not to mention the fact that the central bank had to hike rates to 20% as inflation hit double digits.

Compounding the problem for policymakers is that while pandemic demand could be used to explain some of the price pressure, most of this has to do with what’s happening globally – years of

underinvestment in resource extraction and production, climate change and geopolitics are all conspiring to create a perfect storm of rising prices.

To be sure, a single inflation print won’t dictate policy, and it’s entirely possible that the Fed maintains its 50-basis-point hike next week, which will bring welcome respite to markets, but they could tighten later on in the year, if inflation remains stubbornly persistent.

2. Beijing Doesn't Care about Investors, it cares about Communists

  • Investors should be wary about Beijing's sudden about face when it's come to loosening its grip on the recent crackdown of the economy.

  • Once Chinese President Xi Jinping is installed for an unprecedented third term, many of the recent measures could roll back and Xi may pursue his "common prosperity" push with even greater fervor.

Early on in China’s economic reform, then-Chinese leader Deng Xiaoping famously noted with regards to whether China was to become a capitalist society or not,

“It doesn’t matter if the cat is black or white, as long as it catches mice.”

Which is why investors watching Beijing rollback some of its harshest crackdowns on its economy may be celebrating prematurely – the measures have more to do with cutting unemployment than it does with letting stocks rebound.

Ahead of a significant leadership conclave which looks set to install Chinese President Xi Jinping for an unprecedented third term and potentially leader for life, any hint of dissent and unhappiness must be stubbed out, which includes unemployment.

The big tech companies that suffered a pummeling from regulators has since seen authorities accelerate the approval of new vide game titles while ride-hailing giant Didi Global’s time in the penalty box may finally be over and it could soon welcome new users.

And these shifts have prompted investors to ask whether China’s stock market has bottomed.

Over the past year, Chinese tech companies, the darlings of global investors looking for higher returns from the world’s second largest economy, have lost as much as US$2 trillion in market value, or around 11% of Chinese GDP, according to Goldman Sachs estimates.

Beijing’s sudden change of heart to kick start its economy has more to do with politics than it has to do with economics, with the ability to create jobs a key component of Xi’s desire to promote “stability” especially at a time when frustration is increasing over zero-Covid lockdowns.

Reflecting that concern, Chinese search giant Baidu has seen “layoff” the most trended search term lats month.

In April, unemployment in China’s major cities hit 6.7%, the highest ever on record, while job expectations tanked.

And that may be why Beijing is suddenly loosening its grip on China’s gig economy, which is powered by platforms that do everything from deliver food and people, to picking up dry cleaning and walking dogs.

Making matters worse for Beijing, a record 10.8 million college graduates will hit the job market this summer and as of April, less than half had job offers, according to online recruitment platform Zhaopin.

In the past, tech and media companies were a huge employer of fresh college graduates, with afterschool education accounting for an estimated 17% of recent graduands.

But since Beijing banned for-profit afterschool education programs, that source of employment has all but disappeared, especially since those business models were banned practically overnight.

Workers in the hospitality, retail, transportation and hotel sector are all getting laid off as well because of rolling zero-Covid lockdowns that make it virtually impossible for business owners to plan their staff needs when a closure could be around the corner.

If nothing else, once Xi is installed safely for his third term as President and ascends the throne, many of these interim measures to goose the Chinese economy and roll back some of the measures taken, could be rolled back just as quickly, leaving investors stuck holding the bag.

3. Ethereum is Getting Hammered on Multiple Fronts

  • Ethereum developers delay setting off the "difficulty bomb" that would set the path for the Merge upgrade, raising fears that the software upgrade to a Proof-of-Stake could be delayed further.

  • Ether may face other pressure from potential implosion of Celsius Network as synthetic Ether may be de-pegging as the platform is functionally insolvent.

For the better part of this year, Ethereum investors managed to avoid some of the savage falls in the price of Ether primarily because of optimism over the much-anticipated upgrade of Ethereum’s software to proof-of-stake.

Ethereum’s shift to proof-of-stake has been years in the making, and many had been betting that a move to the more energy efficient system of securing the blockchain would be a huge boost for Ether’s price.

But that upgrade is now facing challenges from a so-called “difficulty bomb” that’s deisnged to slowly kick legacy Ethereum miners off the blockchain.

The difficulty bomb is a special code that’s always been a part of Ethereum, which swiftly increases the computing difficulty of mining Ether and eventually makes it impossible to do so.

When the difficulty bomb goes off and is allowed to run its course, it’s an indication that the Merge will be days in the making.

But core Ethereum developers have decided to delay the setting off of the difficulty bomb after they discussed ironing out various bugs they discovered when they ran tests of the Merge upgrade on one of Ethereum’s testnets known as Ropsten.

Although Ethereum co-founder Vitalik Buterin said that the Merge could happen as soon as August, the decision to delay the difficulty bomb is raising fears that the upgrade of Ethereum could take more time.

The Merge, widely seen as a bullish factor for Ether, could be pushed back to September or October, putting downwards pressure on Ether in an already depressed market.

Complicating matters for Ether investors, troubling news about the Celsius Network’s use of synthetic Ether tokens or stETH is being depegged, trading at 95 cents to the dollar.

Liquidity is drying up on the Celsius Network and the smart money appears to be pulling capital, coupled with the platform’s functional insolvency, could precipitate a massive dump of Ether in the coming days.

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